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District Court of Appeal, Second District, Division 2, California.

George B. PAGE, Plaintiff and Appellant, v. H. B. PAGE, Defendant and Respondent.*

Civ. 24291.

Decided: June 09, 1960

Cavalletto, Webster, Mullen & McCaughey, Jack A. Otero, and Trevey, Schwartz & Wood, Santa Barbara, for appellant. Schauer, Ryon & McIntyre, Robert W. McIntyre, Santa Barbara, for respondent.

Plaintiff appeals from a judgment declaring an oral partnership agreement between plaintiff and defendant to be one for a term, rather than at will.

The partners entered into an oral agreement in December, 1949. This partnership was formed for the purpose of conducting a linen supply business in Santa Maria, California, under the name of Santa Maria Linen Supply. It has been a continuous operation from its inception until the present.

Plaintiff, desiring to terminate the partnership, brought this action to have judicially determined whether the oral partnership agreement was one at will or for a term. The court below determined that the partnership was not at will but that it was for a term, viz., ‘such reasonable time as is necessary to enable said partnership to repay from partnership profits, indebtedness incurred for the purchase of land, building, laundry and delivery equipment and linen for the operation of said business.’

The first question presented by this appeal is whether or not the evidence supports the trial court's determination that the agreement was to continue for the above stated term. The testimony of the defendant relative to this question was substantially as follows: That the partners ‘went into the partnership to start the business and let the business operation pay for itself,—put in so much money, and let the business pay itself out;’ that the partners discussed going into business and that it should be ‘just the same as it always had been,’ referring to previous partnerships between or involving the same parties; that a previous partnership in Bakersfield had provided by a written agreement that the profits were to be retained in the business until all the obligations were paid off; that he could not remember any conversation between the partners wherein the term of the partnership was discussed; that the partners had agreed to pay all obligations out of the operations of the business; that there was no discussion relative to the continuation of business in the event of loss, or as to how the obligations were to be paid in the absence of profits; and, that subsequent to the formation of the partnership, there were, to the best of his knowledge, no discussions regarding the term of the partnership.

Based upon this evidence, the trial court found that ‘it was mutually understood and agreed by the plaintiff and defendant that the partnership as such should borrow money and incur indebtedness for land, building, equipment and linen and that said indebtedness should be repaid out of the profits of the business.’

Certain financial records were also introduced into evidence. These disclose the following facts: (1) That from January 1, 1950, to March 31, 1959, the partnership had a net accumulated operating loss of $56,397.42 for the 9 1/3-year period; (2) that all the obligations for or purchases of capital equipment from the inception of the partnership in December of 1949 up to and including February, 1951, were offset by capital contributions by the partners; (3) that at no time since February, 1951, did the total assets, exclusive of cash and accounts receivable, exceed the total capital contribution of the partners; (4) that the only long-term obligations incurred by the partnership were two loans from the Bank of America, the proceeds of which were used to make payments on an open account which the partnership had with its principal supplier, the Mission Supply Service (wholly owned by the plaintiff); (5) that from February, 1951, to date of trial, no further contributions were made to the capital of the partnership other than credits from profits; (6) that there were no capital withdrawals other than adjustments for losses; and (7) that the outstanding fixed liabilities as of March 31, 1959, i.e., $47,610.32 owing on the open account with Mission Supply Service and $12,794.21 owing on the loan with the Bank of America, are not obligations incurred over and above the capital contributions of the partners.

Based upon this evidence, the trial court found that the indebtedness which ‘should be repaid out of the profits of the business' was, as of March 31, 1959, ‘the sum of $64,842.46.’ The court then made a conclusion of law that ‘the term of said partnership agreement is such reasonable time as is necessary to enable said partnership to pay off its obligations incurred for land, building, equipment and linen,’ which, as of March 31, 1959, amounted to an unpaid balance of $60,404.53.

