The First Hall of the Civil Court, presided over by Madame Justice Lorraine Schembri Orland, on November 19, 2013, in “Edward Engerer v Richard Attard and Hermann Depasquale”, held, among other things, that on his resignation from a partnership, a partner was entitled to demand the liquidation of his share. In this case, in absence of accounting records, the court calculated the share on an arbitrio boni viri basis.
The facts in this case were as follows.
Edward Engerer was a partner in the audit firm Richard J. Attard & Co., together with Richard Attard and Herman Depasquale. After resigning on April 30, 1999, from the partnership, he requested defendants to liquidate and pay him his final share for the period January 1, 1997, to April 30, 1999. He claimed to be entitled to 25 per cent of the earnings of the association.
In absence of any amicable settlement, he proceeded to file legal proceedings against his ex-partners asking the court:
1) to declare that he was entitled to his 25 per cent share from January 1, 1997, to April 30, 1999; and,
2) to liquidate and to condemn his ex-partners to pay him such amount.
Attard and Depasquale, in reply, pleaded that this legal action was prematurely filed and should be dismissed.
They contended that Engerer’s share in the partnership could not be calculated as they still had to collect unpaid invoices and pay certain expenses.
It was stated in their defence that it was not correct that Engerer had a 25 per cent stake in the partnership. Allegedly, the arrangement between them was more complex. They argued that his share could be liquidated only after the partnership’s debts were settled, including general office expenses, salaries, taxes, NI contributions, as well as the firm’s overdraft facility from APS Bank was paid off.
Engerer retained his computer as well as certain payments made by clients of the partnership.
It was not in dispute that his computer was valued at Lm300 and that he was paid Lm2,161 directly by clients of the partnership for services he had rendered.
Engerer submitted that he requested a copy of the accounts of the partnership for the relative period but this was not forthcoming, as the defendants refused to cooperate. Though the defendants did not contest Engerer’s right for payment of his share, they made it difficult for him to determine the amount actually due to him.
The court accordingly, proceeded to calculate the share due to Engerer on an arbitrio boni viri basis, that is, on the basis of the net income of the partners.
Legal considerations: The parties were partners of the audit firm. They disagreed on the rate of Engerer’s participation. Articles 1644 and 1645 of the Civil Code provide:
“Partnership is a contract whereby two or more persons agree to place a thing in common, with a view to sharing the benefit which may derive therefrom.
(1) Every partnership must have a lawful object, and must be contracted for the common interest of the parties.
(2) Every partner must contribute either money or other property, or his skill.”
According to article 1253 (f) of the Civil Code, the partnership deed had to be in writing, which had to be signed by all the partners. In this case, there was no written deed. The partners pooled their earnings from their professional work and distributed profits.
Attard was in charge of the administration of the association. They had an agreement on the contributions and the division of profits among the partners. The court noted that according to case-law, the pooling of earnings created a state of co-ownership between the partners, re. Guiseppe Zammit v Carmelo Zahra dated November 14, 1958 (kum).
It was necessary for the partner who looked after the books to give a regular account on the activities of the partnership. It was not fair for this partner to act in a manner which was prejudicial to others; re Giovanni Lanzon v Giuseppe Vella App.Civ. dated January 12, 1948.
Engerer had a right to demand to have a copy of the accounts and to have his share liquidated and this on the basis of the principle that no one was obliged to remain in a state of co-ownership, according to article 496 of the Civil Code.
The court said that in this case, there was a state of co-ownership between the parties, which could be terminated by a request for a dissolution and eventual liquidation. The process of liquidation involved the computation of the value of the partner’s share and the value of the initial financial contribution of the partners when the association was set up.
Engerer had a right to request its dissolution and the liquidation of his share, including his initial contribution. The burden of proof, however, rested upon him. The court noted that Engerer brought some clients when he joined the firm and, when he left, he retained most of his clients. He retained a computer valued at Lm300 and profits (Lm2,161). The firm had outstanding fees amounting to Lm11,482.
The court felt that Engerer was entitled to a rate of participation of 25 per cent. Reference was made to Spicer & Peglar’s Book-Keeping and Accounts:
“Accrual concepts: Revenue is included in accounts when earned rather than when money is received. Costs are included when incurred rather than when paid. Revenues dealt with in the profit and loss account are then matched with associated costs in order to determine profit.”
The court said that in this case, there was a state of co-ownership between the parties, which could be terminated by a request for a dissolution and eventual liquidation. The process of liquidation involved the computation of the value of the partner’s share and the value of the initial financial contribution of the partners when the association was set up
“Under cash-basis accounting, revenue is recorded when cash is received, regardless of when it is actually earned. Therefore, cash-basis accounting does not link recognition of revenues and expenses to the actual business activity, but rather the exchange of cash. In addition, by recording only the cash effect of transactions, cash-basis financial statements may not reflect all of the assets and liabilities of a company at a particular date. For this reason, most companies do not use cash-basis accounting.
“Accrual-basis accounting is superior to cash-basis because it links income measurement to selling, the principle activity of the company. In contrast to cash basis accounting, accrual accounting is a more complex system that records cash and non-cash transactions.”
According to accounting principles, a trader’s books had to observe ‘matching’ and ‘accruals’, and the books had to be kept on the basis of the principles of accrual accounting and not cash accounting. Cash accounting did not include fees which were not paid and did not include costs if no invoice was received.
The defendants admitted that management accounts were not kept and refused to provide Engerer with a copy of the accounts. The court said that a professional audit firm was obliged to keep accounts for the purpose of taxes and VAT, and the reluctance of defendants to provide a copy of the profit and loss accounts and balance sheet for the period in question was not acceptable, as they were obliged to provide this information to the Tax and VAT authorities.
In this respect, it was impossible for Engerer to produce proof in order to establish his share, as this information was under the control of defendants. Engerer, in this respect, had no other alternative but to request a liquidation on an arbitrio boni viri basis.
On a monthly basis, each partner took drawings on account. The total income for distribution between the partners was Lm40,490 and it was reasonable for this amount to increase at the rate of 10 per cent. A further amount (€10,000) was added to include the value of work in progress.
The court noted that Engerer was obliged to contribute € 7, 619 for the loan taken by the partnership. It also deducted the amounts paid to him during this period. He was also entitled to claim back € 6, 522 from Attard, in respect of the Lm400 monthly payment made by the association to Attard’s company.
For these reasons, on November 19, 2013, the court declared that Engerer was entitled to a share of earnings at the rate of 25 per cent. It liquidated the amount due from defendants on an arbitrio boni viri basis (€15,233) in equal portions and a further amount of €6,522 from Attard only.
Any balance owing to loans from APS Bank remained the exclusive responsibility of defendants and any balance of unpaid fees from clients not working with Engerer would remain for the exclusive benefit of defendants. The court ordered Attard and Depasquale to pay in equal portions €15,233 and, in addition, condemned Attard to pay Engerer a further €6,522 with legal interests from the date of this decision.
Dr Karl Grech Orr is a partner at Ganado Advocates.