Partnership Contract Member Dismissal and Settlement Payment: Goodwill Valuation Methods in South Korea

1. Concept of Partnership Contracts and Member Dismissal

Various forms of disputes frequently occur in partnership relationships in South Korea. Conflicts that arise during joint business operations can be broadly divided into two categories.

First, cases where partners commit clear criminal acts such as embezzlement or breach of trust involving partnership assets. In such cases, dismissal of the partner is relatively clear and easily recognized. Since there are objectively evident illegal acts, proving the existence of ‘legitimate grounds’ presents no significant difficulty.

Second, cases where partners continuously clash due to inability to reach consensus. The question here is whether a partner can be dismissed based solely on differences of opinion. Legal judgment is required regarding whether dismissal is possible in situations where trust relationships have broken down, even without specific criminal acts or clear contract violations.

Partnership contracts are a form of association contract under South Korean Civil Law, where multiple parties contribute capital and jointly operate a business for common purposes. In the case of medical institutions, several doctors jointly establishing and operating a hospital represents a typical partnership contract.

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

When a member is dismissed from a partnership contract, that member withdraws from the partnership and consequently gains the right to receive settlement payment corresponding to their share of partnership assets. The calculation method and scope of settlement payments often become core issues in disputes.

2. Legitimate Grounds for Member Dismissal

Cases with Clear Illegal Acts

When partners commit clear criminal acts such as embezzlement or breach of trust involving partnership assets, this naturally constitutes legitimate grounds for dismissal. In such cases, objective evidence is clear, so proving the legitimacy of dismissal presents no significant difficulty.

Dismissal Due to Breakdown of Trust Relationships

A more complex issue arises when trust relationships have broken down due to continuous conflicts and disagreements between partners, even without clear criminal acts or contract violations. The ‘legitimate grounds’ under Article 718, Paragraph 1 of the Civil Act are not limited only to cases where members have clear culpable reasons.

Court precedents hold that cases where conflicts and discord between members lead to fundamental damage to trust relationships, making smooth joint operations impossible, are also included as legitimate grounds.

Criteria for Determining Legitimate Grounds

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

• Degree of interference with achieving partnership objectives
• Availability of alternative means to remove interference
• Contract content and duration
• Circumstances leading to dismissal

Conflicts During Contract Renewal Negotiations

Conflicts arising during negotiations for contract renewal after the partnership contract’s stipulated period expires can also constitute legitimate grounds for dismissal. Particularly when minority shareholders unilaterally oppose or change their positions regarding reasonable amendments proposed by majority shareholders, preventing agreement, this can be viewed as reaching an objective state where maintaining the partnership relationship is difficult.

Courts view dismissal actions in partnerships as measures for smooth operation of partnerships, which are personal associations based on trust. Therefore, when objective circumstances exist where continuing the partnership relationship is difficult due to destroyed trust relationships from conflicts and discord between members, recognizing the legitimacy of dismissal actions is appropriate.

3. Settlement Payment Calculation Upon Partnership Withdrawal

Occurrence of Settlement Payment Obligations

When a member withdraws from a partnership contract due to dismissal resolution, remaining members have an obligation to pay settlement amounts corresponding to the withdrawing member’s share value of partnership assets, evaluated based on the partnership asset status at the time of withdrawal.

Article 727 of the Civil Act stipulates: “When a member withdraws, the value of their share shall be determined based on 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 payments 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

Particularly, whether goodwill is included significantly affects the scale of settlement payments, making it an important practical issue.

4. Inclusion of Goodwill in Partnership Assets

Concept and Characteristics of Goodwill

Goodwill refers to intangible assets representing a business entity’s earning power that exceeds the normal profit rate of similar enterprises. In the case of medical institutions, reputation, technical expertise, know-how, and customer base constitute elements of goodwill.

Principle of Goodwill Inclusion

Court precedents hold that goodwill should naturally be included when evaluating shares upon a member’s withdrawal from a partnership relationship. However, goodwill can be excluded by agreement between parties, but the burden of proof lies with the person asserting such exclusion.

