Armand DeFelice v. State of Washington, Employment Security Dept.

FILED
MAY 26, 2015
In the Office of the Clerk of Court
WA State Court of Appeals, Division III
IN THE COURT OF APPEALS OF THE STATE OF WASHINGTON
DIVISION THREE
ARMAND DeFELICE, ) No. 32382-0-111
)
Appellant, )
)
v. )
)
STATE OF WASHINGTON, ) PUBLISHED OPINION
EMPLOYMENT SECURITY )
DEPARTMENT, )
)
Respondent. )
BROWN, J. - Dr. Armand DeFelice1 appeals the Employment Security Department
Commissioner's decision affirming an order and notice of assessment requiring Dr.
Armand to pay $1,896.37 in unemployment insurance back taxes, penalties, and
interest. Dr. Armand contends the commissioner erred when it found Drs. Loretta and
Louise were in his employment and not partners excluded under the Employment
Security Act. Because substantial evidence supports the commissioner's factual
findings and the conclusions of law are consistent, we affirm the commissioner's
decision and deny Dr. Armand's attorney fees request.
FACTS
1 This appeal concerns Dr. Armand DeFelice and his family members, Dr.
Loretta DeFelice and Dr. Louise DeFelice. Because they share the same last name,
they are referred to as Dr. Armand, Dr. Loretta, and Dr. Louise for clarity.
No. 32382-0-111
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FACTS
In 1966, Dr. Armand began a dental practice and registered it as a sole
proprietorship. On February 1, 1990, Dr. Armand entered into an association
agreement with Dr. Loretta. On January 2, 2004, Dr. Armand entered into another
association agreement with Dr. Louise. Both association agreements provided that Dr.
Armand "agree~ to have Associate associate with him for the purpose of practicing
dentistry on [Dr. Armand's] patients." Admin. Record (AR) at 241,247. The association
agreements specifically stated all dentists "agreed that the doctors are not partners."
AR at 241,247. The association agreements provided for the manner of termination.
The association agreements specified each dentist's responsibilities. While each
dentist remained responsible for determining how much to charge for their respective
services, charges were billed under Dr. Armand's name and payments were deposited
into his account. In addition, Dr. Armand had to provide necessary facilities and
equipment and pay the rent and all expenses. Both Drs. Loretta and Louise received 35
percent of the fees they produced. This amount later increased to 40 percent.
In 2012, after it was discovered Dr. Armand was not paying unemployment
insurance taxes, the Employment Security Department (the Department) audited the
dental practice to determine whether the dental practice had to pay back taxes,
penalties, and interest. Thus, the principal focus of the audit was to ascertain whether
Drs. Loretta and Louise were employees of Dr. Armand's dental practice. The audit
covered the years 2010,2011, and the first quarter of 2012.
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1 The auditor, Angela Hughes, reviewed various tax returns, quarterly and annual
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I reports, check registers, and general ledger accounts. Ms. Hughes requested any
agreements between the dentists; the. dental practice's bookkeeper complied. Ms.
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Hughes never asked if the association agreements were still valid and enforceable. Ms.
Hughes' review revealed (1) the dental practice was registered as a sole proprietorship
with both the Department and the Washington Department of Revenue, (2) Dr. Armand
listed the dental practice on his tax returns as a sole proprietorship, and (3) payments
made to Drs. Loretta and Louise were reported as miscellaneous income on Internal
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Revenue Service (IRS) Form 1099s. 2 She concluded Drs. Loretta and Louise were
employees of the dental practice and unemployment insurance taxes should have been
paid. The Department issued Dr. Armand an order and notice of assessment requiring
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him to pay $1,896.37 in back taxes, penalties, and interest. Dr. Armand first
administratively appealed.
At the administrative hearing, Dr. Armand testified the association agreements
were no longer valid as the three dentists had orally entered into a partnership. He
stated Drs. Loretta and Louise receive 40 percent of their production, their share of the
dental practice's profits. The remaining 60 percent of production is applied to overhead.
Dr. Armand then took home what was left after overhead was paid, which he claimed
was about 40 percent of his production.
2 In 2013, the dental practice formed and registered a professional limited
liability company (PLLC).
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The administrative law judge (ALJ) concluded Drs. Loretta and Louise were
employees of the dental practice and affirmed. Dr. Armand petitioned the Department's
commissioner for review of the ALJ's decision; the commissioner adopted the ALJ's
findings of fact and conclusions of law and affirmed the ALJ. Dr. Armand sought
superior court review. The superior court affirmed, finding substantial evidence
supported the commissioner's decision. Dr. Armand appealed.
ANALYSIS
The issue is whether the Department's commissioner erred in deciding Dr.
Loretta and Dr. Louise were "in employment" under Washington's Employment Security
Act as found by the ALJ and approving the order to pay unemployment insurance back
taxes, penalties, and interest. Dr. Armand contends Drs. Loretta and Louise are his
partners, and thus, he argues, they are not in his employment.
Because unemployment taxes "exist to aid a class of people that society has
chosen to protect," an employer's claim of exemption is closely scrutinized. W Ports
Transp., Inc. v. Emp'tSec. Dep't, 110Wn. App. 440, 451, 41 P.3d 510 (2002). The
Administrative Procedure Act (APA), ch. 34.05 RCW, governs judicial review of a final
decision of the Employment Security Department Commissioner. Tapper v. Emp't Sec.
Dep't, 122 Wash. 2d 397, 402,858 P.2d 494 (1993). "The []APA allows a reviewing court
to reverse an administrative decision when, inter alia: (1) the administrative decision is
based on an error of law; (2) the decision is not based on substantial evidence; or (3)
the decision is arbitrary or capricious." Id. (citing RCW 34.05.570(3)).
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We sit in the same position as the superior court, applying APA standards
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directly to the agency record. Id.; see RCW 34.05.558. While we review the
commissioner's decision, when the commissioner adopts the ALJ's findings and
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~ conclusions, we review the underlying ALJ findings and conclusions supporting the
decision. Smith v. Emp't Sec. Dep't, 155 Wn. App. 24,32,226 P.3d 263 (2010);
Tapper, 122 Wash. 2d at 406. The commissioner's decision is considered prima facie
correct. Smith, 155 Wash. App. at 32. The burden of demonstrating the decision's
invalidity is on the party asserting invalidity. W Ports Transp., Inc., 110 Wash. App. at
449.
"We review questions of law de novo, giving substantial weight to the agency's
interpretation of the statutes it administers." Smith, 155 Wash. App. at 32. The
commissioner's findings of fact are reviewed for substantial evidence in light of the
whole record. Id. '''Substantial evidence' is evidence that would persuade a fair-minded
person of the truth or correctness of the matter." Id. at 32-33. We defer to factual
decisions, with the evidence viewed in the light most favorable to the party who
prevailed in the highest forum that exercised fact-finding authority; here, the
Department. William Dickson Co. v. Puget Sound Air Pollution Control Agency, 81 Wn.
