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LAW AND THE FAMILY
"'MCSPARRON' REVISITED, REAFFIRMED AND
REFINED"
Joel R. Brandes
New York Law Journal
August 22, 2000
In the 15 years since the formidable O'Brien [FN1] case was
decided by the Court of Appeals, little else has dominated the thoughts and
debates of judges, lawyers, scholars and the like when it comes to the
distribution of professional licenses.
The Court of Appeals, in mandating in O'Brien that the
Equitable Distribution Law be given a liberal interpretation, held that a
professional degree or license was "marital property," subject to
equitable distribution.
It affirmed the trial court's holding that Dr. O'Brien's
medical degree and license, earned during the course of the marriage, had a
present value of $472,000 and awarded the wife 20 percent of that amount. That
figure was computed by comparing the average income of a college graduate to
that of a general surgeon (Dr. O'Brien's then-residency training) from 1985,
when Dr. O'Brien anticipated the completion of his residency, until his 65th
birthday. After considering federal income taxes, an inflation rate of 10
percent and a real interest rate of 3 percent, the court capitalized the
difference in average earnings and reduced the amount to present value.
In McSparron v. McSparron, [FN2] decided 10 years later the
Court of Appeals held that, even after a professional degree or license has
been used by the licensee to establish and maintain a career, it does not
"merge" with the career or ever lose its character as a separate,
distributable asset.
'Merger' Concept Eliminated
It reaffirmed the holding of O'Brien, under which the value of
a newly earned license may be measured by simply comparing the average
lifetime income of a college graduate and the average lifetime earnings of a
person holding such a license, and reducing the difference to its present
value. McSparron held that where the licensee has already embarked on his or
her career and has acquired a history of actual earnings, O'Brien's
theoretical valuation method must be discarded in favor of a more pragmatic
and individualized analysis, based on the particular licensee's remaining
professional earnings potential.
In eliminating the concept of "merger," the court
recognized the ongoing independent vitality that a professional license may
have and focused solely on the problem of valuing that asset in a way that
avoids duplicative awards. It cautioned that care must be taken to ensure that
the monetary value assigned to the license does not overlap with the value
assigned to other marital assets derived from the license, such as the
licensed spouse's professional practice. It emphasized that "courts must
be meticulous in guarding against duplication in the form of maintenance
awards that are premised on earnings derived from professional licenses.''
Rather than limit the maintenance award, the Fourth Department
in Wadsworth v. Wadsworth [FN3] "McSparronized" the property
distribution by holding that, to avoid a double count, the income used in
determining the present value of the law practice must be deducted from the
calculation of future enhanced earning capacity, and that where there is a
maintenance award, "the court [is] obliged to reduce the value of the
enhanced earnings by the amount awarded in maintenance. Not to do so would
involve a double counting of the same income.''
Recently the Court of Appeals revisited, reaffirmed and
refined its McSparron holding in Grunfeld v. Grunfeld. [FN4] In Grunfeld the
Supreme Court [FN5] ordered the defendant to pay maintenance of $15,000 per
month until the sale of the marital home one year after the younger child was
to enter college, in 2000. Thereafter, maintenance was to be reduced to $8,500
per month. The court valued defendant's practice as of the date of
commencement of the matrimonial action, using the "excess earnings"
method. The court first determined the amount that defendant actually earned
in excess of "reasonable compensation," which is the amount paid to
an attorney of similar age and background, in the same geographic area,
without any ownership interest in a law practice. After subtracting taxes and
the income theoretically derived from defendant's share of the firm's tangible
assets ("return on equity"), by agreement of the parties, the
resulting amount was capitalized using a multiple of three. Then, defendant's
interest in the firm's tangible assets was added to the capitalized earnings
to arrive at defendant's interest in his practice, which the Supreme Court
found to be more than $2.58 million.
The Supreme Court also determined the value of defendant's
license to practice law for equitable distribution purposes. It first computed
the value of the "bare license," that is, the present value of the
difference between the average earnings of a first-year associate at a law
firm and a person holding an undergraduate degree, for the remainder of
defendant's work-lifetime, with an adjustment to take into consideration the
possibility of defendant's death before reaching age 65, his anticipated
retirement age. Because the parties did not marry until defendant was halfway
through law school, only one half of the bare license was a marital asset.
Thus, its value was multiplied by a 50 percent "coverture fraction."
Next, the court added the "enhanced earnings
potential" created by the license. To avoid double counting, [FN6]since
defendant's income in excess of "reasonable compensation" had
already been considered in determining the value of defendant's interest in
the practice, the court excluded that portion of defendant's future earnings
from consideration. The enhanced earnings attributable to the license alone
were the difference between reasonable compensation and the earnings of a
first-year associate. The court calculated the present value of these earnings
from the commencement date until the date of defendant's expected retirement,
taking actuarial factors into account. The result was then reduced by 7
percent, "to reflect the premarital, separate property component of that
figure." The sum of the license's bare value and enhanced earnings
potential was found to be more than $1.54 million.
Calculating Future Income
Thus, the Supreme Court determined the value of both
defendant's law practice and license by calculating the current worth of
different components of defendant's projected future income of $1.2 million
per year. To the extent that these "assets" were acquired during the
marriage, they were correctly considered to be available for equitable
distribution.
