PERSONAL GOODWILL & MARTIN ICE CREAM CO. V. COMMISSIONER

The concept of goodwill and the use of goodwill as an intangible asset in mergers, acquisitions, and asset sales has existed for decades, and its use by businesses has generated a non-insignificant amount of legal scholarship and corporate doctrine. However, prior to 1998, the only form of goodwill recognized by courts was the already well-known corporate goodwill. On March 17, 1998, that changed when the Tax Court delivered its opinion on Martin Ice Cream Co. v. Commissioner, a case dealing with a the valuation of assets and a claim by the IRS that the petitioner, Martin Ice Cream Company, had underreported the amount of taxes owed following an asset sale of the company’s assets to Haagen-Dazs Co., Inc.

Martin Ice Cream Company was a father-son business operated out of Bloomfield, New Jersey, that distributed ice cream to the many supermarkets and grocery stores in the area. (See Martin Ice Cream Co. v. Commissioner, 110 T.C. 189, 191-92 (1998)). The father, Arnold Strassberg, had begun a small side-business of selling wholesale ice cream products to grocers in the Newark area after the end of World War II, and by the 1960’s Arnold had developed personal and professional relationships with many of the large supermarket chains that catered to the area. In 1971, Arnold and his son Martin entered into a venture together following a falling-out between Arnold and his main supplier which they named Martin Ice Cream (MIC), and in 1974 the founder of the newly-formed Haagen-Dazs sought out MIC in a bid to use Arnold’s extensive experience in the distribution industry to turn Haagen-Dazs into a well-known brand. In 1988, following several offers by Haagen-Dazs to purchase MIC and disagreements between Arnold and Martin regarding the direction of the company, MIC agreed to spin-off the assets of MIC, including its supermarket distribution rights, in a sale to Haagen-Dazs; in addition to the assets of MIC, Haagen-Dazs also purchased exclusive rights to the expertise, consulting skills, and industry knowledge of Arnold so as to prevent Arnold from competing against them and to express gratification for Arnold’s role in making Haagen-Dazs a national brand. The final bill of sale contained an itemized list of all assets purchased from MIC, the price for each asset, and included a clause including in the sale ". . . and other business records as requested by Buyer, and the goodwill associated therewith."

Following the conclusion of the sale, MIC was required to pay taxes on the gain from assets sold to Haagen-Dazs, and when calculating the amount owed to the IRS the company did not include the amount that was paid to Arnold for the goodwill exchanged during the transaction; the IRS disputed this calculation and levied tax and a penalty on MIC for the full value of the sale amount, which included the exchange of goodwill between Arnold and Haagen-Dazs. However, the tax court disagreed with the IRS determination of tax and found for the first time that the goodwill exchanged between Arnold and Haagen-Dazs had never been owned by MIC, and characterized the goodwill as “personal” rather than “corporate.” 

In ruling that the goodwill that had been exchanged between Arnold and Haagen-Dazs was personal rather than corporate, the court effectively created a new type of asset, but was now required to differentiate between corporate goodwill and personal goodwill. In order to differentiate between the two types of goodwill, the court highlighted a number of factors that set personal goodwill apart from corporate goodwill. First, personal goodwill is based on the relationships created by individuals through the course of their work in a field and generally consists of personal connections to other individuals, industry experience, and industry reputation. Personal goodwill can be created prior to, during, or after working in a particular field, and can also extend into other fields. Second, personal goodwill is differentiated from corporate goodwill in the way that it is transferred; while corporate goodwill can be transferred through a typical asset transfer, a holder of personal goodwill must sign some form of a covenant not to compete. These restrictive covenants can take the form of a traditional covenant not to compete or even employment agreements, but must clearly transfer the intangible assets of the individual to either their employer or any potential buyer. Absent any such agreement, the personal goodwill of an individual remains the property of the individual, and can be used or disposed of however that individual sees fit.
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In addition to creating a new form of goodwill, the decision in Martin Ice Cream generated a larger body of law centered around personal goodwill. Numerous cases have been decided in the years following that expanded on the tax court’s Martin ruling, such as Norwalk v. Commissioner (Norwalk v. Commissioner, 76 T.C.M. 208 (1998)) and Lopez v. Lopez. (In re: Marriage of Lopez, 113 Cal. Rptr. 58 (38 Cal. App. 3d 1044 (1974)). Personal goodwill has also developed as an interesting tax advantaged tool that corporations will use in asset sales and mergers to avoid the issue of double taxation resulting from the deal. Corporations and corporate leaders contemplating mergers or acquisitions should familiarize themselves with this useful and interesting asset due to the many benefits it provides, and the experienced attorneys and professionals at B.J. Kang Law, P.C. are available to assist and counsel you through all aspects of a transaction.