App. 403, 411,914 P.2d 750 (1996). As such, we "will not substitute [our] judgment on
I witnesses' credibility or the weight to be given conflicting evidence." W Ports Transp.,
I Inc., 110 Wash. App. at 449. "When reviewing mixed questions of law and fact, [appellate
I courts] accept the [c]ommissioner's unchallenged factual findings, apply the substantial
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evidence standard to the challenged findings of fact, independently determine the
applicable law, and apply the law to the facts." 'd. at 450 (stating application of law to
facts is de novo). An agency's decision is arbitrary and capricious if the decision is
"willfully unreasonable, without consideration and in disregard of facts or
circumstances." 'd. It is not arbitrary and capricious if the decision is "exercised
honestly and upon due consideration, even where there is room for two opinions." 'd.
Dr. Armand incorrectly contends the evidence solely shows a partnership existed
between him and Drs. Loretta and Louise. In determining whether an employer is
responsible for.contributions to the unemployment fund, the first question is whether an
individual is in '"employment.''' Penick v. Emp't Sec. Dep't, 82 Wash. App. 30, 38, 917
P.2d 136 (1996). "Employment" is defined as "personal service, of whatever nature,
unlimited by the relationship of master and servant as known to the common law or any
other legal relationship, ... performed for wages or under any contract calling for
performance of personal services, written or oral, express or implied." RCW 50.04.100.
If Drs. Loretta and Louise were partners, they would not be in "employment" as defined
by the Employment Security Act.
"[T]he association of two or more persons to carry on as co-owners a business
for profit forms a partnership." RCW 25.05.055(1). Required is joint ownership of the
business and a joint right of control over the business' affairs. Bengston v. Shain, 42
Wash. 2d 404, 409, 255 P.2d 892 (1953). "A person who receives a share of the profits of
a business is presumed to be a partner in the business, unless the profits were received
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in payment" as wages to an employee. RCW 25.05.055(3)(c)(ii); see also Bengston, 42
Wash. 2d at 409 ("The mere sharing of the net proceeds of a business venture with an
employee, without more, does not of itself convert the relationship between the parties
concerned into a partnership.").
The burden of proving a partnership is on the party asserting its existence.
Bengston, 42 Wash. 2d at 409. Just because the parties call their arrangement a
partnership does not make it a partnership. State v. Bartley, 18 Wash. 2d 477, 481,139
P.2d 638 (1943). Essential to the creation of a partnership is an express or implied
partnership contract. Ederv. Reddick, 46 Wash. 2d 41, 49,278 P.2d 361 (1955). Whether
a partnership contract exists depends on the parties' intentions, manifested by all facts
and circumstances, including the parties' actions and conduct. Bartley, 18 Wash. 2d at
482; see also Douglas v. Jepson, 88 Wash. App. 342, 347,945 P.2d 244 (1997). While a
partnership's existence can be established by circumstantial evidence, "circumstantial
evidence does not tend to prove the existence of a partnership unless it is inconsistent
with any other theory." Eder, 46 Wash. 2d at 49. Another important test in determining
whether a partnership is formed is sharing losses. Gottlieb Bros. v. Culbertson's, 152
Wash. 205, 209, 277 P. 447 (1929); see also Bengston, 42 Wash. 2d at 409 ("A partnership
is formed by agreement to place money, effects, labor and skill ... in a lawful business
and to divide the profits and bear the losses in certain proportions.").
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Dr. Armand challenges 16 of the commissioner's findings of fact and four
conclusions of law. 3 The majority of Dr. Armand's error assignments involve disputes
with the commissioner's findings regarding the association agreements. He argues the
association agreements were orally modified and/or revoked and a partnership formed.
But the record contains other facts that do not support his argument.
In 1966, Dr. Armand registered his dental practice as a sole proprietorship with
the Department and the Washington Department of Revenue. In 1990, Dr. Armand and
Dr. Loretta entered into an association agreement which specifically stated Dr. Loretta
was not a partner. In 2004, Dr. Armand and Dr. Louise entered into a substantially
similar association agreement which again explicitly stated Dr. Louise was not a partner.
These association agreements provided for each of the dentist's responsibilities,
providing for the manner of termination in paragraphs seven and eight. 4 However,
terminable-at-will contracts5 may be unilaterally modified provided reasonable notice is
given; once given, the old contract is effectively displaced. See Duncan v. Alaska USA
Fed. Credit Union, Inc., 148 Wash. App. 52, 76-78, 199 P.3d 991 (2008).
The commissioner, by adopting the ALJ's findings and conclusions, found the
association agreements remained effective and rejected Dr. Armand's partnership
3 Dr. Armand assigns error to the following findings of fact: 1-14, 16, and 17. He
assigns error to the following conclusions of law: 6, 7, 8, and 11.
4 These paragraphs provide the association agreement could be terminated
upon 30 days' notice by either party or in the event of incapacity.
5 A terminable-at-will employment relationship is one where the employment is of
indefinite duration and may be terminated at any time, with or without cause, by either
the employer or the employee. Quedado v. Boeing Co., 168 Wash. App. 363, 367, 276
P.3d 365, review denied, 175 Wash. 2d 1011 (2012).
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claims. We do not reexamine evidence weight and witness credibility determinations on
review. Sufficient evidence supports the commissioner's determinations. Calling a
business arrangement a partnership does not make it a partnership. For example, Dr.
Armand continued to retain control over billing patients. For income, Dr. Armand
received whatever was left over after he paid Drs. Loretta and Louise their 40 percent of
production and overhead expenses. Dr. Armand argues there is equal sharing of profits
because he too received 40 percent of his production. But his share is calculated
differently than Drs. Loretta and Louise and is not exact. Drs. Loretta and Louise did
not share losses. Drs. Loretta and Louise always took home 40 percent of their
production regardless of whether the patients actually paid their bills.
Notably, the dental practice registration remained unchanged with the
Department and the Washington Department of Revenue. If Drs. Loretta and Louise
were considered partners, they would have had an account at the Department because
the Department requires employers to report changes in owners and partners at the
same time the quarterly tax and wage report is due. WAC 192-310-010(2}(a}. The
Washington Department of Revenue requires an owner to obtain new registration and
license documents when there is a change in ownership. WAC 458-20-101(11}(a)(iii)
(stating a change in ownership occurs with the "addition of one or more partners where
the general partnership continues as a business organization and the change in the
composition of the partners is equal to or greater than fifty percent"). Instead, Dr.
Armand continued to report the income and expenses of the dental practice on his
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individual income tax return as a sole proprietorship. Dr. Armand continued to report
payments made to Drs. Loretta and Louise as miscellaneous income on Form 1099s.
Regarding the failure to file an IRS Form 1065, the commissioner used that
failure as cumulative circumstantial evidence not showing a partnership. While Dr.
Armand and the commissioner debate filing requirements, we note the penalty, not the
filing requirement, may be waived for small partnerships. Rev. Proc. 84-35, 1984-1 C.B.
509. In light of the other circumstantial evidence demonstrating a partnership was not in
existence, the issue of the failure to file a Form 1065 is not critical.
