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McLelland v. Paxton

Court of Appeals of Washington, Division 3

November 21, 2019

BRYAN W. McLELLAND, D.D.S. and KRISTA McLELLAND, husband and wife, and the marital community composed thereof, and BRYAN W. McLELLAND, D.D.S., P.S., a Washington professional services corporation, Respondents,
v.
MARK C. PAXTON, D.D.S. and DIANE S. PAXTON, husband and wife, and the marital community thereof, and MARK C. PAXTON, D.D.S., P.S., a Washington professional services corporation, Appellants.

          Fearing, J.

         We review a complicated dissolution, between two oral surgeons, of a professional limited liability company, which review includes the question of whether such a company can possess goodwill separate from the professional practitioners. We affirm all rulings of the trial court, including the finding of goodwill, except that we reverse the grant of prejudgment interest afforded respondent Bryan McLelland on the assets awarded him.

         FACTS

         Respondent Bryan McLelland is and appellant Mark Paxton was an oral and maxillofacial surgeon. Paxton died during the pendency of this appeal, and this court substituted the Estate of Mark Paxton as appellant. We will, however, still refer to the appellant as Mark Paxton. The facts of this appeal become complicated because of the various corporations and limited liability companies utilized by Paxton and McLelland when conducting an oral and maxillofacial practice. Despite the use of other business structures, the parties sometimes treat the dispute as one between partners. The parties alternatively label the dispute as centering around the dissolution of a professional limited liability company owned by corporations maintained by McLelland and Paxton or centering around the dissolution of a partnership between McLelland and Paxton. The parties alternatively refer to the relevant claimant as Bryan McLelland or McLelland P.S. and alternatively call the appellant Mark Paxton or Paxton P.S.

         In March 2003, Mark Paxton hired Bryan McLelland as an associate in Paxton's oral surgery practice. In March 2005, McLelland and another associate, Melanie Lang, each through his or her individual professional service corporation, respectively purchased a one-third interest in Paxton's practice also owned by Paxton in a professional services corporation. We identify the three professional service corporations as Paxton P.S., McLelland P.S., and Lang P.S. McLelland P.S. and Lang P.S. each paid Paxton P.S. $619, 835, for a total of $1, 239, 670, to purchase the interests in the oral surgery practice.

         On March 25, 2005, the parties entered executed acquisition agreements to consummate the purchases. Under the agreement between McLelland P.S. and Paxton P.S., McLelland P.S. purchased an undivided interest in the assets of Paxton's practice, "including equipment, furniture, and fixtures, accounts receivable, supplies, one of the buildings in which the practice is operated, goodwill, and patient files." Clerk's Papers (CP) at 2215 (emphasis added). $261, 667 of the $619, 835 purchase price paid by McLelland was allocated for the practice's goodwill. The acquisition agreement entered by Lang P.S. possessed similar language.

         To define the rights and responsibilities attended to the three oral surgeons' interests in the oral and maxillofacial practice, the three professional services corporations entered into a partnership agreement. We quote relevant portions of the lengthy partnership agreement, replete with a table of contents, entered by Paxton P.S., McLelland P.S., and Lang P.S. The terms of the agreement control some of the issues on appeal. The agreement, with a penchant for capitalization, read:

Unless otherwise agreed by the Parties and Shareholders, however manifested or evidenced, the goodwill of the Partnership shall be owned, or considered owned, by the Shareholders, in undivided interests, based on Percentage Ownership of the Partnership.

CP at 45 (emphasis added). The partnership agreement prohibited transfer to a third party of

any interest in the "contract receivables" (oral and maxillofacial surgery contracts in progress), accounts receivable, patient records, or goodwill of the practice, the Partnership, any of the Parties, or any of the Shareholders.

CP at 47 (emphasis added). The partnership agreement also declared that the partnership could

be terminated on at least six (6) months' notice by any of the Parties, at or after the Initial Term, however, the termination date must correspond to an anniversary hereof.

