COURT FILE NO.: 08-CV-352531PD2
DATE: 20141219
ONTARIO
SUPERIOR COURT OF JUSTICE
BETWEEN:
HANIF ISHANI
Applicant
– and –
RENUKA KULASINGHAM and WILLIAM HSIEH
Respondents
Mark A. Klaiman, for the Applicant
G. Gordon Bent, for the Respondents
HEARD: April 28, 29, 30 and May 1, 2, 2014
REASONS FOR JUDGMENT
firestone J.
[1] This matter was commenced by way of Application. On consent the matter was ordered to proceed by way of trial of an issue to determine the state of accounts between the partners of the partnership of Joint Therapy effectively dissolved on July 31, 2007. For the purposes of trial it was ordered that the Affidavits filed by the parties to the date of the order shall stand as pleadings and the cross-examinations thereon shall be treated as examinations for discovery under the Rules of Civil Procedure.
[2] The issues for determination are as follows:
(a) What, if any, share of the Respondents’ new business profits is the Applicant entitled to under s. 42 of the Partnerships Act, R.S.O. 1990, c. P.5 for the Respondents’ use of the old partnership assets?
(b) What is the fair market value of Joint Therapy as of the date of dissolution and what is the Applicant’s one third share of this fair market value?
Factual Background
[3] The Applicant, Hanif Ishani (“Ishani”), and the Respondents, Renuka Kulasingham (“Kulasingham”) and William Hsieh (“Hsieh”), collectively referred to as “the partners,” were high school friends. On July 21, 2003, they formed a partnership operating as “Joint Therapy.”
[4] Ishani is a chiropractor and Kulasingham and Hsieh are physiotherapists. At no time was there a written partnership agreement in place regarding Joint Therapy. However, the partners agreed to share equally in the profits of the partnership, with each partner receiving one third of the profits.
[5] The three partners leased space in the Markham Plaza. They all signed the lease for an initial five year term commencing on October 9, 2003. Included in the lease were terms or restrictions regarding the permitted signage and the name to be displayed as well as penalties for failure to continue to carry on business in the premises.
[6] The partners obtained a bank loan of $80,000 for necessary start-up expenses, including the purchase of accounting software, furniture for the reception area, and equipment for the treatment rooms, such as beds and rehabilitation gym equipment. The partners hired a receptionist and eventually two massage therapists working as independent contractors.
[7] The Joint Therapy space consisted of a common reception area, a chiropractic room with bed, a physiotherapy room with bed, a massage therapy room with bed, and a common treatment area with three beds and a rehabilitation gym area.
[8] All three of the partners worked part-time at Joint Therapy and maintained outside employment. The partners divided non-treating duties, which included marketing, cleaning, computer work, accounting, and the ordering of supplies, among themselves. The partners were responsible for marketing. There is a dispute regarding the extent of Ishani’s expected and actual performed duties in this regard.
[9] The partnership by all accounts was moderately successful. The exact numbers are in dispute; however, the partnership net income in the last three years of its operation, according to the evidence, averaged approximately $165,000.
[10] Over time the relationship between Ishani and the other two partners, Kulasingham and Hsieh, deteriorated. As a result, Kulasingham and Hsieh terminated the partnership effective July 31, 2007.
[11] The events leading up to the partnership dissolution are a subject of debate between the parties. Kulasingham and Hsieh claim they repeatedly voiced a growing concern that Ishani was not doing his share of marketing, and that since most clients of Joint Therapy came from doctor referrals, such marketing efforts were essential and of fundamental importance to Joint Therapy’s success. Ishani claims that no such complaints were made, and that there is a telling absence of complaints in the minutes of partnership meetings.
[12] On August 9, 2007, Ishani left the rental premises of Joint Therapy and ceased working from the Joint Therapy location. After his departure, Kulasingham and Hsieh continued to operate out of the Joint Therapy premises, and they continue to do so today under the name of “Joint Rehab.” The initial lease term expired in October 2008.
[13] The events subsequent to August 9, 2007, are also a source of controversy between the parties. Kulasingham and Hsieh allege that Ishani walked away from the premises and refused to negotiate with them, thereby engineering the situation he now claims compensation for under s. 42 of the Partnerships Act. Ishani states that there were attempted negotiations, but the Respondents did not propose any viable and fair way to share the space.
SECTION 42 CLAIM
[14] Post dissolution, the Respondents continued to operate out of the old Joint Therapy leased premises, where all the equipment remained. They re-hired or continued to employ the same staff (the receptionist and independent massage therapists). A computer was delivered to Ishani in April 2009. He had requested it so that he could complete his taxes. That computer is still with him and has partnership accounting software on it.
[15] In July 2009 Kulasingham and Hsieh forwarded Ishani a cheque for $1,713.70. This amount, they contend, represented one third of the net bank balance remaining after they paid off the bank loan and payables and completed their collection efforts. Ishani took nine patient files with him when he left Joint Therapy. He did not take any chiropractic equipment with him, and post-dissolution he did not contribute to the lease, which was in all three partners’ names.
[16] Ishani in his closing submissions asks the court to order a reference to a Master because the Respondents have failed to produce documents or evidence at trial which would allow for a proper accounting of the profits of Joint Rehab for the period from 2009 to the present. The only known evidence pertaining to the s. 42 claim is from August 1, 2007, to December 31, 2008.