Dr. Armand argues the commissioner disregarded certain evidence tending to
show a partnership existed. First, he points to his testimony at the administrative
hearing regarding ownership of equipment where he stated the equipment is owned by
all of the dentists. No documentation supported this assertion, and the commissioner
was entitled to weigh its credibility. We do not re-weigh the credibility of witnesses. W
Ports Transp., Inc., 110 Wash. App. at 449. Second, he discusses the discretion and
control Drs. Loretta and Louise exercised in caring for their patients. While control is
relevant in establishing a partnership, doctors who are employees exercise control in
treating their patients; professional discretion is an essential element of being a doctor.
Third, he pOints to Dr. Louise's membership in the family limited liability company that
owns the building where the dental practice leases space. But this is irrelevant to
whether she is a partner in the dental practice. Fourth, Dr. Armand argues Ms. Hughes'
failure to ask if the association agreements were still valid demonstrates bias. But the
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commissioner apparently found her process testimony more credible. Fifth, Dr. Armand
argues the 40 percent production payments to Drs. Loretta and Louise show the
association agreements were terminated, however, these could be explained as
contract modifications. Sixth, while the creation of the PLLC in January 2013 and
individual maintenance of insurance may tend to show the existence of a partnership,
this circumstantial evidence is inconsistent with other evidence.
Given our analysis, we conclude the commissioner's findings of fact are
supported by substantial evidence. Next, we conclude the commissioner's conclusions
of law rejecting a partnership and deciding Drs. Loretta and Louise were in employment
are supported by the findings of fact.
Drs. Loretta and Louise must be in "employment" in order to for Dr. Armand to be
covered by the Employment Security Act. RCW 50.04.100. '''[E]mployment' exists if (1)
the worker performs personal services for the alleged employer, and (2) if the employer
pays wages for those services (or pays under any contract calling for personal
services)." W Ports Transp., Inc., 110 Wash. App. at 451.
To meet the first prong of this test, "the personal services must clearly be
performed for the alleged employer or for its benefit." Language Connection, LLC v.
Emp't Sec. Dep't, 149 Wash. App. 575, 582, 205 P.3d 924 (2009). Dr. Armand's dental
practice requires dentists in order to perform dental services. Drs. Loretta and Louise
provided such services for Dr. Armand's benefit. Thus, Drs. Loretta and Louise
performed personal services for Dr. Armand.
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For the second prong, the contract called for the performance of personal
services with Drs. Loretta and Louise receiving remuneration from Dr. Armand.
'"Wages''' are "remuneration paid by one employer during any calendar year to an
individual in its employment." RCW 50.04.320(1). '"Remuneration''' includes "all
compensation paid for personal services." RCW 50.04.320(4). The money collected
from the dental practice's patients was collected by Dr. Armand and deposited into Dr.
Armand's account. Dr. Armand then paid Drs. Loretta and Louise out of this account.
Drs. Loretta and Louise did not receive their payment when they finished a procedure.
See Penick, 82 Wash. App. at 41 (holding employer paid wages when he collected
payment from customers without evidence of separate accounts between sole
proprietor and his employees and employees did not receive payment when a
transaction closed but bi-weekly).
CONCLUSION
We hold the Department's commissioner, by adopting the ALJ's findings of fact
and conclusions of law, correctly decided Dr. Loretta and Dr. Louise were covered
employees under Washington's Employment Security Act. Because Dr. Armand does
not argue Drs. Loretta and Louise were independent contractors, we do not address the
Department's briefing on that subject. Finally, considering our holding, we do not reach
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Dr. Armand's attorney fee requests because the Department prevails.
Affirmed.
Brown, J.
I CONCUR:
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SIDDOWAY, C.J. (dissenting) The initial decision of the administrative law
judge (ALI) in this matter, which the commissioner ofthe Department of Employment
Security adopted and the Superior Court then affirmed, was not based on the ALl's
resolution of factual disputes. It was based on four legal conclusions urged by the
department: (1) that the written employment agreements entered into at the time Dr.
Armand DeFelice's daughters joined his practice could not be replaced years later by a
partnership relationship without terminating the employment agreements in writing; (2)
that the Washington revised Uniform Limited Partnership Act (RUPA), chapter 25.05
RCW, mandates precisely equal profit sharing among partners; (3) that the RUPA
mandates an agreement to share all losses equally; and (4) that the conduct of business by
three professionals in a form other than a partnership, standing alone, supports the
conclusion that they are not partners.
The four legal conclusions were in error, and under the Administrative Procedure
Act, a court shall grant relief from an agency order in an adjudicative proceeding if it
determines that the agency has erroneously interpreted or applied the law. RCW
34.05.570(3)(d). The decision ofthe commissioner should be reversed.
The Department ofEmployment Security's assessment was based on
, form, not substance.
Department tax specialist Angela Hughes assumed upon beginning her audit of the
DeFelice Dentistry practice that it was a sole proprietorship because Dr. Armand
DeFelice v. Emp '( Sec. Dep '(
No. 32382-0-111- dissent
DeFelice (whom 1 will refer to hereafter as "Dr. Armand" for purposes of clarity, as the
majority does)) was registered with the department as a sole proprietor doing business as
Armand V. DeFelice DDS. Administrative Record (AR) at 222. He reported federal
income and other taxes on the same basis. At the outset of the audit, and armed with
three forms 1099 that Dr. Armand had filed with his federal tax return, Ms. Hughes asked
the dental practice's bookkeeper for any written agreements with recipients of the forms
1099. She was provided with association agreements that Drs. Loretta and Louise had
signed with their father upon joining his practice in 1990 and 2004, respectively. She
was also provided with an agreement with a janitorial service that proved to Ms. Hughes'
satisfaction to be an independent contracting relationship. Ms. Hughes admitted that she
never asked, and was never told, whether the association agreements from the practice
files were in effect at the time of her June 2012 audit.
Because Ms. Hughes never considered the possibility that the dentists had begun
operating as a partnership, she spoke only briefly with Dr. Armand, characterizing her
conversation with him as a casual, "[H]ere is what 1 found, this is what is happening, this
is what is next." AR at 112. Dr. Armand agrees that to the best of his recollection, Ms.
Hughes did not ask him any questions. Jd. at 131. Ms. Hughes spoke with only one of
ILike the majority, 1 will likewise refer to Dr. Armand's daughters and co-partners
as "Dr. Loretta" and "Dr. Louise."
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No. 32382-0-III- dissent
the women dentists-and so passingly that not only did she make no notes of the
conversation, she couldn't even remember whether she spoke to Dr. Loretta or Dr.
Louise. Id Dr. Louise testified that Ms. Hughes never spoke with her. AR at 155.
Ms. Hughes therefore had no occasion to ask anyone about which dentists made
decisions about operations, whether individual dentists had their own patients, whether
the dentists shared profits, or other business or financial matters relevant to operation as a
partnership. Although DeFelice Dentistry had some employees and filed reports and paid
unemployment insurance taxes, Ms. Hughes evidently never asked why the dental
practice was paying employment taxes with respect to some of its employees but not with
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respect to Drs. Loretta and Louise.
