The Goodwill Payment Conundrum: A Never-ending Debate

[By Saloni Neema & Jeeri Sanjana Reddy]

The authors are students of Damodaram Sanjivayya National Law University Visakhapatnam.

 

Introduction

Partnerships have emerged as a distinguishing element of the business world as a long-term success element. An established business accrues goodwill by building relationships in the market based on customer trust and preference. Goodwill is therefore considered to be the reputation associated with a business or the “economic benefits a going concern may enjoy as compared to a new firm.” The goodwill of a partnership is ascribable to all partners since it is the result of their collaboration.

Dissolution of partnership is followed by the distribution of assets, and factoring in goodwill as an intangible asset is not uncommon. However, while the law is well-settled on the sale of goodwill after dissolution and the intricacies surrounding non-competes, a partner’s demand for payment for the goodwill of the firm after leaving the firm remains controversial. When a partner is fired, will the firm’s refusal to pay up lead to a breach of fiduciary duty by the remaining partners? These questions remain largely unaddressed in India, where the law on the existence and ownership of goodwill is not very uniform.

Goodwill Payment: Lessons From Across Jurisdictions

In the landmark judgment of Dawson v. White & Case LLP (‘Dawson’), Mr Dawson returned from a vacation in July 1988; he found that his partners had decided to dissolve the firm and start a new one without him. The partners of White & Case founded a new firm with the same name, address, and customer list after expelling him. He filed a lawsuit to see if the Court would rule in his favour about his claim to goodwill in the company and if so, the value of that goodwill.

Judge Ciparick settled the issues in this case as to whether goodwill is a “distributable asset” of a partnership and whether an underfunded pension plan would become a liability of the firm upon its dissolution. Regarding the first issue, the court determined that goodwill should be considered as the partnership’s asset, unless the agreement declares it to be of no value and the partners’ business conduct supports that assertion. The Court will honour an agreement among partners, whether express or implied, to determine the goodwill and assets of the firm. According to White and Case, unfunded pension plans, the future pension payments were property disallowed as partnership liability. This case stirs up many questions on the valuation of goodwill, classifying it as a distributable asset and the possibility of paying goodwill compensation to a fired partner.

Entitlement To Goodwill: Conflicting Views

Generally, the goodwill earned by an employee’s actions belongs to the employer, and the firm ensures the quality of services provided by every attorney. Lord Hacon in Bhayani v. Taylor Bramwell LLP[i] (‘Bhayani’) held that the individual creates goodwill in his professional capacity as a partner of the firm, not personally. Therefore, if a person worked for a partnership, the goodwill created by his actions would typically belong to the partnership. Similar reasoning was adopted in Starbucks (HK) Ltd v. British Sky Broadcasting Group Plc. (‘Starbucks’). If the quality falls short, the firm is liable for the compensation, not the individual attorney.

The Court further concluded in Mrs Sujan Suresh Sawant v. Dr Kamlakant Shantaram Desa (‘Sujan Suresh’). Even a partner’s legal representative will be eligible for a share of goodwill of a continuing partnership. It was further held that, “it is impractical to direct a sale of goodwill between partners when goodwill has been fully appropriated by the surviving partner with all the benefits resulting from the previous business dealings.” In these situations, it is more likely to distribute a proportionate share of goodwill to the heirs of the deceased partner after proper valuation. Another argument in favour of goodwill payment is that “partnership assets encompass anything to which the firm or all of its partners may be deemed entitled.” Referring to Section 52 of the Partnership Act, 1932 the Calcutta High Court, in Bhuban Mohan Das v. Surendra Mohan Das reasoned that in the event that a contract creating a partnership is rescinded, the party who rescinds has the right to the “surplus” of the firm’s assets which remain after its debts have been paid, and for any amount paid by him towards the partnership.

Contractual Stipulation of Goodwill in the Agreement

Another approach of determining whether or not a leaving partner is owed goodwill depends on whether or not the partnership agreement specifically mentions goodwill. The Supreme Court of Ohio in Spayd v. Turner, Granzow & Hollenkamp held that good will payments to a terminating partner are subject to contractual specifications and should be specified in the partnership agreement with the approval of all partners.

