Partnership Member Expulsion and Settlement Calculation: Core Principles of Goodwill Valuation

1. Legal Basis for Business Partnerships and Member Expulsion

Business partnerships experience various forms of conflict situations on an ongoing basis. The types of disputes that arise during joint business operations can be broadly categorized into two main categories.

The first category involves situations where a business partner misappropriates common assets or commits breach of trust, constituting clear illegal acts. In such cases, the expulsion of a partnership member is relatively clearly recognized. Since objectively verifiable illegal acts exist, there is no significant difficulty in proving the existence of ‘legitimate grounds.’

The second category involves conflict situations arising from differences of opinion and continuous friction between business partners. The key issue here is whether a partnership member can be expelled based solely on simple differences of opinion. Legal interpretation is needed regarding whether expulsion is possible in situations where trust relationships have broken down, even without special criminal acts or clear contract violations.

Business partnerships are a form of partnership contract under civil law, where multiple parties contribute capital for common objectives and jointly operate a business. In the medical field, multiple doctors jointly establishing and operating a hospital represents a typical form of partnership contract.

Article 718 of the Civil Code stipulates regarding the expulsion of partnership members: “When there are legitimate grounds, a partnership member may be expelled by unanimous agreement of other partnership members.” The interpretation and application of ‘legitimate grounds’ becomes an important issue in practice.

When a partnership member is expelled from a partnership contract, that member withdraws from the partnership and consequently has the right to receive settlement for their share of partnership assets. The calculation method and scope of settlement payments often become core issues of dispute.

2. Legitimate Grounds for Partnership Member Expulsion

Cases Involving Clear Illegal Acts

When a business partner misappropriates partnership assets or commits breach of trust constituting clear criminal acts, this naturally becomes legitimate grounds for expulsion. In such situations, since objective evidence is clear, there is no significant difficulty in proving the legitimacy of expulsion.

Expulsion Due to Breakdown of Trust Relationships

A more complex issue arises when trust relationships between business partners have broken down due to continuous conflicts and disagreements, even without clear criminal acts or contract violations. The ‘legitimate grounds’ in Article 718, Paragraph 1 of the Civil Code are not limited solely to cases where partnership members have clear attributable faults.

Court precedents hold that cases where conflicts and discord among partnership members due to specific members have fundamentally damaged trust relationships, making smooth joint operations impossible, are also included in legitimate grounds.

Criteria for Determining Legitimate Grounds

Whether trust relationships have broken down is determined by comprehensively considering the following factors:

• Degree of hindrance to achieving partnership objectives
• Availability of other means to remove hindrances
• Contract content and duration
• Circumstances leading to expulsion

Conflicts During Contract Renewal Negotiations

Conflicts arising during negotiations for contract renewal after the agreed term of a partnership contract expires can also constitute legitimate grounds for expulsion. Particularly when minority shareholders unilaterally oppose or reverse their positions regarding reasonable modification proposals presented by majority shareholders, preventing agreements from being reached, this can be viewed as reaching an objective state where maintaining the partnership relationship is difficult.

Courts view that expulsion measures in partnerships should be interpreted as being for the smooth operation of partnerships, which are personal associations based on trust. Therefore, when there are objective circumstances making it difficult to maintain partnership relationships due to destroyed trust relationships from conflicts and discord among partnership members, it is appropriate to recognize the legitimacy of expulsion measures.

3. Equity Settlement Procedures Upon Termination of Partnership

Obligation to Pay Settlement Amounts

When a partnership member withdraws from a partnership contract following an expulsion resolution, the remaining partnership members have an obligation to pay settlement amounts equivalent to the value of that member’s share of partnership assets, evaluated based on the state of partnership assets at the time of withdrawal.

Article 727 of the Civil Code stipulates: “When a partnership member withdraws, the value of their share shall be determined according to the state of partnership assets at the time of withdrawal and returned.”

Scope of Partnership Assets

Determining the scope of partnership assets when calculating settlement amounts is an important issue. Generally, the following assets are included in partnership assets:

• Tangible assets such as real estate, equipment, and facilities
• Cash and deposits
• Intangible assets such as goodwill
• Other rights and obligations

Whether goodwill is included has a significant impact on the size of settlement amounts, making it an important practical issue.

4. Criteria for Recognizing Goodwill as Partnership Assets

Concept and Characteristics of Goodwill

Goodwill refers to intangible assets where a business has earning power exceeding the normal profit rate of similar enterprises. In medical institutions, elements such as reputation, technical expertise, know-how, and customer base constitute components of goodwill.

Principle of Goodwill Inclusion

Court precedents hold that goodwill should naturally be included when evaluating shares when partnership members withdraw from business relationships. However, goodwill can be excluded by agreement between parties, with the burden of proof resting on those making such claims.