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i When the lawyer for DeFelice Dentistry was informed that Ms. Hughes had
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dba Armand V. DeFelice DDS was in order based on his asserted employment of Drs.
Loretta and Louise, the lawyer asked Ms. Hughes if there could be an exit interview in
order to explain why an assessment would be in error. Ms. Hughes declined, stating that
Dr. Armand could appeal. While Ms. Hughes was entitled to close her-audit without
granting further interviews, the result was that the department did not have any occasion
to further inquire about the substance of the dentists' business relationship before the
appeal hearing.
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Dr. Armand did appeal. In his prehearing memorandum filed three months before
the administrative hearing, he characterized the association agreements as "ancient
document[s]," stated that the relationship between the dentists had been amended orally
before the audit period as "can be established by a quick review ofthe Income
Statement," and stated that by the time of the audit period, the dentists "are in fact
partners." AR at 259.
One might infer from the majority's opinion that the department then developed
and presented evidence at the hearing relevant to the substance of the dentists' business
relationship during the audit period, so that the ALJ's task was to determine whose
evidence about the actual dental practice operations, financial and otherwise, was worthy
of belief. But at the time of the administrative hearing, the department did not offer
evidence on the substance ofthe dentists' relationship. It called only one witness-Ms.
Hughes, who knew nothing about actual practice operations during the audit period. In
an examination in the department's opening case that comprises only eight pages of the
administrative record (the department's rebuttal case is reflected on an additional two
pages), the department presented Ms. Hughes' evidence on the only two facts it viewed
as mattering: (1) Dr. Armand was registered with and reported to several agencies as a
sole proprietorship, and (2) Ms. Hughes was given two association agreements for Drs.
Loretta and Louise, dated 1990 and 2004, respectively, that the department argued were
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required by their terms to be terminated in writing, but never were. See AR at 102-09,
125 (department examination in opening case); AR at 83-84 (rebuttal evidence).
Dr. Armand's defense case was itself not long, although longer than the
department's. At issue, after all, was only a $1,869 assessment. AR at 222. Through Dr.
Armand's petition for review, his testimony and that of Dr. Louise, and the cross-
examination of Ms. Hughes, Dr. Armand presented evidence and argument on the
following matters:
o That Ms. Hughes never asked whether the association agreements were in
effect during the audit period and was never told by any representative of
the practice that they were (AR at 108, 112-13);
o That the dental practice had evolved into a partnership; according to Dr.
Louise, this was in or about 2008 (AR at 73-74, 78-79, 86-87);
o That based on the practice's operating overhead of 60 percent of total
collected revenues, the three dentists had arrived at a profit sharing
arrangement designed to distribute to each dentist a 40 percent profit on his
or her production, although Drs. Loretta and Dr. Louise took distribution
checks based on a flat 40 percent profit, while Dr. Armand agreed to
assume the benefit or burden of a somewhat higher or lower percentage
(depending on whether the overhead proved to be a lower or higher
percentage of total collected revenues) (AR at 156-57, 159);
o That based on the daughters' 40 percent profit sharing distribution
established at the hearing, one could determine by analyzing the income
statements that Dr. Armand had received a similar share of the profits (AR
at 36-37);
o That Dr. Armand did not control the work of his daughters, who were
experienced and successful professionals and together produced
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approximately 63 percent of the total production of the practice in 2010
CAR at 119-20, 163-64)2;
o That "the practice"-meaning the three dentists, as partners--owned the
equipment of the practice and operated its business CAR at 145-47);
o That each dentist had his or her own patients (AR at 71-73; 156); and
o That the home page ofthe practice website for DeFelice Dentistry
characterized the practice in partnership terms, stating that "Dr. Armand
DeFelice, Dr. Lorrie Rosier and Dr. Louise DeFelice work together as a
team to provide you with the highest standard of dental care available."
(AR at 207, 230)
The department cross-examined Dr. Armand and Dr. Louise about the profit-
sharing arrangement. The ALJ also asked a number of questions. The department's
lawyer elicited Dr. Louise's agreement that under the dentists' distribution arrangement,
if Dr. Louise hypothetically did not work for a month, then she would not contribute
towards that month's overhead. AR at 159-60.
In rendering its decision following the hearing, the ALJ did not make a factual
finding as to whether the dentists had or had not orally agreed to begin operating as
partners sometime before 2010. The department had not thought it mattered; its position
was and remains that because the dentists admit that they never terminated the
association agreements in writing then the agreements were not terminated, period. The
2 The evidence at the hearing was in dollar terms; I substitute percentages out of
respect for the dentists' financial privacy. By the same analysis, Drs. Loretta and Louise
together produced approximately 64 percent of the total production in 2011. See AR at
234.
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ALJ adopted the department's position and, on that basis, relied upon association
agreements that it treated as continuing to control as a matter of law, not fact, for a dozen
findings. See AR at 292-94 (findings 1-12).
The department responded to testimony and financial record evidence that Drs.
Loretta and Louise indisputably collected a 40 percent profit from their production during
the audit period (an amount inconsistent with the association agreements) by taking the
position that it is not "profit sharing" ifpartners agree that some of them will take
distributions based on projected profit while others will assume the risk that the actual
profit might be higher or lower than projected. The ALJ implicitly adopted the
department's position. AR at 296 (conclusion 7).
The department also took the position that partners are required to share losses. It
took the position that partners are not sharing losses ifthere is a conceivable, even if
implausible scenario under which one partner alone could incur a loss. The ALJ
implicitly adopted that position. See id.
Finally, the department took the position that the sole proprietorship form in which
Dr. Armand had reported and registered with it and other agencies was sufficient,
standing alone, to support the conclusion that the dentists were not operating as a
partnership. The ALJ adopted that position. See id.
Each of these conclusions was wrong as a matter of law.
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Partner services are not employment.
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There is no employer-employee relationship when an owner provides services to a
I business. Accordingly, partners of a partnership are not covered for unemployment
I
insurance purposes. WAC 192-300-190; RCW 50.40.100. While the department argues
that a party claiming an exemption from taxation bears the burden of proof (see Br. of
I Resp't at 13), DeFelice Dentistry does not rely on an exemption but on its position that an
owner's services are not "employment" under the Employment Security Act.
j
A partnership is an association of two or more persons to carry on as co-owners a
business for profit; in Washington, at the time Drs. Armand, Loretta and Louise testify
they began to operate as partners, the formation of a partnership was governed by RCW
25.05.055. RCW 25.05.005(6). These are provisions of the RUPA, which was adopted
in Washington in 1998. LAWS OF 1998, ch. 103, § 1302.
Few reported Washington decisions apply the RUPA in determining whether
individuals have formed a partnership. Since RCW 25.05.904 provides that the RUPA
"shall be applied and construed to effectuate its general purpose to make uniform the law
with respect to the subject of the act among states enacting it" it is appropriate to look to
the official comments to the Uniform Partnership Act (1997), promulgated by the
National Conference of Commissioners on Uniform State Laws, as aids in its
construction. Cf Townsend v. Quadrant Corp., 153 Wash. App. 870, 878 n.7, 224 P.3d
8
DeFelice v. Emp 't Sec. Dep't
No. 32382-0-III- dissent
818 (2009) (looking to comments to the uniform arbitration act as aids in construing the
Washington statute). RCW 25.05.904's command that the chapter be applied and
construed with a view to uniformity is also direct legislative authority for looking to case
law from other adopting states.