[17] Kulasingham and Hsieh in their closing submissions submit that they refused on cross examination in November 2008 to produce the financial records of the practice and Ishani did not bring a motion to seek to compel that information. They submit that the onus is on the Applicant to prove his case and not the Respondents.
[18] At no time did the Applicant indicate that the trial should not proceed because information had not been produced. No request for an adjournment or a production order was made at the outset of trial.
[19] Ishani argues that he is entitled to one third of the profits of Joint Rehab; that the entire profits of the ongoing business of Kulasingham and Hsieh is attributable to the use of the partnership assets, which Ishani submits includes not just the hard assets, but the name, the lease premises, the specific location, the sign, and all the goodwill of the business.
[20] Regarding the s. 42 claim for the period of August 1, 2007, to December 31, 2008, Ishani submits that the proper approach is to take the Joint Rehabilitation gross business income, deduct business expenses, and divide that figure by three in order to determine his one-third entitlement. He submits this method is the appropriate one because during the partnership this was the partners’ method of determining each partner’s share. The partners would then each deduct their personal expenses from their individual share.
[21] In determining the appropriate amount for each of the months of 2007, Ishani submits that Joint Rehab’s declared net income for 2007 of $331.63 should be taken as a starting point. To that should be added back any deductions listed in the 2007 Statement of Professional Activities as “WH/RK” (being the Respondents’ initials), which the accountant, Bruno Hartrell, testified represented personal expenses. The total of such expenses for that period is $57,381.29, thereby creating a total 2007 amount of $57,712.92. Ishani submits that his portion should be this figure divided by three, for a total amount of $19,237.
[22] For the 2008 year Ishani submits that the Respondents began deducting their salaries as business expenses, as confirmed in Joint Rehab’s Statement of Income for the year ending December 31, 2008, which was entered into evidence. Subtracting the net loss for 2008 of $7,321.29 from the salary figure, and dividing by 3, Ishani submits his share is $62,226.23.
[23] The total s. 42 claim for the years 2007 and 2008 Ishani submits is therefore $81,463.87 ($19,237.64 + $62,226.23).
[24] Kulasingham and Hsieh submit that fundamental to Ishani’s calculation of the s. 42 claim is the position that all of their post-dissolution business income for 2007 and 2008 is attributable to the Joint Therapy partnership assets.
[25] The Respondents dispute this and argue that this business income was attributable to their effort and skill. The evidence was consistent among the parties that it was important that the clinic be located in Markham, Ontario, the area from which most referrals came. The Respondents, however, disagree that the specific location of the clinic was important and contributed to its business. The Respondents’ evidence is that it was in fact their personal connection with doctors that generated business.
[26] Kulasingham and Hsieh assert that Ishani “engineered” the post-dissolution situation, and it would be inequitable to award any compensation under s. 42 of the Partnerships Act given that he made a personal decision not to cooperate with them in order to address the various equipment, lease, and loan issues.
[27] Section 42(1) of the Partnerships Act provides as follows:
Where any member of a firm dies or otherwise ceases to be a partner and the surviving or continuing partners carry on the business of the firm with its capital or assets without any final settlement of accounts as between the firm and the outgoing partner or his or her estate, then, in the absence of an agreement to the contrary, the outgoing partner or his or her estate is entitled, at the option of the outgoing partner or his or her representatives, to such share of the profits made since the dissolution as the court finds to be attributable to the use of the outgoing partner’s share of the partnership assets, or to interest at the rate of 5 per cent per annum on the amount of his or her share of the partnership assets.
[28] Section 42 does not address the issue of the outgoing partner’s failure to take or continue to use such assets. I do not accept the Respondents’ proposition that the partners’ inability to come to an agreement as to the shared use of the partnership assets post dissolution should be used against the Applicant in his s. 42 claim. On the evidence before me I do not find that Ishani’s actions post dissolution rose to the level of “engineering the situation,” as the Respondents allege, in order to bolster his claim or take advantage of s. 42 of the Partnerships Act.
[29] I do accept that with his departure, Ishani left Kulasingham and Hsieh with not just the benefits of the partnership, but also the obligations, including lease payments. The applicable lease contained a penalty clause which meant that if the Joint Therapy offices did not open for business, the landlord was entitled to collect liquidated damages in the amount of $.25 per square foot for each day of default.
[30] There is no doubt on the evidence that Kulasingham and Hsieh continued to use the Joint Therapy equipment, including the gym, physiotherapy tables, office furniture, and computers, in their new business, at least initially. One computer was subsequently given to Ishani. Kulasingham and Hsieh state that they have since upgraded or sold much of the equipment.
[31] No specific evidence was introduced of such sales and upgrades; however, much of the equipment, particularly the computer, would have completely depreciated after five years. The total fair market value of all tangible assets as of the date of dissolution was approximately $38,000, according to Schedule 2 contained in the revised valuation report of VSP Valuation Support Partners Ltd. (“VSP”) (retained on behalf of the Respondents), dated April 21, 2014.