The Supreme Court stated that it had considered all of
defendant's future income in setting the maintenance award. It noted that the
methodology of determining the value of defendant's license was based on the
earnings differential between reasonable compensation and the income of a
nonlicensed college graduate. It then explained that it would violate the
McSparron rule against double counting to actually award one half the value of
the license, since the earnings differential upon which it was based had
already been considered in fixing the award of maintenance. To avoid giving
plaintiff two separate awards derived from the same stream of future income,
the court excluded the license from the marital assets in determining the
distributive award.
The Appellate Division modified, [FN7] directing that the
one-half of the value of defendant's professional license - $773,500 - should
also have been distributed to plaintiff. The court held that the reduction of
maintenance from $15,000 to $8,500 per month should begin following full
payment of the distributive award. The Appellate Division also ordered
defendant to pay plaintiff interest on the unpaid balance of the distributive
award at the statutory rate.
The Court of Appeals
The Court of Appeals modified [FN8] the order of the Appellate
Division because it double counted defendant's income in ordering that
plaintiff should receive both undiminished maintenance and the full
distributive award of one- half the value of plaintiff's law license.
The Court of Appeals noted that, in contrast to passive
income-producing marital property having a market value, the value of a
professional license as an asset of the marital partnership is a form of human
capital, which is dependent upon the future labor of the licensee. The asset
is totally indistinguishable and has no existence separate from the projected
professional earnings from which it is derived. To the extent that those same
projected earnings used to value the license also form the basis of an award
of maintenance, the licensed spouse is being charged twice with distribution
of the same marital asset value, or with sharing the same income with the non-
licensed spouse.
In Grunfeld, when setting the level of maintenance, Supreme
Court included as part of defendant's earning capacity the projected earnings
derived from his professional license. The court also used the same earnings
attributable to the law license to determine the present value of the license
as a marital asset. The Court of Appeals held that, to comply with McSparron,
Supreme Court had to reduce either the income available to make maintenance
payments or the marital assets available for distribution, or some combination
of the two.
Double-Counting
Once a court converts a specific stream of income into an
asset, that income may no longer be calculated into the maintenance formula
and payout. It stated that where license income is considered in setting
maintenance, a court can avoid double-counting by reducing the distributive
award based on that same income.
"The necessity of this reduction was recognized in
Wadsworth v. Wadsworth (219 AD2d 410). Not to do so would involve a double
counting of the same income." The court noted that "one advantage of
this method is that the maintenance award may be adjusted in the future if the
licensed spouse's actual earnings turn out to be less than expected at the
time of the divorce." It added: "This method is also consistent with
our observation that in particular cases the value of the license 'may be
nominal'." It also noted that "there may be cases where it is more
equitable to avoid double counting by reducing the maintenance award (***).
Where the license is likely to retain its value in the future but the
nonlicensed spouse may only be entitled to receive maintenance for a short
period of time, it may be fairer actually to distribute the value of the
license as marital property rather than to take the license income into
consideration in determining the licensed spouse's capacity to pay
maintenance.''
The Court of Appeals found that the Appellate Division based
its ruling, in part, on the fact that "defendant's future earnings"
- which only could be expected to come from his own professional endeavors -
were likely "to exceed $1 million yearly." Additionally, that court
apparently recognized that income from other resources could only be expected
to support "a portion of the maintenance." It held that on the face
of the Appellate Division's decision, by ordering full distribution of
plaintiff's share of defendant's license without any adjustment of
maintenance, the court engaged in double counting of income, which was
inconsistent with McSparron. Therefore, it remitted the matter to the Supreme
Court to recalculate the required reduction in the license distributive award,
in accordance with McSparron and its opinion.
The Court of Appeals also pointed out that Courts have the
discretion to value "active" assets, such as a professional
practice, on the commencement date, while "passive" assets such as
securities, which could change in value suddenly based on market fluctuations,
may be valued at the date of trial. It noted that "Such formulations,
however, may prove too rigid to be useful in particular cases. Thus, they
should be regarded only as helpful guideposts and not as immutable rules of
law." Here, the Trial Court correctly used the active/passive distinction
as a "helpful guidepost.''
FN(1) 66 NY2d 576, 498 NYS2d 743 (1985)
FN(2) 87 NY2d 275, 639 NYS2d 265 (1995)
FN(3) 219 AD2d 410, 641 NYS2d 779 (4th Dept, 1996)
FN(4) 255 AD2d 12, - NYS2d -, New York Law Journal, 6-12-2000,
p. 27, col 1 (2000)
FN(5) Grunfeld v. Grunfield, 170 Misc 2d 808 (Sup. Ct., 1998)
FN(6) Justice Saxe of the Appellate Division explained (255
AD2d 12) that the term "double counting" is frequently used to refer
to the use of the same stream of income to calculate the value of more than
one asset, and that "double dipping" is sometimes used to refer to
the court-ordered payment of more than one financial obligation from the same
source. The potential for "double counting" arises because in
determining the value of a spouse's interest in a law practice, the court
takes into account not only the practice's tangible assets and liabilities,
such as accounts receivable and inventory, but also the intangible value of
the practice, known as its "goodwill.''
FN(7) Grunfeld v. Grunfield, 255 AD2d 12, - NYS2d - (1st Sept.
1999)
FN(8) See N.4, Supra
Joel R. Brandes has law offices in Garden City and New
York City. He co- authored the nine-volume Law and the Family New York and Law
and the Family New York Forms (both, published by West Group). Bari R.
Brandes, a member of the firm, co-authors the Annual Supplements to Law
and the Family New York 2d and assisted in the preparation of this article.
8/22/2000 NYLJ 3, (col. 1)