Under the RUP A, it is the attribute of co-ownership that distinguishes a
partnership from a mere agency relationship:
A business is a series of acts directed toward an end. Ownership involves
the power of ultimate control. To state that partners are co-owners of a
business is to state that they each have the power of ultimate control.
UNIF. P'SHIP ACT (1997) § 202 cmt.l, 6 pt. 1 U.L.A. 93 (2001). RCW 25.05.055(3)(c)
provides three rules of construction that apply in determining whether a partnership has
been formed. Relevanthere is the rule that "[aJ person who receives a share of the profits
of a business is presumed to be a partner in the business," subject to a few exceptions.
By its plain terms, and as reflected in the comments to the RUP A, profit sharing gives
rise to a rebuttable presumption of a partnership. Id. The presumption applies whether
the profit share is a single flat percentage or a ratio that varies. Id.
The association agreements offered in evidence by the department could be
terminated by a mutual oral agreement to begin operating as a partnership.
It was legal error to conclude otherwise.
Dr. Armand and Dr. Louise both testified that during the tax years covered by the
audit, the parties were operating as a partnership. Dr. Louise testified that the three
9
DeFelice v. Emp 't Sec. Dep't
No. 32382-0-111- dissent
dentists began operating as a partnership in or about 2008. The ALJ's finding that Ms.
Hughes asked the practice bookkeeper for "copies of any agreements to show the
relationship between Dr. Armand, Dr. Louise and Dr. Loretta" (AR at 294, finding 10), is
not supported by the evidence; Ms. Hughes admitted she only asked if there were
agreements with the form 1099 recipients and simply assumed that the dentists stood in
an employment relationship from the two association agreements that were produced in
response. 3 Those agreements, which indisputably created an employment relationship,
3 Ms. Hughes testified as follows:
Q. Were you provided with any copies of any written contracts or
agreements between Loretta and Armand DeFelice?
A. Yes. 1 asked for-when 1 saw their names on the 1099,1 asked for
any agreements and did receive a-the agreements for each of them, that
they had signed with Dr. Armand.
AR at 108. On cross-examination, she testified:
Q. Did you ask either lady or anyone that gave you the agreement or
agreements whether or not the agreements were valid and enforceable?
A. Well, since 1 had-was talking to the bookkeeper and had asked for
the agreement, 1 assumed the one she gave me would be valid.
Q. You assumed, but you didn't ask?
A. 1 didn't ask if what she was giving me was valid, no.
AR at 112-13.
10
DeFelice v. Emp 't Sec. Dep't
No. 32382-0-111- dissent
would have been 22 and 8 years old by the time of the department's 2012 audit. AR at
113-14, 125.
It was the position of the department that it didn't matter ifthe dentists had orally
agreed to change the nature of their relationship, because they had never terminated the
association agreements in writing. The ALJ adopted the position of the department,
finding that the association agreements "[were] to continue until termination in a manner
set forth in the agreement, specifically paragraph 7 and 8." AR at 292 (finding 2). Many
of the ALJ's other findings are predicated on this legal proposition that the association
agreements remained operative because they had not been terminated in the manner set
forth in paragraph 7 or 8.
When, as here, the interpretation of a contract does not depend on the use of
extrinsic evidence, it presents a question of law. Viking Bank v. Firgrove Commons 3,
LLC, 183 Wash. App. 706, 711, 334 P.3d 116 (2014). A conclusion oflaw is reviewed as a
conclusion of law, even if erroneously labeled as a finding of fact. Dave Johnson Ins.
Inc. v. Wright, 167 Wash. App. 758, 778, 275 P.3d 339 (2012). We review conclusions of
law de novo.
Section 3 of the association agreements provide the date on which the term of
agreement begins and that the agreement "shall continue until terminated in a manner set
forth in paragraphs 7 and 8." AR at 241,247. Section 7 of the association agreements
11
DeFelice v. Emp 't Sec. Dep't
No. 32382-0-111- dissent
addresses the manner by which "either" party may terminate the agreement-thereby
addressing the fact that the relationship is terminable at the will of either party, as the
majority observes. 4 AR at 243,249; see majority at 8. Section 8 deals with termination
in the event of a party's incapacity by reason of illness or other causes, an event that no
one suggests ever arose. Neither section 7 nor 8 deals with termination ofthe agreement
by mutual agreement of the parties. Notwithstanding the language of section 3 of the
agreements, the parties could mutually agree, orally, to terminate or modifY the
agreement.
It is hornbook law that a contract in writing, but not required to be so by the statute
of frauds "may be dissolved or varied by a new oral contract, which mayor may not
adopt as part of its terms some or all of the provisions of the original written contract."
29 RICHARD A. LORD, WILLISTON ON CONTRACTS § 73.21 at 67 (4th ed. 2003); Bader v.
Moore Bldg. Co., 94 Wash. 221,224, 162 P. 8 (1917); Sherman v. Sweeny, 29 Wash.
321,69 P. 1117 (1902). This is true even if there is no express agreement that the new
contract shall have that effect. E.g., Dunlap v. Fort Mohave Farms, Inc., 89 Ariz. 387,
363 P.2d 194 (1961) and cases cited therein.
4The section provides, "Owner and Associate may terminate their relationship
upon thirty (30) days' written notice by either party." AR 243,249 (emphasis added).
12
DeFelice v. Emp 't Sec. Dep't
No. 32382-0-111- dissent
A related principle is that parties to a bilateral contract may make an agreement of
rescission discharging each other from all remaining obligations under an existing
agreement and that such an agreement "need not be expressed in words. Other conduct
may show an intent by both parties to abandon their contract." RESTATEMENT (SECOND)
OF CONTRACTS § 283, cmt. a (1981); Lockhart v. Greive, 66 Wash. App. 735, 741, 834
P.2d 64 (1992).
Parties may orally modify even agreements that prohibit oral modification. As
explained in Pacific Northwest Group A v. Pizza Blends, Inc., 90 Wash. App. 273, 277-78,
951 P.2d 826 (1998), it is "[a] paradox of the common law is that a contract clause
prohibiting oral modifications is essentially unenforceable because the clause itself is
subject to oral modification." The common law rule permitting oral modification "has
been consistently followed in Washington." Id. Accordingly, even if section 3 of the
association agreements could be construed to prohibit the parties from orally terminating
or modifying the association relationship it would be meaningless, since section 3 was
itself subject to oral modification.