Requirements for Recognizing Goodwill

For goodwill to be recognized, the following requirements must be met:

• Maintaining continuous growth and substantial reputation
• Achieving high sales and operating profits
• Systematized operations beyond individual capabilities
• Stability unaffected by the withdrawal of any single partnership member

In actual cases, courts have recognized the existence of goodwill based on hospitals maintaining continuous growth since opening, sustaining substantial reputation and scale, and achieving high sales and operating profits. This was judged to be due not solely to individual doctors’ capabilities but to intangible assets such as reputation, technology, and know-how beyond tangible assets, plus having systems unaffected by any single partnership member’s withdrawal.

5. Goodwill Valuation Methodologies

Various Valuation Methods

There are several methods for goodwill valuation, with major ones including:

• Discounted Cash Flow (DCF) Method
• Valuation method according to Inheritance and Gift Tax Act Enforcement Decree
• Net Asset Value Method
• Earnings Value Method

Application of Discounted Cash Flow Method

Courts have held that valuation methods for unlisted corporation stock values may be applied when evaluating assets of profit-oriented partnerships, while stating that no single valuation method must always be applied, requiring comprehensive consideration of the partnership’s circumstances and industry characteristics.

For businesses continuing operations after some partnership members withdraw, valuation methods reflecting future earning capacity are appropriate. Particularly for medical institutions where goodwill and intangible assets constitute a significant portion, the discounted cash flow method that adequately reflects goodwill and future earning capacity can be viewed as best reflecting partnership asset values.

Limitations of Inheritance and Gift Tax Law Valuation

Valuation methods under inheritance and gift tax law have limitations in that they are based only on past three years’ financial data and goodwill valuation amounts decrease when equity is large. For hospitals with large sales and operating profit scales, this may not adequately reflect future earning capacity, making it restrictive.

6. Deduction Factors in Settlement Calculation

Handling Damage Compensation Arising During Partnership Operations

When damage compensation (settlement amounts) must be paid due to accidents occurring during partnership contract operations, how to handle this in settlement amounts becomes an issue. Generally, partnership contracts often stipulate that accident liability should be shared according to ownership ratios. However, when there are separate agreements between parties, these should be given priority consideration.

In actual cases, there was recognition of an agreement where the plaintiff stated “I think I should bear the responsibility because my responsibility is too heavy” and agreed to bear the entire settlement amount, resulting in that amount being deducted from settlement payments.

Other Deduction Items

When calculating settlement amounts, examination is needed regarding whether the following items can be deduction targets:

• Income taxes and other taxes (generally cannot be deducted as individual payment obligations)
• Accounts receivable or accounts payable
• Debts borne by individual partnership members

7. Principles of Simultaneous Performance and Practical Considerations

Recognition of Simultaneous Performance Defense

Simultaneous performance defense may be recognized regarding settlement payment related to partnership member withdrawal. When withdrawing partnership members hold shares in real estate registered under partnership names, the obligation to transfer registration of those shares and the obligation to pay settlement amounts are considered to be in simultaneous performance relationships as they are related with consideration meaning.

Registration Transfer Obligations

When real estate provided for partnership purposes is registered under individual names, there is an obligation to transfer this to remaining partnership members upon withdrawal. This is understood as part of organizing and settling partnership assets.

Limitations on Delay Damages

For obligations in simultaneous performance relationships, delay liability is not incurred until the other party’s performance is tendered. Therefore, even if the performance period for settlement payment obligations has arrived, delay damages cannot be claimed without tender of performance of registration transfer obligations by withdrawing partnership members.

Practical Considerations

When concluding partnership contracts, it is advisable to clearly stipulate the following matters:

• Settlement amount calculation methods upon withdrawal
• Whether goodwill is included and valuation methods
• Methods for sharing contingent liabilities such as medical accidents
• Handling methods for registered assets such as real estate
• Timing and methods of settlement payment

8. Key Summary

Partnership member expulsion in partnership contracts is recognized not only when there are clear criminal acts but also when there are legitimate grounds such as breakdown of trust relationships. Even simple disagreements can constitute legitimate grounds for expulsion if conflicts and discord among partnership members have fundamentally damaged trust relationships, reaching situations where smooth joint operations cannot be expected.

Settlement amounts upon withdrawal should be calculated based on all partnership assets including goodwill. Goodwill valuation should select appropriate methods such as discounted cash flow considering the business entity’s characteristics and future earning capacity, and when there are special circumstances such as medical accident settlement amounts, these can be deducted from settlement payments.

To prevent partnership contract disputes, it is important to specifically and clearly stipulate matters regarding withdrawal and settlement from the time of contract conclusion. Particularly, pre-agreeing on whether goodwill is included, valuation methods, and methods for sharing contingent liabilities can prevent a considerable portion of future disputes.

Complex issues related to goodwill valuation and settlement calculation in partnership contract disputes require professional legal review, making comprehensive consultation considering specific circumstances and conditions for each case important.