Requirements for Goodwill Recognition

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

• Sustained growth and maintenance of considerable reputation
• Achievement of high sales and operating profits
• Systematized operations beyond individual capabilities
• Stability unaffected by withdrawal of one member

In actual cases, courts recognized the existence of goodwill, noting that hospitals maintained sustained growth, considerable reputation and scale, and achieved high sales and operating profits since opening. The court determined that such achievements resulted not only from individual doctors’ capabilities but also from intangible assets including reputation, technology, know-how, and systems unaffected by withdrawal of one member.

5. Goodwill Valuation Methods

Various Valuation Methods

Several methods exist for goodwill valuation, with major ones including:

• Discounted Cash Flow (DCF) method
• Valuation method under Inheritance and Gift Tax Act Enforcement Decree
• Net asset value method
• Earnings value method

Application of Discounted Cash Flow Method

Courts held that stock valuation methods for unlisted corporations can be applied by analogy when evaluating assets of profit-seeking partnerships, but no single valuation method must always be applied. The partnership’s circumstances and industry characteristics must be comprehensively considered.

For businesses continuing operations after some members withdraw, valuation methods reflecting future earning capacity are appropriate. Particularly for medical institutions with significant goodwill and intangible assets, the discounted cash flow method, which adequately reflects goodwill and future earning capacity, best represents partnership asset value.

Limitations of Inheritance Tax Law Valuation

Valuation methods under the Inheritance and Gift Tax Act have limitations, being based only on financial data from the past three years and reducing goodwill valuation when equity capital is large. For hospitals with large sales and operating profit scales, this method has limitations in adequately reflecting future earning capacity.

6. Deductions in Settlement Payment Calculation

Handling Damages from Partnership Operations

When damages (settlement amounts) from accidents during partnership contract operations must be paid, how to handle these in settlement payment calculations becomes an issue. Generally, partnership contracts stipulate that accident liability is shared proportionally by ownership shares. However, when separate agreements exist between parties, these must be considered with priority.

In actual cases, the plaintiff’s own statement “I think the responsibility is too heavy for me to bear, so I should handle it” was recognized as agreement to bear the entire settlement amount, leading to deduction of that amount from settlement payments.

Other Deduction Items

When calculating settlement payments, review is needed regarding whether the following items can be deducted:

• Income taxes and other taxes (generally not deductible as individual payment obligations)
• Accounts receivable or accounts payable
• Debts borne by individual members

7. Simultaneous Performance Defense and Practical Considerations

Recognition of Simultaneous Performance Defense

Simultaneous performance defense can be recognized regarding settlement payment obligations upon member withdrawal. When withdrawing members hold real estate shares registered under partnership names, the obligation to transfer registration of such shares and settlement payment obligations are related with reciprocal meaning, constituting simultaneous performance relationships.

Registration Transfer Obligations

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

Limitations on Delay Damages

For debts in simultaneous performance relationships, no liability for delay exists until the other party provides performance of their debt. Therefore, even if settlement payment debt performance periods arrive, delay damages cannot be claimed without withdrawing members providing registration transfer obligation performance.

Practical Considerations

When concluding partnership contracts, clearly stipulating the following matters is advisable:

• Settlement payment calculation methods upon withdrawal
• Whether goodwill is included and valuation methods
• Sharing methods for contingent liabilities such as medical accidents
• Handling methods for registered assets such as real estate
• Settlement payment timing and methods

8. Conclusion

Member dismissal in partnership contracts is recognized not only when clear criminal acts exist but also when legitimate grounds such as breakdown of trust relationships exist. Even simple disagreements can constitute legitimate grounds for dismissal when conflicts and discord between members fundamentally damage trust relationships, making smooth joint operations impossible.

Settlement payments 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. When special circumstances such as medical accident settlement amounts exist, 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 contract conclusion. Particularly, pre-agreeing on goodwill inclusion and valuation methods, contingent liability sharing methods, etc., can significantly prevent future disputes.

K&P Law Firm has been performing extensive advisory services related to partnership contracts, including successfully advising on complex matters related to goodwill valuation and settlement payment calculation in recent partnership contract disputes in South Korea.