In the context of professional service providers, it is not unusual for an
employment relationship to ripen into a partnership. An experienced dentist, like any
experienced professional, will often want the right of control over a new professional in
his practice and to have the right to terminate a relationship that might not work out.
l3
DeFelice v. Emp '( Sec. Dep '(
No. 32382-0-111- dissent
Once the professionals have worked together successfully over time, however, the hiring
professional may well be comfortable relinquishing control and sharing ownership, and
the junior professional might insist on becoming a partner. If not, she might leave in
order to practice where she is better compensated and entitled to share more control.
There is no question that Dr. Armand and his daughters could implicitly terminate
the association agreements by orally agreeing to begin operating as a partnership. A
partnership agreement may be oral and may even be implied. RCW 25.05.005(7)
(defining "partnership agreement"); Roediger v. Reid, 133 Wash. 608,234 P. 452 (1925)
(a partnership may be established without a formal contract and may be made by oral
agreement),
If the issue of whether the dentists had modified or terminated the association
agreements had been treated as an issue of fact, we would review whether substantial
evidence supported the ALJ's finding. But here, the ALJ implicitly accepted the
department's argument that there was no issue of fact because the association agreements
were never terminated in writing; as a result, it must treat the relationship as governed by
those agreements. The ALJ made no findings addressing the actual nature of the dentists'
business relationship during the audit period.
The ALl's implicit conclusion that the association agreements remained binding
as a matter oflaw is subject to de novo review, and was in error. As a result, the
14
DeFelice v. Emp't Sec. Dep't
No. 32382-0-111- dissent
commissioner's adopted findings 1 through 12, all of which are predicated on the
conclusion that the association agreements remained in effect as a matter of law, are
II
§
unsupported.
Sharing profits does not require strictly equal sharing and it was legal
I error to conclude otherwise.
,
Dr. Armand and Dr. Louise both testified that in arriving at a partnership
II arrangement, they recognized that the dental practice ordinarily operates with overhead
amounting to 60 percent of collected revenues, with the result that there is ordinarily 40
percent in profits available to share. Both testified, and the ALJ found, that by the time
I
, of the audit, Drs. Loretta and Louise were paid 40 percent of their production. AR at 294
(finding 13). This is contrary to the association agreements' provisions that the daughters
would be paid 35 percent. Dr. Armand received whatever was left-which, if the parties
were right about the overhead, would be something close to 40 percent of the remaining
production. As Dr. Louise testified, the arrangement was designed so that all three would
receive 40 percent of their production: "[B]asically all of us get-end up getting 40
percent of the amount we--of production on our patients and we split the overhead,
which is 60 percent." AR at 156. The lawyer for the dental practice undertook to
illustrate this from the 2010 operating results during the hearing and reproduced the
analysis in his brief. See AR at 119-20; Br. of Appellant at 7-8.
15
I
I
j
DeFelice v. Emp 'f Sec. Dep 'f
No. 32382-0-111- dissent
I,
! The commissioner's pivotal conclusion of law identifying the basis for rejecting
I DeFelice Dentistry's claim to be a partnership is conclusion 7, which offers three reasons
i
,I
i that 1 address here, and in the two sections that follow.
I
!
I
J The first was that the dentists did not share profits. The ALJ implicitly accepted
~
~
!I the department's position that it is not enough for partners to arrive at a system for profit
1
I sharing that they conclude is fair-and in this case, that the partners concluded was close
I enough to giving each partner an equal profit percentage on his or her production. 5
j The dentists' agreement that the daughters would receive paychecks equal to 40
I percent of the professional fees collected from their services, while Dr. Armand would
II take "whatever was left" is not inconsistent with the existence of a partnership. RCW
I 25.05.015(1) provides that with respect to most matters, "relations among the partners
and between the partners and the partnership are governed by the partnership agreement."
Many provisions of the RUPA govern the partners' relations when the partners fail to
agree on a contrary rule; a few "nonwaiveable" provisions are identified by RCW
5 Conclusion 7 states in relevant part:
First, Dr. Louise and Dr. Loretta did not share in the profits .... They were
each paid exclusively a percentage of their own respective gross
production.... After payments to Dr. Louise and Dr. Loretta, Dr. Armand
earned only whatever was left each month.
ARat296.
16
DeFelice v. Emp '( Sec. Dep '(
No. 32382-0-III- dissent
25.05.015(2). How partners share profits and losses is one ofthe matters that partners are
free to decide. 6 It is only a default provision of the RUP A that provides for an equal
sharing of profits and equal charging of losses if the partners have no different
agreement. See RCW 25.05.150.
The dearth of Washington case law addressing partners' prerogatives under
modern partnership statutes might have contributed to the department's and the ALl's
error. Bright line rules that might be implied by old cases on which the department relies
have been rejected with the legislature's enactment, first, of the Uniform Partnership Act
(UPA), and then (and even more clearly) with RUPA. As the reporters for the RUPA
have explained:
Across all substantive areas, RUP A reflects the policy judgment that,
with rare exceptions, partners are permitted to govern relations among
themselves by agreement. Almost all ofRUPA's rules governing the
relations among partners are merely default rules rather than mandatory
rules. That is, the statutory rules apply only in the absence of a partnership
agreement to the contrary.
6 For federal tax purposes, the Internal Revenue Service also respects the parties'
agreement as to distributive shares of income, gain, loss, deduction or credit (including
different ratios for profits vs. losses), as long as the allocations have "substantial
economic effect." 26 U.S.C. § 704. Simply stated, the requirement of "substantial
economic effect" means that the allocation must be reasonably expected to substantially
affect the partner's shares independent of tax consequences, and that the recipient partner
must erUoy the economic benefits or bear the economic burdens associated with the
allocation. Treas. Reg. § 1.704-1.
17
DeFelice v. Emp't Sec. Dep't
No. 32382-0-III- dissent
Donald 1. Weidner & John W. Larson, The Revised Uniform Partnership Act: The
Reporters' Overview, 49 Bus. LAW. 1,2 (1993). While observing that under the
predecessor UPA "it [was] not clear which rules are merely default rules and which rules
are mandatory rules," the reporters state, "Under RUPA, every rule governing the
relations among partners is a default rule unless it is separately listed as a mandatory
rule."
This is not to say that how parties share profits and losses will not have a bearing
on whether they are found to have "associate[ed] ... to carry on as co-owners a business
for profit," as is required to form a partnership under the RUPA. As the Supreme Court
of Nebraska observed, applying the RUPA, the indicia of co-ownership, which include
profit sharing and loss sharing, "are only that; they are not all necessary to establish a
partnership relationship, and no single indicium of co-ownership is either necessary or
sufficient to prove co-ownership." In re Key Tronics, 274 Neb. 936, 744 N.W.2d 425,
441 (2008).
In Stuart v. Overland Medical Center, 510 S.W.2d 494,497-98 (Mo. Ct. App.
1974), a court applying the Uniform Partnership Act (UPA), the predecessor to the
RUPA (the UPA was in effect in Washington from 1945 until its repeal in 1998 7) held
Former chapter 25.04 RCW, adopted by LAWS OF 1945, ch. 137, §§ 1-43;
7
repealed by LAWS OF 1997, ch. 103, § 1308.