[32] Regarding the intangible assets, based on the evidence it is unclear to what extent the specific Joint Therapy location in Markham Plaza and the built-up goodwill of the business (if in fact there was any goodwill inherent in the business, as opposed to individual practitioners) may have contributed to the profits of Joint Rehab. Doctors may have continued to refer patients, for a short period of time, to Joint Rehab as a result of marketing efforts of the partners in Joint Therapy. However, there is evidence that Kulasingham and Hsieh forwarded Ishani’s calls and informed patients seeking Ishani’s services of his new location and that they continue to do so.
[33] While there was evidence of considerable overlap between the practice areas of chiropractors and physiotherapists, all parties also agreed that physiotherapists cannot do a level 5 manipulation of the spine. Patients coming to Joint Rehab seeking certain chiropractic treatment, therefore, rather than physiotherapy, could not have been treated by Kulasingham or Hsieh.
[34] As previously indicated, Ishani also took nine patient files with him. He testified these nine patient files included his mother, his father, his uncle, the mother of a friend, some acquaintances, and one patient who was subsequently treated by his wife.
[35] The evidence confirmed that after the typical treatment period of 4-6 weeks the majority of former patients would not return in the future. The partners agreed that most patients were a one off. There is insufficient documentary evidence to establish an accurate percentage of repeat business. Kulasingham testified that it was 1 percent. The patient history print out of Ishani (from 01-Jan-1980 to 06-Feb-2012) as well as the patient history print out of Kulasingham (from 01-Jan-1980 to 06-Feb-2012) entered as exhibits do not provide accurate evidence in this regard.
[36] These patients were selected by Ishani as examples of patients who were treated by more than one practitioner, and the small sampling cannot, in my view, be used as a representative sample to determine the percentage of repeat patients.
[37] The only evidence Ishani introduced as to quantum of the claim pertains to the period between August 1, 2007, and December 31, 2008. For the applicable period in 2007-08, Ishani submits that the appropriate quantum of his s. 42 entitlement is the full one third of all net profits, so that his entitlement post dissolution is identical to the entitlement he would have had, had the partnership remained in effect.
[38] Section 42 does not, in my view, provide the outgoing partner with an automatic share of all profits earned following dissolution merely because some partnership assets were used. The section directs the court to determine the amount it “finds to be attributable to the use of the outgoing partner’s share of the assets.” Under Ishani’s analysis, zero of the Joint Rehab business would be attributable to Kulasingham’s and Hsieh’s own efforts. This is not a plausible result, particularly in a business that required extensive marketing to secure doctor referrals, where the treatment required skill as well as years of training, and where patients were largely loyal to one practitioner, at least during their treatment cycle.
[39] In addition, post-dissolution the Respondents’ professional fees billed would naturally have dropped, given that they had lost one practitioner and their only chiropractor. The evidence substantiates that such a drop in professional fees billed did occur. For the first seven months of 2007, before Joint Therapy’s dissolution, the average monthly gross income was, according to the evidence on behalf of Kalex Valuations Inc. (“Kalex”) (retained on behalf of the Applicant) and VSP (retained on behalf of the Respondents), somewhere between $32,289.71 and $31,211.71.[^1]
[40] In contrast, according to the Joint Rehab Statement of 2007 Professional Activities for the remainder of 2007, Joint Rehab made $112,328 gross income, for a monthly average of $22,465.60. This would indicate that the gross monthly income of Joint Rehab in those months is only about 70-72% of the Joint Therapy gross monthly income for the earlier months.
[41] To allow the Applicant a full third of the profits of Joint Rehab would mean he is entitled to this income without incurring any of the expenses associated with it. The Applicant testified that in each year the partners had professional expenses associated with their professional billings. The 2007 Professional Activities statement of Joint Rehab (Hsieh and Kulasingham) as well as the Joint Rehab statement of income for the year ending December 31, 2008, establishes that Hsieh and Kulasingham continued to incur expenses in 2007 and 2008. While many of those expenses—$4,835.03 for personal phone bills, for example—are likely entirely personal in nature and are not necessary for the business, some portion of those expenses would be essential. Other expenses, such as insurance and professional fees, are entirely essential.
[42] To find that nevertheless the Applicant is entitled to one third of the profits of this reduced professional practice is not appropriate. While the Applicant is not entitled to one third of the profits of Joint Rehab, he is entitled to some percentage of profits in 2007-2008 for a share of the tangible assets, and possibly some small additional percentage, at least in 2007, for the ongoing referrals to Joint Therapy, which in many cases would translate into business for Joint Rehab. Neither party has submitted an alternative method of calculating the s. 42 claim.
[43] In Tecle v. Hasson, 2012 ONSC 2233, the court considered the rental of half a taxi plate as one appropriate measure of Mr. Tecle’s entitlement. By analogy, one means of calculating the percentage of profit attributable to the assets such as beds and tables as well as the rehab gym would be to determine what these would cost to rent. There is, however, no evidentiary basis to allow the court to make that determination.