CP at 35. The partnership agreement further read:

It is hereby acknowledged by the Parties and Shareholders that no definite and equitable methodology presently exists for dividing the jointly owned Practice Interests of the Parties and Shareholders, upon termination of this Agreement, for any reason. The Parties and Shareholders further appreciate that future economic and financial uncertainties further make it impossible to define such a methodology. Consequently, upon the termination of this Agreement, and the necessary division of the jointly owned Practice Interests, the Parties agree to negotiate, in good faith, so to divide such jointly owned Practice Interests. Further, the Parties will then determine which of the Parties will continue to practice at each of the places of business of the Partnership.

CP at 79.

         The partnership agreement provided, in pertinent part:

         Default; Dissolution and Reconstituting.

A. Default Defined. It is agreed that upon the occurrence of any of the following events, constituting defaults, this Agreement may be dissolved, either during the Initial Term, or any annual renewal period, at the option of the non-defaulting Party or Parties, except for those provisions expressly intended and provided for to survive. Such events are as follows:
(viii) Claim Against Other Parties or Shareholders. Any of the Parties or any of the Shareholders shall take any action, or fail to take any action, which results in any material claim, suit, or action being filed, or threatened or asserted in any way against any of the other Parties or Shareholders, except fully insured malpractice claims (the deductible of which shall be paid by the Party or Shareholder who treated the patient making such malpractice claim), or which results in any material damage to or material liability of any of the other Parties or Shareholders.

CP at 50-52.

         One partnership agreement paragraph addressed an award of prejudgment interest. The paragraph reads:

B. Interest on Unpaid Monies. Whenever herein it is provided that a Party or a Shareholder shall pay any sums of money, either to any of the other Parties or other Shareholders, or to third parties, including, but not limited to . . . all other sums required to be so paid hereunder, or under the terms of any other documentation entered into in connection herewith, notwithstanding any contrary terms thereof, if any of such sums are not paid, as and when due and payable to the other Parties or Shareholders, or to third parties, if the other Parties or Shareholders, in the case of sums being owed to third parties, shall be then, or at any time thereafter, required to pay the sums owed by such Party or Shareholder by whom such sums are owed, to any such third party, for any reason, including as a result of being jointly or severally liable for the payment of all or any portion of such sums, or in order to protect their own interests or assets, and including any pension plan for the benefit of employees, such sums shall bear interest at the highest lawful rate, from the due date, until paid.

CP at 82-83. Finally, a closing paragraph declared:

If any action at law or in equity is necessary to enforce the terms of this Agreement, the prevailing Party or Parties, or Shareholder or Shareholders, shall be entitled to reasonable attorneys fees and costs, in addition to any other relief to which entitled.

CP at 83.

         In late 2005, after briefly existing as Paxton, Lang, and McLelland Oral and Maxillofacial Surgery Partnership, the three oral surgeons changed the business entity that conducted the surgery practice from a general partnership to a professional limited liability company, Spokane OMS, PLLC. Spokane OMS thereafter conducted business under the trade name Spokane Oral & Maxillofacial Surgery. Despite the formation of a limited liability company, the partnership agreement remained the governing document for the relationship between the three surgeons and their respective professional services corporations. The record does not show that they executed any operating agreement for the professional limited liability company or that the oral surgeons or any of their corporations entered any new agreement on the formation of the limited liability company.

         Spokane OMS maintained two office locations in 2005: a Spokane Valley office and a South Hill office. Melanie Lang and Bryan McLelland created a separate entity, SOMFS Property Holdings, LLC when they purchased interests in the oral and maxillofacial practice. SOMFS bought a two-thirds interest in the Spokane Valley building, while Paxton P.S. held the remaining one-third interest.

         Mark Paxton and his wife, Diane Paxton, owned a 20 percent interest in South Stone, LLC, which originally leased the South Hill location of the oral and maxillofacial practice to Paxton P.S. After McLelland P.S. and Lang P.S. acquired an interest in the practice, Spokane OMS paid rent to South Stone for the South Hill location. In 2008, the three doctors' respective professional service corporations purchased a fractional interest in a third building, a Post Falls, Idaho office, owned principally by another entity. The practice opened a third location for the oral and maxillofacial practice in the Post Falls office building.