In contrast, the approach taken in Roger Siddall v. Cletus Keating et al. (‘Siddall’) holds that a partnership, whose repute depends on the individual skills of the members, has no goodwill to be divided as a partnership asset following its dissolution. This approach is further backed by the settled position of law that partnership books and entries belong not only to the firm but to each member of the firm, as laid down by Justice Sterling in Tregov. Hunt (‘Trego’).[ii] The Bombay High Court in Sujan Suresh appears to have followed a similar line of reasoning when it ruled that under Section 55(1) of the Partnership Act, 1932, goodwill must be categorised as an asset even if the partners have not made any provisions for it in their partnership agreement. In the event that the agreement mentions it, goodwill must be sold in accordance with it.

Decoding The Reluctance: Are Goodwill Payments and Loss To The Existing Firm Interconnected?

The standard practise is for a departing partner to sell his share of goodwill to the other partners if the firm continues regardless of his departure. He doesn’t sell his share of the firm’s goodwill but loses it when expelled. Therefore, he should be able to rightfully claim compensation. Moreover, as recognized in Johnson v. Hartshorne (‘Jonhson’), the firms’ anticipated earnings are largely linked to the partners’ qualifications and standing. So why do claims for goodwill compensation lead to disputes?

The primary concern might be that the leaving partner might use the goodwill accrued by the firm to springboard his activities. The Bombay High Court in Novartis Vaccines & Diagnostics Inc. v. Aventis Pharma Limited has voiced this concern. The Court accepted that there was no financial or profit-sharing remedy for allowing other partners to conduct competitive activity. Without formal consent or a contract, such a rival or competing firm will undermine the partnership’s goals. However, as laid down in cases such as Trego and Jennings v. Jennings,[iii] where the goodwill of a firm is traded, the seller partner may open a competing establishment but is not permitted to contact clients of the previous business. Restrictions can also be imposed on using the name of the partnership firm if the former partner intends to run a competing business, as laid down in Churton v. Douglas.[iv] Therefore, despite the constraints placed on restrictive covenants such as non-competes under Section 27 of the Indian Contract Act, 1872, partnership firms still can afford to protect their goodwill despite the exit of one of the partners along with goodwill payment.

Breach Of Fiduciary Duty and Ethical Constraints In Case Of Non-Payment

The fiduciary duty of the partnership to old partners ordinarily ends with their departure. There are several reported cases involving the liability of former partners for partnership obligations incurred during the partnership. For instance, in Bane v. Ferguson(‘Bane’), it was held that a law firm does not owe a duty to a retired partner to perpetuate itself to maintain a pension plan. Interestingly, scarce literature directly discusses a firm’s duty to former partners. Cases rarely discuss the liability of a firm to former partners for obligations of any kind arising during the course of the partners, let alone the liability for non-payment of goodwill. However, suppose the profits of the firm are the result solely of professional skill and labor, as stated in Johnson. In that case, payment of goodwill to the former partner is an important obligation that the firm must discharge. Another consideration underlying the non-payment of goodwill compensation is ethical constraints, such as preserving business relationships. If goodwill can be paid during the distribution of assets of the partnership after its dissolution, it may be time to consider goodwill payment to former partners and make it the new norm.

Conclusion

Goodwill is a broad concept in professional business that includes more than just skill. A brief review of the aforementioned cases clearly explains the position of an individual within a partnership. Goodwill generated by his acts, in the ordinary course, have always vest in the partnership unless the partnership agreement stipulates certain conditions to the contrary. However, in some instances, such as the dissolution of a firm/death of a partner, goodwill has been distributed to the former partner or the legal representative of the deceased partner. It is argued that a partner who does not wrongfully depart from his firm must be allowed goodwill payment as his rightful share. However, Indian law is still not clear regarding the liability of a firm to a former partner when the partner has abandoned or exited the law firm, since the scope of the Partnership Act as it stands today is restricted to only discussing goodwill in the context of the dissolution of a firm.

 

[i]Bhayani v Taylor Bramwell LLP (2016) EWHC 3360.

[ii]Trego v Hunt (1896) AC 7.

[iii]Jennings v Jennings (1898) 1 Ch 378.

[iv]Churton v Douglas(1859) Johnson 174.

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