This is a story about a recent case involving a fight over the inclusion or exclusion of goodwill in valuing the interest of a retired partner in a medical practice organized as a limited liability partnership, and how it easily could have been avoided. But first, it helps to understand the legal framework for valuing such an interest and the type of goodwill at issue.

The limited liability partnership or LLP is a highly popular form of business association for professional practices including law firms and medical groups. As its name suggests, the LLP combines the attributes of a partnership with the limited liability traditionally associated with corporations, except that professionals in LLPs generally remain personally liable for their own misconduct or negligence.

In New York, the formation and registration of LLPs is governed by Article 8-B of the Partnership Law. In all other respects, as to both their internal and external affairs, the New York LLP is governed by the same provisions governing general partnerships codified in Sections 1 through 82 of the Partnership Law based on the ancient Uniform Partnership Act promulgated in 1914.

Under Partnership Law § 73, when a partner withdraws from the partnership or dies triggering dissolution, and the other partners continue the business, the withdrawn partner or estate of the deceased partner is entitled to be paid “the value of his interest at the date of dissolution ascertained.” As dramatically illustrated by the Congel case about which I wrote several weeks ago, a partner who wrongfully dissolves the partnership in contravention of partnership agreement likewise is entitled to receive the value of his or her interest when the other partners continue the business, but under Partnership Law § 69 such value excludes “the good-will of the business” and is further offset by any damages caused by the wrongful dissolution.

What is Goodwill?

The International Glossary of Business Valuation Terms defines goodwill as “that intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified.”

The goodwill associated with a company or company-owned brand (think Coca-Cola) is a valuable, saleable asset no less so than any tangible asset.  In professional practices, however, there can be two separate types of goodwill: personal and business a/k/a enterprise goodwill. In other words, there’s goodwill that attaches to a professional’s persona by reason of their personal skill, judgment and reputation which is non-transferable and non-saleable, and then there’s goodwill derived from characteristics specific to a particular business such as location, staff, reputation, logo, website, etc., regardless of who owns or operates it, which is transferable and saleable.

It’s not always easy to separate the two kinds of goodwill in professional practices, as any matrimonial lawyer who represents doctors and lawyers in divorce cases will tell you.

The Romanoff Case

A notable decision last month by Supreme Court Commercial Division Justice Richard M. Platkin in Romanoff v Center for Rheumatology, LLP, 2016 NY Slip Op 50856(U) [Sup Ct Albany County May 24, 2016], centered on the question whether a partner who retired from a medical practice organized as an LLP that had no written partnership agreement and was dissolvable at will, and the business of which thereafter was continued by the other partners, was entitled to have his partnership interest valued inclusive of the practice’s goodwill value that he claimed existed.

The plaintiff was a founding partner of an Albany-based rheumatology practice founded in the mid-1980s where he worked until his retirement in 2013 by which time the practice had expanded to two locations, enjoyed annual revenues over $18 million, and had about 70 professional and non-professional employees providing medical and non-medical services such as laboratory testing. Plaintiff brought suit for the valuation and payment of his partnership interest after the other partners allegedly refused to comply with his demands, after which they offered plaintiff about $77,000 excluding any goodwill value. (Although the decision doesn’t say, I assume that figure represents book value.)

Prior to the completion of discovery, both sides moved for partial summary judgment on the issue of goodwill value. In support of their motion to exclude goodwill, the defendants essentially argued that there was an implied agreement among the partners, evidenced by their course of dealings and accounting practices, not to recognize goodwill attributable to the practice.

First, they stressed that none of the practice’s five partners, three of whom joined some years after its founding, paid anything for the partnership’s goodwill upon joining, and that the payments made by two of them upon joining were in consideration of hard assets and receivables.

Second, they argued that goodwill was not recorded as an asset in the practice’s financial statements in any meaningful fashion. In support, they submitted the affidavit of the practice’s CPA who averred that when he was first engaged in 1993 there already was an entry in the partnership’s books for goodwill in the sum of $16,647 which never changed despite the growth in revenues, profits, and reputation over the years. As Justice Platkin described the affidavit,

According to Tully [the accountant], the true intangible value of the Center’s goodwill inevitably would change over time, but there never was any internal effort or discussion to assign an accurate value for goodwill. Tully further maintains that the portion of the partners’ buy-in allocated to accounts receivable without a multiplier is not an indicator of goodwill. Based on the foregoing, Tully opines that the entry labeled “goodwill” on the Center’s books and records “is what is known in accounting as a place holder figure in order to equalize capital accounts of the partners upon the original formation of the enterprise”.