         In June 2014, McLelland P.S. and Paxton P.S. each paid Lang P.S. $265, 000, including $121, 250 in goodwill, to purchase her interest in the practice. The three surgeons agreed to a discounted price for Lang's interest after McLelland and Paxton demanded that Lang exit the practice "for significant reasons." Report of Proceedings (RP) at 87. The record does not disclose those reasons. As a consequence of the purchase of Lang P.S.'s interest, Paxton P.S. and McLelland P.S. each owned an undivided one-half interest in the assets of Spokane OMS, PLLC. Following Lang's departure, McLelland and Paxton continued to operate the practice from the three separate locations.

         Bryan McLelland and Mark Paxton also encountered unknown irreconcilable differences and began to discuss separation and division of assets. On August 4, 2014, Bryan McLelland, through counsel, sent a letter to Mark Paxton's counsel declaring McLelland's intent to dissolve Spokane OMS in six months, as allowed by the partnership agreement. The lengthy letter also responded to an offer by Paxton with regard to a division of the professional limited liability company's assets. Consistent with the partnership agreement, the two surgeons began negotiating the division of the practice's assets, including assignments to the surgeons of the locations where the limited liability company held offices. Under the terms of the partnership agreement, the oral and maxillofacial partnership contractually dissolved on February 28, 2015, six months after Bryan McLelland gave his notice.

         On June 23, 2015, Bryan McLelland's counsel sent a letter to South Stone, LLC requesting that South Stone lease, in part, the oral and maxillofacial practice's South Hill location to McLelland, P.S. South Stone declined the request. Accordingly, McLelland's and his corporation's ability to practice at the South Hill location ended.

         PROCEDURE

         On January 28, 2015, Bryan McLelland and McLelland P.S. sued Mark Paxton and Paxton P.S. for breach of contract, detrimental reliance, negligent misrepresentation, breach of the implied duty of good faith and fair dealing, and breach of fiduciary duties. As part of the action, Bryan McLelland and his corporation sought dissolution of Spokane OMS, PLLC. On March 20, 2015, the superior court, by stipulated order, judicially dissolved the partnership of McLelland P.S. and Paxton P.S. pursuant to RCW 25.15.275, a former limited liability company statute. On that same day, the superior court appointed a receiver to supervise the winding down process and to preserve the professional limited liability company's business as a going concern for a reasonable period of time until a final division of Spokane OMS's assets and liabilities between the owners of the company and until Mark Paxton and Bryan McLelland could practice separately. After the judicial dissolution, Paxton P.S. and McLelland P.S. continued to utilize the limited liability company's assets, including its equipment, location, employees, name, website, and phone number. The two surgeons divided the staff and files by agreement and continued to practice in the same three locations. Meanwhile, the parties continued to negotiate details of the dissolution, including locations of the respective practices.

         In May 2015, without advance notice, South Stone, LLC, owned in part by Mark Paxton, evicted Spokane OMS and McLelland P.S. from the South Hill office. South Stone then entered into a new long-term lease with Paxton P.S. for the location.

         On November 24, 2015, Mark Paxton and Paxton P.S. asserted counterclaims against Bryan McLelland and McLelland P.S. for (1) interference with contractual relationships, (2) breach of contract for refusing to provide financial contributions as agreed by the parties, (3) invasion of privacy for intentionally intercepting and converting e-mail communications between Paxton P.S. and its employees and between Dr. Paxton and South Stone, LLC, (4) infringement of intellectual property rights in a logo and tradename, (5) breach of fiduciary duty and self-dealing because of McLelland's treatment of patients with a device and treatment protocol named NuCalm, in which McLelland owned an interest, (6) and breach of the duty of good faith and fair dealing in failing to inform Paxton of McLelland's ownership interest in NuCalm and American Healthcare Lending. On March 18, 2016, Bryan McLelland and McLelland P.S. amended their complaint to include an allegation of constructive fraud against Mark Paxton and Paxton P.S. for evicting McLelland from the South Hill office.

         Before trial, the parties presented competing motions for summary judgment. The trial court granted McLelland P.S.'s motion for partial summary judgment that determined Paxton P.S. breached the partnership agreement, breached its fiduciary duties, and committed constructive fraud by evicting Spokane OMS and McLelland P.S. from the South Hill location in June 2015. A summary judgment order read that McLelland P.S. withdrew its claims against Paxton P.S. for three incidents of alleged theft of patients and for the alleged theft of $100, 000.