[44] The appropriate calculation of the profits made since dissolution that are attributable to the use of Ishani’s share of the partnership assets, based on the evidentiary record, can be arrived at based on the following methodology:
[45] The court, as a starting point, will take the profit figures advanced by the Applicant of $19,237.64 for 2007 and $186,678.71 for 2008. However, rather than being entitled to a full one third of the profits, Ishani is entitled to another percentage that more accurately accounts for the matrix of factors that allow for the earning of that income, such as the skill and labour of the Respondents. It is reasonable that the appropriate percentage for 2008 be lower than that for 2007 given that it is likely, on balance, that any goodwill associated with Joint Therapy would have all but disappeared by 2008, and therefore the only partnership assets being used would be the hard assets, which would continue to depreciate each year.
[46] Based on the evidence, the income generating ability of Joint Rehab, or any professional clinic offering these types of services, is attributable to a number of factors, such as skill of the practitioners, the location, the advertising, the built up relationships with physicians, the other employees, and the physical assets.
[47] In considering these factors and the evidence of the parties it is reasonable to conclude that at least 50% of the profit-generation is directly attributable to the skill of the practitioner rather than any physical or intangible assets. Of the remaining 50%, 20% is attributable to hard assets such as the equipment, the lease/location, and the employees. The final 30% is attributable to the relationships formed and built up with various referral sources.
[48] Ishani is entitled to a percentage of profits that are attributable to the hard assets and the doctor relationships he helped acquire. However, it is important to consider that patients seeking chiropractic treatment and care from Ishani were referred to him, and he took some patients with him when he left.
[49] As a result, in my view, Ishani cannot claim that the full 30% of total Joint Rehab profits attributable to doctor relationships are themselves attributable to a “partnership asset,” since he profited in his own practice from a share of that asset. Chiropractic referrals would have followed Ishani when he left the partnership or would have gone to another chiropractor. This is evidenced by the fact that after he left, the monthly revenue for the business was only approximately 70% of what it had been while he was present.
[50] Therefore, I find that in 2007 the total amount of Joint Rehab profits which is attributable to the assets of the partnership is 35%. As a result for 2007, this results in 35% of the $57,712.92 profit being attributable to the assets, or $20,199.52. I therefore find that Ishani’s one third share of the profits for 2007 is $6,733.
[51] For the 2008 year the same analysis is to be applied. Fifty percent of the profit is due to the Respondents’ skill and expertise. Thirty percent is due to the doctor and other referral relationships, and twenty percent is due to the physical assets. I find that however, by 2008, the percentage of both hard assets and doctor relationships that can be said to be properly attributable to Joint Therapy “partnership assets” would have diminished significantly. The hard assets depreciated, and the doctor relationships that existed in 2008 would have been due to the Respondents’ work and ongoing efforts, rather than to the lingering goodwill of Joint Therapy.
[52] As a result, I find that half of the hard assets that existed in 2008 can be properly considered “partnership assets” in 2008, and only approximately a sixth or less of the doctor relationships or other patient referrals can be said to be attributable to the partnership. Using this method of calculation, 15% of the Joint Rehab profits of 2008 are attributable to the partnership assets. Fifteen percent of $186,678.71 is $28,001.81. Ishani’s one third share for 2008 is therefore $9,333.94. The total amount of Ishani’s s. 42 claim for 2007 and 2008 is $16,066.94.
[53] On the facts of this case I decline to order a reference for the period from 2009 to the present. On their cross examinations in 2008, the Respondents refused to produce the financial records of Joint Rehab. No motion was brought. While I agree that the court is entitled to draw an adverse inference from the failure to produce information, this does not negate the fact that the onus is on the Applicant to prove his case. This is not a situation where the Respondents, rather than refusing, undertook to provide information and never fulfilled that undertaking. Here the refusal to produce information was known to the Applicant. There was no request at the outset of trial for an adjournment or that the trial be bifurcated and a reference be ordered. No motion for production was brought at the outset of trial.
[54] Rule 54.02(1) of the Rules of Civil Procedure, R.R.O. 1990, Reg. 194 (“the Rules”) states as follows:
Reference of Whole Proceeding or Issue
54.02 (1) Subject to any right to have an issue tried by a jury, a judge may at any time in a proceeding direct a reference of the whole proceeding or a reference to determine an issue where,
(a) all affected parties consent;
(b) a prolonged examination of documents or an investigation is required that, in the opinion of the judge, cannot conveniently be made at trial; or
(c) a substantial issue in dispute requires the taking of accounts.
[55] Rule 54.02 gives a trial judge “broad discretion to refer matters to others for determination,” where its requirements are met: Cookish v. Paul Lee Associates Professional Corp., 2013 ONCA 278 at para. 32.
[56] A reference is generally not appropriate under rule 52.02 in order to develop a claim not made out at trial. In Coca-Cola Ltd. v. Sports Network (1992), 1992 15437 (ON SC), 44 C.P.R. (3d) 478, [1992] O.J. No. 2010 (Gen. Div.), Farley J. stated as follows:
I would think it is generally and inherently unfair to any defendant for a plaintiff to say “Hear my case, grant me my mandatory order, but if I haven’t made out my case for a mandatory order, allow me to come back to court at a later date to see if I can then develop my claim for damages as a form of my relief.” Can anything be said that there were unusual circumstances that would override the fact that the parties have not agreed on a later determination of damages in the event that Coke were unsuccessful in obtaining the mandatory order?
