Law Firm’s Contingency Fees were Marital Property

A court found that unpaid contingency fees earned by a husband’s personal injury law practice were marital property, but it rejected the historical average income approach used to value the fees. This article looks at the important lessons of the case.

In a recent case, Stageberg v. Stageberg, a Minnesota appellate court found that unpaid contingency fees earned by a husband’s personal injury law practice were marital property. But the court rejected the historical average income approach used to value the fees.

Marital status
The husband argued that the contingency fees did not qualify as marital property, because 1) they were merely an expectation interest, not an enforceable contractual right; 2) they represented future income; and 3) they were too remote, speculative and uncertain.

The court disagreed, analogizing the husband’s work-in-progress to pensions and incentive stock options, which are enforceable contractual rights. The court observed that Minnesota and several other states grant attorneys a compensation lien on any money involved once a legal proceeding starts.

As to the future income argument, the court held that treating contingency fees as income was inconsistent with state authority on the characterization of contract rights. What’s more, such treatment would preclude the wife from receiving a portion of the fees as part of the property division.

The court conceded that the husband’s third argument found support in a minority of jurisdictions, but concluded that the fees’ contingent nature was more appropriately addressed in a valuation context.

Valuing judgments
The trial court valued the fees using the historical average income approach, treating all of the cases-in-progress as a single asset and assuming a 40% tax rate. The court calculated the husband’s average annual net profit over the previous five years and reduced it by 50% to reflect the average declining percentage of marital effort in cases concluded during the course of a year. It awarded the wife half of the remaining after-tax marital share.

The appellate court rejected this approach on three grounds:

  1. The trial court failed to provide any authority for its method,
  2. By using the annual income figure and applying the formula to only one year of the husband’s practice, the trial court assumed that all of his contingency fee cases-in-progress on the valuation date would be resolved within one year, which the appellate court found unsupported either by evidence or general experience, and
  3. The trial court’s approach overstated the wife’s interest in fees not yet received because it failed to reduce her interest to present value.

The appellate court reversed and remanded the case to the trial court for revaluation of the fees. It advised the trial court either to value the marital interest in a legally supportable manner or retain jurisdiction and divide the marital interest in the fees as they are received.

Guidance but no real answers
Although it clarifies the inclusion of contingency fees in marital property under Minnesota law, Stageberg leaves some thorny questions unanswered. By retaining jurisdiction over the fees and dividing the marital interest as they are paid, a court could stretch out the case for an uncertain length of time and potentially generate additional litigation.

On the other hand, valuing future contingency fees could prove tricky, as well, and would depend on difficult estimates of the value of pending cases. And how does a valuator determine the marital and nonmarital portions of future recoveries? Perhaps future decisions will provide guidance.