         As part of the competing summary judgment motions, Paxton P.S. moved for partial summary judgment on the issue of whether McLelland P.S. can recover an amount for the goodwill of Spokane OMS as part of the limited liability company dissolution. Paxton argued that, as a matter of law, the oral and maxillofacial practice lacked any goodwill after February 28, 2015, because the limited liability company was dissolved and was no longer a going concern. The trial court ruled that the existence and value of goodwill of Spokane OMS raised questions of fact, and the court thereby denied the summary judgment motion.

         The remaining claims and counterclaims went to trial. Mark Paxton and Bryan McLelland reached a settlement agreement on the second day of trial regarding the logo and name of the practice, with Paxton agreeing to pay $20, 000 for the rights to both. The principal questions at trial surrounded the existence and value of goodwill of the practice.

         Bryan McLelland called to testify valuation expert Lenore Romney. Romney testified that the oral and maxillofacial practice had enterprise goodwill that an appraiser could value on a going concern basis. Romney averred:

[McLELLAND COUNSEL:] And then the-the very next sentence in that same paragraph, you state, "Since the assets would continue in use, my opinions represent fair market value on a going concern basis.'" Can you explain that opinion to this court?
[ROMNEY:] So we-we have a unique situation in-in this-in this case. It's unlike a-a corporation that we might value where all of the assets are owned by the business we're valuing, okay? So in this case, the way the parties set it up is Dr. Paxton's professional corporation sold undivided interests in these practice assets to the individual, Dr. Lang and Dr. McLelland's, professional corporations; but then they have a separate entity that's administering the practice affairs, and that entity doesn't own any of these assets. So it's-it's unlike maybe what you might think of as the typical situation. So these assets that we're talking about that have to be-that are still owned in undivided interest, that now we have to figure out what to do with that comprise the assets in use at the practice locations, are actually owned in Dr. McLelland's PC and Dr. Paxton's PC in undivided interest. So the only way we can really think about them is that the assets are at the locations, that that's what comprises the [S]OMS practice; we have three locations, and all the assets that were originally acquired by Dr. McLelland in 2005 are still all in use at those offices today.
And so that's what "going concern" means, is that you're going to continue using these assets. And so this entity, the PLLC that ends up dissolving after they're not going to practice together anymore, is irrelevant, because it never owned the assets in the first place. So-but that doesn't mean that the assets inside of the two docs' professional corporations, they are still being used, they are continued to use. So from the [S]OMS practice standpoint, it's still a going concern, those assets are being used.

RP at 273-74 (emphasis added). Romney testified that many of the same features that the practice had on February 28, 2015, still existed at the time of trial:

[T]he locations are still being used; ... the name that the practice calls itself... is still... a presence; the website is still active; the phone numbers are still in use; and . . . many of the same . . . staff are still working at the offices; and ... the systems and the procedures that the parties used before [the] 3/1/2015 [dissolution] are still being used.

RP at 267.

         Lenore Romney declared that the value of goodwill of the oral and maxillofacial practice could be calculated by assessing a discrete value for each of the three practice locations. While relying on a fair market approach, Romney calculated a goodwill value of $821, 760 for the Valley office, $503, 470 for the South Hill office, and $497, 158 for the Post Falls office, for a total goodwill value of $1, 822, 388. Romney relied on "value indications" from the 1999 practice prospectus for Mark Paxton's solo practice, the goodwill value used for the McLelland P.S. and Lang P.S. 2005 purchases of an undivided interest in the practice, the McLelland P.S. and Paxton P.S. 2014 purchase of the Lang P.S. interest in the limited liability company, and the 2014 Goodwill Registry, a recognized industry source that reports on sales of professional practices. By employing the 2005 purchase price, Romney determined that patient files represented 8.1 percent and goodwill represented 25.3 percent of the value of the practice. When combined, the two components equaled a total intangible value of the practice of 33.4 percent. Romney then identified the net practice production for each office and multiplied that number by 8.1 percent for the patient files. She then took the net production for each office and multiplied that number by 25.3 percent for goodwill. Adding the two components, Romney reached the total value of the practice to be $1, 822, 388.