[57] The court has inherent jurisdiction to split a trial in the interests of justice and order a reference, but such power is narrowly circumscribed and is to be exercised only in the clearest of cases: Reservoir Group Partnership v. 1304613 Ontario Ltd. (2007), 2007 921 (ON SC), 84 O.R. (3d) 180; affirmed 2009 ONCA 278, 56 B.L.R. (4th) 170.
VALUATION OF PARTNERSHIP INTEREST
[58] It is agreed between the parties that Ishani is entitled to one third of the value of Joint Therapy as of the date of dissolution. The expert valuators retained by the parties, Melanie Russell (“Russell”) of Kalex, for the Applicant, and Jason Kwiatkowski (“Kwiatkowski”) of VSP, for the Respondents, were qualified to give opinion evidence. They agree that the partnership was a going concern at the time of dissolution. The fundamental disagreement is whether the partnership generated any excess earnings and whether goodwill should be attributed and valued. The experts’ different opinions on these points lead them to adopt different valuation methods.
[59] The Respondents also submit that any claim is subject to a set off for unpaid fees owing on the nine files taken by the Applicant, such set off being $8,348.03. The Applicant submits that the appropriate set off amount is the amount he actually collected, such sum being $1,755.40. The Applicant submits that if he is to be accountable for bad debt on those nine files, then the Respondents must in turn be accountable to the Applicant for the bad debt on the files in their possession.
The Kalex Report Approach
[60] Central to the Kalex Report is its use of the capitalized cash flow approach, which is an income based approach. This approach is based on the theory that a hypothetical purchaser would want to buy into the partnership and thereby acquire a share of its future earnings. Kalex begins with the before tax income of the business for each year of operation. For 2007 it extrapolates the full-year earnings from the seven months of earnings reported before dissolution. It then determines the maintainable earnings of the business, which involves taking the earnings contained in Schedule 4 of the report and adjusting them for extraordinary or non-recurring items, in order to obtain an estimate of earnings that are expected to prevail in the future. Those numbers are set forth on a yearly basis in Schedule 3 of that report as follows:
Adjusted earnings by year – Kalex report
2007
$237,819
2006
$242,316
2005
$235,704
2004
$129,681
2003
$ 36,203
[61] The Kalex report, rather than averaging adjusted per year amounts, goes on to weigh various years on a scale of 0-4 to arrive at a likely trend of annual future earnings. At paragraph 27 of the report, Kalex states that weighing is generally used “where there is a definite trend in the sales patterns and operating results.” The year of 2007, being the most recent year of operation, is given the highest weight of 4. The 2006 year is given a weight of 3, and each previous year is weighted one less, with the 2003 year being given a weight of zero.
[62] The weighted average of five years is $228,000. This is significantly higher than the simple average, which would have been $176,000, but lower than the simple average of the three most recent years, with 2007 being extrapolated, which would be $239,000.
[63] The Kalex report then goes on to take the weighted average of $228,000 as the low estimate of annual pre-tax cash flow, and $242,000 as the estimated high value. From these calculations, Kalex then deducts taxes, expenses, debts/liabilities, and management remuneration. Management remuneration is calculated using a rate of $35-$37 per hour for a physiotherapist and $30-$32 per hour for a chiropractor.
[64] This management remuneration figure is based, as indicated in Schedule 1 of the report, on a discussion with Ishani and a review of the 2002 and 2006 Ontario Physiotherapy Association compensation surveys. In terms of hourly rates, chiropractic rates are estimated at $5 less than those of a physiotherapist. It is agreed between the parties that whatever the appropriate compensation is for physiotherapist, chiropractor compensation is $5 less. Such figures result in a total annual salary deduction of $113,000 to $120,000 for the three partners. This would equate to individual salaries of approximately $37,666 to $40,000.
[65] As specified in Schedule 1, the adjusted maintainable earnings amount is multiplied by the valuation multiple in order to convert the anticipated cash flow into a lump sum which represents the capitalized earnings value, or the going-concern value.
[66] Kalex then goes on to arrive at a calculated fair market value of the capital of Joint Therapy. The value range is between $312,000 (low) and $376,000 (high). Kalex takes the midpoint of $344,000 which is then divided by a third arrive at $114,665, being Ishani’s share. A minority discount of 10-15% is then applied to this share to arrive at a midpoint figure of $100,000 for the value of Ishani’s share of the partnership as of July 31, 2007, as detailed in Schedule 1.
The VSP Report Approach
[67] VSP uses the excess earnings approach to determine whether or not any excess earnings in fact existed. As explained by Kwiatkowski, the excess earnings approach is an income-based approach which is a variation of the capitalized cash flow approach used by Kalex.
[68] An excess earnings approach requires a determination of whether there are any earnings, in addition to the economic salaries of the partners, which would accrue to a potential purchaser. If this is the case, such excess earnings are multiplied by a “goodwill multiplier” to determine the value of the business’s goodwill, or intangible assets.
[69] The appropriate goodwill multiplier is determined after considering a number of factors, including whether the goodwill is transferable or nontransferable—i.e., whether it accrues to the partnership, or on the other hand, whether it is personal. The goodwill amount is added to the value of the tangible assets (i.e., capital assets) in order to determine the value of the business.