18
DeFelice v. Emp't Sec. Dep't
No. 32382-0-III- dissent
that an economic arrangement under which professionals received an amount equal to the
revenues they produced less a percentage determined by their shared expenses was profit-
sharing, explaining that "because the expenses each doctor had to pay bore no
relationship to the actual expenses of each doctor, some doctors were receiving profits
that otherwise might have been distributed to the doctor or doctors whose actual expenses
were slight when compared to the actual expenses of other doctors." Stuart's holding
that individuals who share expenses indirectly accomplish profit-sharing and thereby
function as a partnership has been followed under RUPA by the District of Columbia
Court of Appeals. Brown v. 1401 New York Ave., Inc., 25 A.3d 912,916 n.8 (2011).
In a dental practice that the partners evidently believed had a reasonable
predictable overhead burden it was reasonable that, rather than close out the books each
pay period or take draws subject to a later accounting, Dr. Armand agreed that his
daughters would be paid the projected net profit on their production and he would enjoy
the benefit or bear the burden of any discrepancy between the projected and actual
overhead.
This is not tantamount to saying that any owner of a business could pay employees
a commission based on a percentage of production, call it "profit sharing," and thereby
claim partnership status for purposes of the Employment Security Act. The facts in this
case are distinguishable from that scenario in two respects. The first is that the
19
DeFelice v. Emp 't Sec. Dep't
No. 32382-0-111- dissent
department never challenged that the flat 40 percent paid to Drs. Loretta and Louise was
the parties' reasonable, good faith projection of net profits, supported by the income
statements, with the objective that all three partners receive a fair share but without
requiring more complete accounting. The second is that Drs. Armand, Loretta and
Louise were prepared to argue that they operated in other respects as co-owners. If the
substance of their relationship during the audit period was not more fully investigated and
debated at the hearing, it was because the department, and ultimately the commissioner,
concluded that what the dentists were doing in/act didn't matter.
By way of example, the commissioner adopted the finding that Dr. Louise and Dr.
Loretta were "likely" subject to at least some direction and control by their father during
the audit period, based on the 1990 and 2004 association agreements. The finding is not
supported by any evidence of actual operations. Dr. Louise, the newest dentist in the
practice, testified:
Q. [D]oes he ever kind of tell you-I know he is your father-as part as
your dental practice, as fathers would do, does he ever tell you how to do
things?
A. No.
Q. Okay. You are kind of on your own, you have total discretion with
your patients?
A. Yes. 100 percent.
AR at 163-64.
20
DeFelice v. Emp 't Sec. Dep't
No. 32382-0-111- dissent
If the issue of whether the dentists were operating as a partnership during the audit
period had been treated as an issue of fact, taking into consideration the evidence of the
dentists' intent and the aspects of their actual operations between 2010 and 2012 that
would reflect on an intent to operate as co-owners, then we would review whether
substantial evidence supported the ALl's finding. One piece of that evidence would be
the dentists' profit-sharing understanding. But here, the ALJ was not examining all of the
evidence bearing on whether Drs. Armand, Loretta and Louise intended to operate as co­
owners. Instead, the ALJ accepted the department's position that the distribution of
something other than exactly equal percentages of profits was another bright-line reason
for finding as a matter of law that there was no partnership. That implicit conclusion is
subject to de novo review.
The more a profit-sharing arrangement deviates from what is equal or what can
otherwise be defended as reasonable among partners, the more likely it will not be
viewed as consistent with the intent "to carry on as co-owners a business for profit."
RCW 25.05.055(1). But the RUPA expressly provides that how partners choose to divide
profits is a matter for their agreement. For the commissioner to conclude that anything
other than exactly equal profit-sharing prevented the formation of a partnership is
contrary to Washington statutes.
21
DeFelice v. Emp 't Sec. Dep't
No. 32382-0-111- dissent
It is not necessary that partners always share losses equally and it
was legal error to conclude otherwise-particularly based on
hypothetical losses that are unlikely ever to occur.
The commissioner's second reason for concluding that DeFelice Dentistry was not
a partnership was its acceptance of the department's position that the partners do not
share losses, since "if [the daughters] did not work, they did not contribute to overhead"
leaving the burden to fall disproportionately on Dr. Armand. AR at 296 (finding 7}.8
This was based on Dr. Louise's response to a hypothetical question from the
department's lawyer who inquired whether, "[i]f [she] decide[d] to take the month off,"
she would contribute anything to overhead. 9 Dr. Louise acknowledged that in that event,
based on the dentists' compensation agreement, she would not contribute to overhead.
She immediately added, "But 1 can also tell you I have never taken a month off." AR at
159-60.
8 Conclusion 7 further states:
Dr. Louise and Dr. Loretta did not share in ... losses.... If they did not
work, they did not contribute to overhead. After payments to Dr. Louise
and Dr. Loretta, Dr. Armand earned only whatever was left each month.
ARat296.
9 Somewhat inconsistent with its ultimate position, the department's hypothetical
suggestion that Dr. Louise might decide to take a month off attributes to her the
prerogatives of an owner, not an employee. The association agreement that she signed in
2004 contemplated that she would work three days, more or less, per week. AR at 247.
22
I
!i
!
!
Ij
~ DeFelice v. Emp't Sec. Dep't
!j
• No. 32382-0-111- dissent
Ii
~l First, and as with profits, a sharing of losses is not required by chapter RCW
j
I
t
I,
;
25.05. See RCW 25.05.015(1) (with respect to most matters, "relations among the
!
partners and between the partners and the partnership are governed by the partnership
agreement"); UNIF. P'SHIP ACT (1997) § 401 cmt. 3, 6 pt. 1 U.L.A. 134 (2001) ("If
I partners agree to share profits other than equally, losses will be shared similarly to
I
J
profits, absent agreement to do otherwise .... Of course, by agreement, they may share
I
:1 losses on an entirely different basis from profits.").
I
I! Washington cases have long supported partners' flexibility when it comes to
I
!
sharing losses. In two decisions involving the same partnership accounting, the
Washington Supreme Court reversed and remanded the accounting because the trial court
I! failed to determine the partners' understanding as to how losses were to be borne. In the
I first, Richert v. Handly, 50 Wash. 2d 356, 361-62, 311 P.2d 417 (1957), the Supreme Court
recognized that the partners could, but need not, agree to share losses equally; it
remanded because the trial court's findings were inconsistent as to what the partners in
that case had agreed to do. In the second, Richert v. Handly, 53 Wash. 2d 121,.123,330
P.2d 1079 (1958), the Supreme Court held that since the trial court found upon remand
that the parties never agreed upon the basis on which losses would be shared, then the
court could not simply leave the parties where it found them; it was required to apply the
default provisions of the former UPA. See also Dow v. Dempsey, 21 Wash. 86, 93, 57 P.
23
DeFelice v. Emp 't Sec. Dep't
No. 32382-0-111- dissent
355 (1899) (citing a treatise for the proposition that "it is natural to suppose" that partners
intended to share losses "ifthey have said nothing to the contrary"); Refrigeration
Engineering Co. v. McKay, 4 Wash. App. 963, 974, 486 P.2d 304 (1971) (while the law
will assume an agreement to share losses from silence, "Ifjoint venturers wish to have a
contrary agreement as to the sharing of losses, they can easily make an express agreement
to that end.").