         Dr. Mark Paxton presented two valuation experts. Expert Charles Wilhoite disputed Lenore Romney's conclusions that entity goodwill existed, and he argued that her failure to consider the earnings of the practice invalidated her opinion. Wilhoite testified:

I didn't think there was any material level of institutional goodwill based on the fact the practice wasn't generating earnings sufficient enough to pay the practitioners at a level equal to market-based compensation.

RP at 472.

         Mark Paxton's second expert, Scott Martin, valued only Spokane OMS, PLLC, which purportedly held no assets itself, an anomaly that neither party mentions in this appeal. On cross-examination, Dr. McLelland's attorney asked Martin:

[COUNSEL:] ... I take it since you were valuing the PLLC and instead of the entities that the assets were held in, you weren't aware that the assets were actually owned in undivided interest by Dr. McLelland and Dr. Paxton in their professional service corporations; is that a fair conclusion?
[MARTIN:] I would say I didn't think about it that way when I was doing my valuation, yes.

RP at 552. Martin also admitted that he did not perform any valuation of assets of the practice as they existed as of February 28, 2015, the date of contractual dissolution. Nevertheless, Martin, even without considering the assets owned by the parties' professional service corporations, valued the practice's goodwill at $148, 111 in 2013. He also found that, on April 30, 2014, the three locations of the practice comprised entity goodwill totaling $206, 548. Because Martin believed that the practice lacked any goodwill after dissolution, he failed to provide any valuation for the practice's goodwill on or after February 28, 2015.

         During his counsel's closing argument, Mark Paxton raised, for the first time, a contention that Bryan McLelland violated the partnership agreement by prematurely filing the lawsuit. According to Paxton, a partner in the practice could not sue for a division of assets until after the professional limited liability company dissolved under the terms of the partnership agreement. Spokane OMS was contractually dissolved on February 28, 2015, but McLelland filed suit on January 28, 2015. Counsel intoned during summation:

So if you go to Plaintiffs Exhibit 4, A at page 21, it defines default and it basically says these are some of the things that can be default and it lists out a number of them. Well, one we 've never talked about in this case is at page 22-23 in Section 7-(viii), "Claims Against Other Parties or Shareholders." It states, "Claim against other Parties or Shareholders. Any of the Parties or any of the Shareholders"-and this is what-if they do it, it's a bad thing-"shall take any action, or fail to take any action, which results in any material claim, suit, or action being filed or threatened or asserted in any way against any of the other Parties or Shareholders. . ." The plaintiffs jumped the gun. They filed their lawsuit before the dissolution had occurred.

RP at 805 (emphasis added) (alteration in original).

         The trial court issued a letter ruling. In the ruling, the trial court concluded that entity goodwill existed as of February 28, 2015. The court deemed location to be a critical factor in the goodwill value of the practice. The trial court adopted the goodwill value by location opined by Lenore Romney and thus attached a total value of goodwill for the practice at $1, 822, 388, to be split between the parties depending on the location or locations awarded each.

         In the letter ruling, the trial court awarded McLelland P.S. the Post Falls location and Paxton P.S. the South Hill and Valley locations. To ensure an equal distribution of the total value of goodwill at the three practice locations, the trial court ordered Paxton P.S. to pay McLelland P.S. $414, 036 as an equalization payment. The trial court also awarded 12 percent prejudgment interest on the equalization payment beginning August 4, 2014, to remedy Paxton P.S.'s use of its partner McLelland P.S.'s assets "without remuneration." CP at 3089-90. The trial court granted Paxton P.S.'s claim for reimbursement for certain expenses at the Spokane Valley office and ordered McLelland P.S. to pay Paxton P.S. $7, 587.99 for those expenses.

         The trial court denied the following claims asserted by Mark Paxton against Bryan McLelland: (1) breach of fiduciary duty by reason of treating patients with a device and treatment protocol named NuCalm, in which McLelland held an interest, (2) McLelland's failure to inform Paxton of McLelland's ownership interest in NuCalm and American Healthcare Lending, (3) breach of contract by reason of McLelland's purchase of a Sullivan Road building, (4) breach of fiduciary duty related to McLelland's purchase of the Sullivan Road building, and (5) breach of the partnership agreement by filing a complaint before dissolution. Although the trial court already granted summary judgment in favor of McLelland P.S. on its claims of breach of ...


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