[70] It is the conclusion of the VSP report that there are no excess earnings. VSP uses, in Schedule 5 of its revised report, a significantly higher hourly wage estimation than does the Kalex report. VSP uses an estimate of $59.11 for physiotherapists and $45-$50 for a chiropractor.
[71] VSP in their revised report dated April 21, 2014, relies on the same Ontario Physiotherapy Association compensation surveys used by Kalex. However, it takes its figures from the “owner/manager” column rather than the contractor column. Using these figures, VSP calculates the economic partner salaries at a range between $204,000 and $221,000. The evidence confirms that this is the major point of contention between the two competing expert valuation positions. Further, it is this per hour wage difference which leads to VSP using the asset-based approach to valuation.
[72] VSP’s net income figures are similar to those of Kalex, with the largest discrepancy being the annualization figure for 2007 revenue: $374,541 rather than the number arrived at by Kalex of $387,477. It is noted that VSP deducts bad debt expenses of 4.3% of revenues from the net income amounts. A comparison of VSP’s earnings before tax, compared to those of Kalex, are set forth in the chart below:
| Year | Kalex | VSP |
|---|---|---|
| 2007 | $237,819 | 188,700 |
| 2006 | $242,316 | 205,450 |
| 2005 | $235,704 | 190,629 |
| 2004 | $129,681 | 91,489 |
| 2003 | $36,203 | [not calculated] |
[73] VSP then goes on to average the 2005 and 2006 earnings to arrive at the high end average of $198,000, and averages the 2005 to 2007 earnings to arrive at a low end average of $195,000.
[74] In order to determine goodwill, the VSP approach, according to the evidence, is to subtract the economic salaries from the maintainable earnings in order to determine what amount the partnership earns in excess. However, since VSP calculates maintainable earnings as between $195,000 and $198,000 but economic partner salaries as between $204,000 and $221,000, it concludes that there are no excess earnings.
[75] VSP concludes that since the maintainable earnings are less than the economic partner salaries, there is no goodwill. As a result, it uses the value of the capital assets, namely, $38,237, divided by three, to determine Ishani’s share of $12,746, as detailed in Schedule 1. VSP then applies a higher minority discount of between 20 to 30 percent to Ishani’s share. At page 12 of their report VSP sets forth the factors considered in arriving at this discount number. The final midpoint value calculated is $9,600.
Analysis of Major Differences between the Expert Reports
(a) Economic Partner Salaries
[76] The most contentious issue is the hourly figure used to calculate the partners’ economic salaries. There are difficulties with the assumptions used by both experts.
[77] Kalex assumes a relatively low hourly salary of $35 to $37 per hour. It assumes $5 less per hour for chiropractors, or $30 to $32 per hour. All parties agreed on this differential. Kalex relies on the 2002 and 2006 Compensation Surveys prepared by the Ontario Physiotherapy Association, and specifically the salary figures contained in them for independent contractors.
[78] This assumption fails to account for the wide range of experience that an independent contractor may have or not have. The economic salary is meant to represent the amount that it would cost for the partners to hire someone to replace them, or to perform all their work-related duties as a practitioner and as administrator and business developer.
[79] On cross examination Russell testified that it is only necessary to compensate someone for the bookkeeping and administrative work of an owner if that work is over and above the hourly rate. It was Russell’s opinion that this work was not over and above the hourly rate.
[80] I disagree with this proposition. The range of $35 to $37 per hour is not, in my view, adequate to compensate someone for the additional marketing and managerial functions which are required in a partnership like the one at issue.
[81] It does not seem plausible that someone investing in a partnership like the one in this action, whose success is built on the efforts of the practitioners, would want to rely on a junior or inexperience practitioner to generate partnership revenue. The necessary business and administrative development functions require a person with an additional skill set and range of experience.
[82] The partners cannot simply rely on an entry or mid-level chiropractor or physiotherapist. In addition, as the Respondents submit, independent contractors would receive a percentage of additional pay in lieu of vacation benefits, but those additional benefits are not reported in the hourly rates, as detailed in the email from Kwiatkowski to R. MacLean dated April 28, 2014, and from R. McLean to Kwiatkowski dated April 29, 2014.
[83] There are also difficulties with the revised VSP approach to salary. The revised VSP report relies upon the same surveys, but uses the “owner/manager” column rather than the independent contractor column to arrive at an hourly rate of $59.14 per hour for physiotherapists. A rate of $45 to $50 is used for chiropractors.
[84] The physiotherapy figures in the owner/manager column are in my view too high for a number of reasons. Firstly, many of those who are managers have reached a managerial level after many years of experience, and their pay will likely reflect this level of seniority. I do not accept that it is necessary, however, for someone entering in the role of a partner in Joint Therapy to be at a senior managerial level of experience. Further, for owners, based on the evidence, I find that some of the compensation would in all likelihood account for a return on equity component, or a portion of compensation that represents profit-sharing.
[85] In light of these difficulties I find that an hourly rate between that used in VSP’s initial report and that used in the Kalex report is the most reasonable. The ranges in VSP’s initial report are $50 to $55 for a physiotherapist and $45 to $50 for a chiropractor. In my view, an hourly rate of $45 for a physiotherapist and $40 for a chiropractor is in keeping with the rates of pay experienced by Ishani, Kulasingham, and Hsieh in their other positions at the time of dissolution, and with Ishani’s evidence regarding the amount he paid physiotherapists, once some additional compensation is added in for the business development and administrative functions that would be expected.