Washington cases recognize that some "loss sharing" is reflected in the fact that
partners share net profits rather than gross revenues. See, e.g., Oriental Realty Co. v.
Taylor, 69 Wash. 115, 120, 124 P. 489 (1912) ("It is true no mention is made of the
losses, but losses, if any, must first be deducted before there could be profits, and
necessarily must be borne equally"). Courts in Ohio, which has adopted the RUPA, have
concluded that even limited partners, who are statutorily protected from liability, are
treated as employers for unemployment contribution purposes as long as they act and are
treated like general partners in virtually every important respect other than their limited
liability. Appeal ofAnderson, 29 Ohio App.3d 248,504 N.E.2d 1155, 1159 (1985),
In this case, given the dentists' use ofa projected overhead factor that was based
on all collected revenues and all practice expenses, each dentist risked loss in two
respects. First, and as discussed in the Stuart case, supra, each dentist faced the risk that
one or two dentists might operate less economically, with the result that the overhead
24
DeFelice v. Emp 'f Sec. Dep 'f
No. 32382-0-III- dissent
borne by an efficient dentist would be higher than it would be if she or he were practicing
alone. Second, the partners' projection ofthe overhead factor might prove in a given
year to be too high or too low, with the result that Dr. Armand might receive a higher
profit percentage or a lower percentage in some years than Drs. Loretta and Louise. 1o
The prospect of un shared loss on which the department focused and that the ALJ
relied upon as a basis for its conclusion that there was not a partnership, was the prospect
that one of the daughters would simply not work. The hypothetical assumed that
overhead would remain the same and fall disproportionately on Dr. Armand. The
hypothetical was pure conjecture. Dr. Louise testified that she had never taken a month
off and the income statements in evidence demonstrated that Drs. Loretta and Louise
were successful professionals, producing a substantial portion of the collected revenues
of the practice.
Here, as with profit-sharing, the more a loss-sharing arrangement deviates from
what is equal or what can otherwise be defended as reasonable among partners, the more
likely it will not be viewed as consistent with the intent "to carry on as co-owners a
business for profit." RCW 25.05.055(1). If a loss contingency is either (1) theoretically
10 If the actual overhead proved to be less than 60 percent of total collected
revenue, then Drs. Loretta and Louise would receive a smaller percentage profit from
their production than Dr. Armand. If the actual overhead proved to be more than 60
percent of total collected revenue, then Dr. Armand would receive a smaller percentage
profit on remaining revenue than was received by Drs. Loretta and Louise.
25
DeFelice v. Emp 't Sec. Dep't
No. 32382-0-IU- dissent
possible but highly implausible, or (2) would occur over time and could be addressed
through the partners' agreement that financial interests may need to be adjusted, then it
might not weigh heavily, if at all, against finding formation of a partnership. In this case,
both Dr. Armand and Dr. Louise testified that when unforeseen contingencies arose in
their family partnership, they "talk about it." AR at 138-39, 147 (Dr. Armand).
In any event, dispositive here is that the RUP A expressly provides that how
partners choose to divide losses is a matter for their agreement. For the commissioner to
conclude that anything other than exactly equal loss-sharing prevented the formation of a
partnership is contrary to Washington statutes.
The form in which Dr. Armand reported and registered the practice is
insufficient as a matter oflaw to support characterization as a partnership.
It was legal error to conclude otherwise.
The third basis for the commissioner's pivotal conclusion that the dentists were
not operating as a partnership was its findings that Dr. Armand did not update his 1966
registration with the department in 2008 to reflect the fact that he had begun operating in
partnership with his daughters; that the daughters also failed to establish accounts with
the department upon becoming partners in 2008; that Dr. Armand did not update his
registration with the Department of Revenue to reflect partnership operations; and that
Dr. Armand had continued through 2012 to report liability for federal taxes as a sole
26
DeFelice v. Emp 't Sec. Dep't
No. 32382-0-III- dissent
proprietorship. AR at 294 (findings 14, 15, and 16).11 As the majority recognizes, the
Internal Revenue Service has published a revenue procedure recognizing that a small
partnership (less than 10 partners) whose partners have fully reported their shares of the
income, deductions and credits of the partnership on their timely filed individual income
tax returns will satisfy the "reasonable cause" test for failure to timely file a partnership
tax return. Rev. Proc. 84-35, 1984-1 C.B. 509.
In determining the character of the business relations of parties, "[m]any times
form must give way to substance." State v. Bartley, 18 Wash. 2d 477,481-82, 139 P.2d 638
(1943) (arrangement was partnership in form, but not in substance).
The RUP A is even more explicit on this score. It provides that "the association of
two or more persons to carry on as co-owners a business for profit forms a partnership,
whether or not the persons intend tolorm a partnership." RCW 25.05.055(1) (emphasis
II Conclusion 7 provided in part:
[M]ore significantly, although claiming to be a tax partnership entity, the
business was registered as a sole proprietorship and did not file any
notification with the state regarding its changed status. Nor did it file any
federal income tax returns evidencing a partnership entity, such as a Form
1065. Dr. Armand was reporting income and expenses for the business on
his individual tax return as a sole proprietorship. This is absolutely
inconsistent with the Petitioner's claim the business was a partnership tax
entity during the [time] period at issue.
ARat296.
27
DeFelice v. Emp 't Sec. Dep't
No. 32382-0-III- dissent
added). In other words, even if Drs. Armand, Loretta and Louise had intended to operate
as a sole proprietorship but were acting in substance as partners, the "sole proprietorship"
form of their registration and tax reporting would not matter-they would still be treated
as a partnership.
A fortiori, if they were not only acting in substance as partners but also intended to
form a partnership, the fact that they reported and registered as a sole proprietorship
cannot possibly matter. To conclude otherwise is contrary to RCW 25.05.055(1).
Courts of the State of Tennessee, which has adopted the RUPA, have come to the
same conclusion, reasoning that because it is not necessary under the RUP A that the
parties know the legal results of their actions in creating a partnership "the terminology
used by the parties to describe their business relationship is of little import." Messer
Griesheim Indus. v. Cryotech ofKingsport, Inc., 45 S.W.3d 588, 605 (Tenn. Ct. App.
2001) (citing Bass v. Bass, 814 S.W.2d 38, 41 (Tenn. 1991».
For the commissioner to conclude that the form in which the practice was
registered and reported was sufficient to defeat the existence of a partnership is contrary
to Washington statutes.
Conclusion
When one sets aside the commissioner's unsupported factual findings and
erroneous legal conclusions, there is no basis for his ultimate conclusion that DeFelice
28
DeFelice v. Emp '( Sec. Dep '(
No. 32382-0-111- dissent
Dentistry was not a partnership for tax purposes during the period covered by the audit.
Because the commissioner's decision should be reversed, 1 respectfully dissent.
:)ztih ~ ~&:
Siddoway, C.J.
I
29