In opposition the plaintiff argued that at least a portion of the practice’s success as measured by its growth in size, revenues, and profitability was attributable to the goodwill and reputation of the practice itself, separate and apart from the personal skill, judgment and reputation of its individual physicians. Plaintiff also submitted an affidavit of his own accountant opining that a proper appraisal and evaluation of the practice should include a component attributable to the professional goodwill of the enterprise.

Justice Platkin’s initial discussion of the applicable legal standard “in the context of professional firms” cited the leading case of Dawson v White & Case involving the valuation of a partnership interest in a law firm whose partnership agreement expressly deemed the firm’s goodwill to be of no value, in which the New York Court of Appeals wrote that “even if a given partnership might be said to possess goodwill, the courts will honor an agreement among partners — whether express or implied — that goodwill not be considered an asset of the [partnership].”

Justice Platkin also cited a 1926 Court of Appeals decision in Matter of Brown (242 NY 1) standing for the proposition that “[g]ood will, when it exists as incidental to the business of a partnership, is presumptively an asset to be accounted for” and therefore, under Partnership Law § 71, distributable as partnership property “subject to any agreement to the contrary.”

Ultimately Justice Platkin ruled that neither side was entitled to summary judgment at the pre-discovery stage. “[T]he present record,” he wrote, “compiled without the benefit of any discovery, falls short of compelling the conclusion that plaintiff and the other Partners agreed to exclude goodwill as a distributable asset as a matter of law.” As he further explained:

The facts here do not rise to the level of Dawson and Matter of Brown, where goodwill did not appear on the partnership’s books, and there was a history of withdrawing partners not being compensated for goodwill (Dawson, 88 NY2d at 672; Matter of Brown, 242 NY at 7). Indeed, while a course of dealing may give rise to an implied agreement to exclude goodwill as an asset of the partnership, goodwill “is presumptively an asset to be accounted for”, and “there must be caution before property interests of value are thus excluded by implication” (Matter of Brown, 242 NY at 7). “The life of the business must be scrutinized for every relevant circumstance affecting the intention of the partners. The inference is one of fact, to be drawn, if at all, when intention is thus appraised and probabilities are measured” (id.).

Justice Platkin also found questions of fact warranting discovery and precluding summary judgment as to the existence of distributable goodwill belonging to the practice:

Defendants have not supported their motion with proof in admissible form sufficient to demonstrate, prima facie, that the Center lacks distributable goodwill in its own right. While defendants’ moving papers make passing reference to changes in the name and location(s) of the Partnership over the years, they have not met their initial burden of affirmatively demonstrating, as a matter of law, that the Center lacks the ability to attract patients as a result of a result of its name, location(s) and reputation (see Dawson, 88 NY2d at 670). And, to the extent that plaintiff’s affidavit in support of the cross-motion demonstrates the existence of distributable goodwill, the reply affidavit of [defendant] Dr. Greenstein suffices to raise questions of fact. Accordingly, neither side is entitled to summary judgment on the issue.

Avoiding the Next Romanoff

Although I’ve seen worse, Romanoff could serve as a poster child for the ills that can befall any large, successful, multi-partner professional practice that has no written partnership agreement. Inevitably a partner will withdraw or die at some point, triggering dissolution by operation of law. No partner should sleep well at night knowing that, without an agreement, the creaky default rules of New York’s outdated Partnership Law will bring them dyspepsia, dissension, and costly legal disputes.

There’s no single way to address the issues in a professional partnership’s written agreement, although the ones I’ve come across generally exclude enterprise goodwill as a separately quantifiable, distributable or compensable element of value in the event of a partner’s separation. Perhaps that’s because the valuation of such goodwill, and its separation from the personal goodwill of the partners, is inherently elusive and therefore prone to differences of opinion leading to conflict. There’s also the related, problematic issue of requiring non-founding partners to pay for goodwill upon joining the practice.

In any event, there are other, more certain techniques for determining amounts due a withdrawing partner or the estate of a deceased partner. Partners who fail to deal with it in a written agreement, as in Romanoff, are setting off a ticking time bomb.