(b) Bad Debt
[86] Kalex does not discount the partnership net income for bad debt. VSP, in its revised report, assumes an ongoing actual bad debt expense of 4.3% for professional fees. This percentage is based on a review of the Joint Therapy bank statements and the amount of actual billed professional fees which remain uncollected from Joint Therapy’s inception in 2003 to the closure of the bank account on July 3, 2009. The uncollected amounts owing in 2004 and 2007 were, according to VSP, 9.1% and 8.6%, respectively.
[87] Ishani submits that because the partners on occasion divided cash payments received on the spot and took them home, some payments were never deposited in the bank account and were therefore reported falsely as bad debt by VSP. The parties cannot agree on the extent of his practice.
[88] VSP assumes a bad debt percentage that is quite a bit lower than that reflected by a comparison of fees billed and bank deposits. Some bad debt is inherent and expected in any business. Ishani testified that of the total owed on the nine patient files taken with him when he left Joint Therapy, which was $9,224.49, he was only able to collect $1,755.40. This equals a bad debt expense of 19%.
[89] Russell testified that it was inappropriate to deduct a bad debt percentage given that such bad debt was already written off in the calculation of partnership fees charged. However, the evidence confirms that VSP compared the professional fees with the actual bank deposits made to the Joint Therapy account to calculate bad debt. As a result, there is no likelihood that VSP’s estimate of bad debt is “double counting” the same bad debt. It is therefore appropriate to factor in a bad debt expense. In my view the percentage used by VSP is appropriate.
(c) The Average Income (Weighting or Straight Average)
[90] Kalex uses a weighted average of the adjusted earnings per year in order to determine maintainable earnings. Russell testified that the use of weighting is appropriate only if a business is on an upward trajectory. This, to some extent, is at odds with her testimony that Joint Therapy had stabilized in his last three years and that there was not much fluctuation in earnings. Income figures for 2005-2007 show some fluctuation, but not evidence of such a trajectory. As a result, in my view, a straight average is a more accurate method of arriving at an estimate of maintainable cash flow.
[91] Notwithstanding that I do not accept the theoretical basis for Kalex’s use of the weighted average, the end result is not much different than it would be with a straight average approach. It is the bad debt discount that creates a real difference between the parties’ starting pre-tax cash flow numbers.
(d) The Appropriate Minority Discount Percentage
[92] Another highly contentious factor between the parties is the minority discount percentage to be applied. This has a significant effect on the ultimate value arrived at. Kalex uses a relatively low minority discount rate of 10-15%. VSP uses a 20-30 % discount rate.
[93] Russell in her testimony at times appeared to downplay the factors that go into a minority discount. However, Joint Therapy was a very small business. It had only two independent contractors and one receptionist. There was only one location. The business was not well established, having only been in existence for approximately four years. As well, the nature of the business was such that its income was almost entirely dependent on the skill and business efforts of the partners. On cross-examination Russell agreed that all these factors would influence the discount rate.
[94] Ishani and Russell focused on the idea of the “swing vote,” namely that two partners could create a market for the one-third interest of the third partner and potentially “bid up the value” of Ishani’s share, because they both want to buy it to gain control. However, there was no evidence that this would or did in fact occur.
[95] In addition, such a possibility does not seem to outweigh the serious risk factors outlined above. Kwiatkowski testified that this “swing vote” phenomenon was a possibility, and that VSP had taken it into account in their report, to the extent that there were two other shareholders, and they look at the spread of shareholders when arriving at a minority discount rate.
[96] Russell testified that it was unreasonable for Kwiatkowski to use such a high discount rate with the book value approach. In light of a value based purely on hard assets, and the existence of the Partnerships Act, she testified that an investor could get his or her money out relatively easily, even in the absence of a partnership agreement and even if it cost some money to do so. This litigation demonstrates the difficulty with any assumption that the Partnerships Act can make up for the risk associated with the lack of a partnership agreement, and suggests that a 10-15% discount is too low. I find that in light of all the evidence the VSP bad debt percentage of 20-30% is appropriate.
(e) Goodwill
[97] It is a question of fact whether transferable commercial goodwill exists: Prothroe v. Adams (1977), 1997 14851 (AB KB), 203 A.R. 321 (Q.B.) at para. 338. Kwiatkowski in his report and in oral testimony indicated that there is a two-part test for commercial goodwill. Firstly, excess earnings are required. If there are excess earnings, one needs to consider whether any of that goodwill adheres to the business, or is commercial rather than simply personal in nature. Kwiatkowski concludes that even if there were excess earnings, any goodwill would be personal, in light of the nature of Joint Therapy’s business.
[98] Joint Therapy had just one location. It did not have a high percentage of repeat customers. Further, most customers were doctor referrals. Joint Therapy did not have permanent signage facing the street. There was no real brand transfer.