The judgment is based in its entirety upon the case of Owen v. Cohen, 19 Cal.2d 147, 119 P.2d 713. In a memorandum opinion, the trial judge stated that he felt he was bound by the presumption stated in the Owen case. There, the partnership was formed to operate a bowling alley. At its inception, the partnership was indebted for the purchase of assets to the extent of $17,482.63 represented by notes and a loan from one of the partners to the partnership. The partners agreed to repay these obligations out of the profits of the business. (The venture had been in operation only three months and had made a consistent profit.) The trial court held that the partnership was one at will, and decreed dissolution. Under these circumstances, the Supreme Court held (19 Cal.2d at page 150, 119 P.2d at page 715): ‘Defendant's objection to the finding that the partnership was one at will is fully justified by the uncontradicted evidence that the partners at the inception of their undertaking agreed that all obligations incurred by the partnership, including the money advanced by plaintiff, were to be paid out of the profits of the business. While the term of the partnership was not expressly fixed, it must be presumed from this agreement that the parties intended the relation should continue until the obligations were liquidated in the manner mutually contemplated. These circumstances negative the existence of a partnership at will, dissoluble at the election of a member thereof (Mervyn Investment Company v. Biber, 184 Cal. 637, 194 P. 1037), and demonstrate conclusively that the assailed finding is without support in the record.’ (Emphasis added.)

The factual distinctions between the Owen case and the instant proceeding are clear. The partnership in the Owen case had been in existence only three months; in this case, the partnership had been in continuous existence for 9 1/3 years at the time of trial. At the inception of the Owen partnership, debts were incurred for capital items; in this case, all original capital expenditures were covered by capital contributions. In the Owen case, the business made a consistent profit; in this case, the business has lost money in almost every year of operation. Thus, the reasoning of the court in the Owen case must be considered in the light of the particular facts there presented.

The parties specifically agreed to pay off particular obligations incurred by the partnership at its inception; debts necessarily undertaken in order to begin operating a bowling alley. There was no manifested intention to pay all obligations, whenever incurred, out of profits. Thus, the holding in the Owen case is clear: that the partnership was to continue for the term necessary to retire those debts originally incurred by the partnership as a necessary incident to going into active business operations. The Owen case does not stand for the proposition that all the obligations of the partnership, whenever incurred, had to be retired out of profits before the relation could be terminated at will. The essence of the holding is that the partners had mutually agreed to retire specific debts out of profits and that the term of the partnership was therefore presumed to be for such a period of time as was necessary to accomplish this objective. This is consonant with the cases wherein the term of a partnership is said to be for the term of the leasehold acquired by the partnership (Zeibak v. Nasser, 12 Cal.2d 1, 12–13, 82 P.2d 375), on the grounds that the partners are presumed to have mutually agreed to continue the relationship for at least the term of the lease. It is also in harmony with Bates v. McTammany, 10 Cal.2d 697, 76 P.2d 513, wherein a partnership formed to operate a radio station was held to be for the term of the license granted to operate the station. See also Meherin v. Meherin, 93 Cal.App.2d App.2d 459, 462, 209 P.2d 36.

The only case cited by the Owen court for its holding was Mervyn Investment Co. v. Biber, 184 Cal. 637, 194 P. 1037. In that case, the term of the partnership was presumed to be for a period of time necessary for the profits of the partnership business to retire certain debts incurred by the partnership at its inception. None of these obligations represented capital contributions but were treated by the partners as debts of the partnership, even though the actual advance was made by one of the partners. 184 Cal. at page 643, 194 P. at page 1039. Again, it is apparent that the Owen case refers only to specific obligations incurred at the inception of the partnership which the partners specifically agree to pay off out of profits.

The cases following the Owen case which have cited it as authority also bear out this interpretation. In Vangel v. Vangel, 116 Cal.App.2d 615, 254 P.2d 919, this court held that the partnership was for a term necessary to repay (out of partnership profits) advances to one of the partners by the other two. In commenting upon the analogous facts in the Owen case, this court said: ‘There, one of the partners advanced a substantial sum to the partnership for the purpose of buying necessary equipment with the understanding that the advance was to be considered a loan * * *’ to be repaid out of profits. 116 Cal.App.2d at page 625, 254 P.2d at page 925. We then concluded that the money advanced by two of the partners was to be paid back out of profits according to the written partnership agreement, and that the partnership could not be terminated at will until this was accomplished.