[99] The Applicant took nine patient files with him. Those files were for the most part those of family members or friends. Therefore the goodwill of those files was personal in nature. However, in considering all of the evidence I find that there is some commercial goodwill and that the goodwill multiplier used by Kalex is appropriate. I find this based in part on my findings with respect to the appropriate economic partner salaries to be used, and my finding that, in light of those salaries, there were excess earnings.
The Appropriate Valuation Method
[100] I find that the Kalex approach of capitalized cash flow is appropriate. I therefore use Schedule 1 of the Kalex report as the starting point. The subsequent analysis is summarized in table form below:
Joint Therapy Fair Market Value at Date of Dissolution
| Range of fair market values | Low | High |
|---|---|---|
| Estimated annual pre-tax cash flow before certain items | 218,200 | 231,600 |
| Less: Econ/market level of expenses | ||
| Mgmt. remuneration | (146,640) | (146,640) |
| Bank charges and interest | (4,722) | (4,722) |
| 66,838 | 80,238 | |
| Less: Income taxes | (20,524) | (21,828) |
| 46,314 | 58,410 | |
| Less: Annual sustaining capital expenditures | (1000) | (2000) |
| Add: Tax shield | 69 | 151 |
| Maintainable discretionary cash flow | 45,383 | 56,561 |
| Capitalized at WACC rates | 3.6 | 4.1 |
| Enterprise business operating value | 163,378.80 | 231,900.10 |
| Add: tax shield on existing assets | 6000 | 6000 |
| Value of business operations | 169,378.80 | 237,900.10 |
| Less: value of structural debt | ||
| bank loan | (25,654) | (25,654) |
| Cash | 11,651 | 11,651 |
| 155,375.80 | 223,897.10 | |
| Calculated FMV of Joint Therapy, rounded | 155,000 | 224,000 |
| Midpoint | 189,500 | 189,500 |
| Ishani’s share | 63,166.67 | 63,166.67 |
| Less: Minority discount of 20-30% | (12,633.33) | (18,950) |
| 50,533.34 | 44,216.67 | |
| Calculated FMV of Ishani’s share, rounded | 50,500 | 44,200 |
| Midpoint | 47,350 |
[101] In addressing bad debt, the “Estimated annual pre-tax cash flow” needs to be adjusted for bad debt. If the low of $228,000 and the high of $242,000 are reduced by 4.3%, a reduction of $9,800.00 and $10,400 respectively, the new low is $218,200 and the new high is $231,600.
[102] In addressing management remuneration, an appropriate hourly rate for a physiotherapist is $45 and $40 for a chiropractor. Using those figures, the economic salary for two physiotherapists and one chiropractor each working 1128 hours per year would be $146,640. This figure would replace Kalex’s estimate for management remuneration of $113,000 to $120,000.
[103] Using the new starting estimate for annual pre-tax cash flow, and subtracting the new management remuneration figures, but keeping all of the numbers the same, the new maintainable discretionary cash flow figures would be a low of $45,383 and a high of $56,561.
[104] Once again keeping all of the numbers the same, the fair market value low (rounded) would be $155,000 and the high (rounded) would be $224,000. The midpoint is $189,500. Ishani’s one third of this amount would be $63,166.67. A minority discount of 20% would result in a deduction of $12633.33. A discount of 30% would result in reduction of $18950. The resulting fair market value of Ishani’s one third share is between $50,500 and $44,200. The midpoint value is therefore $47,350.
[105] The Respondents claim that the Applicant’s share should be subject to a set-off for the unpaid fees owing from the nine patient files the Applicant took with him when he left the Joint Therapy premises, in the amount of $8,348.
[106] The Applicant’s evidence at trial, however, was that of that amount owing he has only been able to collect $1,755.40. Given the time that has passed, it is unlikely he will now be able to collect any more of the fees outstanding. The Applicant should not have to account to the Respondents for receivables that were not collected.
[107] In valuing the partnership I have already factored in a bad debt percentage to account for such uncollected receivables. Accepting the Applicant’s evidence that the amount collected was $1,755.20, two-thirds of that amount, or $1,170.26, properly represents the Respondents’ share. As a result I find that the amount owing to Ishani for his one-third share of Joint Therapy on the evidentiary record is $46,179.74.
Disposition
[108] I order that the Applicant is entitled to payment of the sum of $62,246.68 from the Respondents on a joint and several basis. I encourage the parties to agree on the issue of pre-judgment interest and costs. If they cannot I may be contacted in order to set a time table for their delivery.
[109] I wish to thank both counsel for the professional and cooperative manner in which this case was presented, in the finest traditions of the bar.
Firestone J.
Released: December 19, 2014
ONTARIO
SUPERIOR COURT OF JUSTICE
BETWEEN:
HANIF ISHANI
Applicant
– and –
RENUKA KULASINGHAM and WILLIAM HSIEH
Respondents
REASONS FOR JUDGMENT
Firestone J.
Released: December 19, 2014
[^1]: These figures were arrived at by taking the professional fees of $226,028 provided in Schedule 4 of the Kalex report and dividing it by the seven months for a total of $32,289.71, and the professional fees of $218,482 in Schedule 4 of the VSP revised report and dividing it by seven months for a total of $31,211.71. The VSP revised report at page 8 indicates that the differences between the two expert reports’ figures arise because each of the experts was working from totals provided to them by their respective clients, and those totals do not match.