This court again had occasion to apply the Owen rule in the case of Shannon v. Hudson, 161 Cal.App.2d 44, 325 P. 2d 1022. In the Shannon case, the partners agreed to construct, operate and sell a motel. We concluded that the agreement to eventually sell the motel implied that the parties intended to sell it at a profit, and that the term of the venture should coincide with the time necessary to complete the avowed purpose of the partners, unless it should become obvious that the enterprise was a failure. Therefore, we again applied the Owen rule in the limited context obviously intended by that court, i. e., that an agreement made between partners at the inception of the partnership to accomplish and identifiable and positive objective (whether to pay off certain debts incident to establishing the business, or to sell a motel, or to operate a radio station during a license period), raises the presumption that the partners intended that the term of the partnership should be long enough to accomplish this objective.

We turn next to a consideration of the present case to determine whether or not the Owen rule was properly applied by the court below. It is immediately apparent that unless some positive and identifiable debts or obligations were incurred by the partnership which the partners specifically agreed to repay out of the profits of the business, the Owen rule can have no application. As we have previously noted, the accounting records introduced in evidence disclose that all the capital expenditures were offset by capital contributions by the partners. These capital contributions do not comprise debts or obligations of the partnership, as apparently contended by the defendant. Thus, even if the partners agreed to repay the initial debts of the partnership, this agreement could have no meaning or significance unless debts actually were incurred and were capable of being ascertained at the time of trial.

Assuming that the evidence supports the trial court's finding that the obligations of the partnership were agreed to be repaid out of profits, still the conclusion of law that the present obligations are to be repaid before the partnership may be dissolved at will is dependent upon the presumption stated in the Owen case. This conclusion of law and the judgment based thereon are erroneous in that they extend the Owen rule to include an agreement that all debts, whenever incurred during the course of the operation of the business, shall be repaid from profits, and that until the venture is debt free it may not be dissolved at will. As previously discussed, such a result is not within the purview of the principle announced in the Owen case, nor has any other court extended the Owen rule beyond its clear limits. Moreover, the obligations said by the court below to be payable ‘within a reasonable time’ before the partnership term would be at an end, are: (1) $47,610.32 payable on the open account with Mission Supply Service; and (2) $12,794.21 payable to the Bank of America. The record discloses that as to (1) above, the partnership, during its existence, has paid $236,114.34 to Mission Supply Service on the open account, while at the same time, suffering losses in excess of $56,000; and with respect to (2) above, the sum represents the balance due on a loan, the proceeds of which were used to reduce the balance due on the open account. The amounts so represented were not to be paid out of profits but out of the operations of the partnership. They represent normal obligations which the business must support as a cost of doing business, not as an investment in, or a loan to, the partnership. Yet the judgment decrees that these sums be repaid out of profits. Nothing could be further from the manifested intentions of the partners, for the present obligations are merely the balance remaining unpaid upon obligations which have been consistently paid out of the business operations, not the profits. Moreover, the evidence shows that the partners agreed that the bank loan be repaid from the operations of the business.

It is therefore clear that, no only were no debts incurred at the inception of the business which could have been the subject of an agreement to pay them off out of profits, but it is also clear that no subsequent debts payable out of profits have been incurred. To apply the presumption of the Owen case under these circumstances was error.

Defendant's argument that the partnership obligation represented by the open account with Mission Supply Service was, in effect, an advance by plaintiff to the partnership since plaintiff is the sole owner of Mission Supply Service, is not realistic. The Santa Maria Linen Supply (the partners' business venture) is in the linen supply business. It necessarily must obtain linen and machinery from some supplier, and must necessarily pay for the same, whether in cash, on an open account, or by borrowing the funds from an outside source. Therefore, the mere fact that plaintiff owns the Mission Supply Service does not indicate that the relations between the two businesses were other than would be usual in any event, nor does it show that plaintiff had made advances to the partnership which would be subject to repayment out of profits.

Defendant's further argument, that sums contributed as capital by the partners were subject to the Owen rule because they were to be paid back out of profits, fails to recognize the essential difference between capital contributions and loans or debt obligations. The profits of a partnership are the increment on the capital investment of the partners, not the means by which the partners are repaid the principal sums so invested. Therefore, the Owen rule obviously does not apply to the capital contributions of the partners.

In view of the foregoing, the other contentions raised in the briefs need not be here discussed.

The judgment is reversed.

FOX, Presiding Justice.

ASHBURN, J., concurs. Hearing granted; SCHAUER, J., not participating.

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