How Are Founder Disputes Over Inventory Valuation Resolved?

Introduction

When co-founders separate after a business dispute, the division of commercial goods, warehouse stock, machinery, and other equipment can become more difficult than determining ownership of cash or shares. The disagreement usually concerns the identity of the assets, their condition, their market value, and the proper allocation of gains, losses, and risks.

Philippine law addresses these disputes through the rules on partnership obligations, corporate liquidation, accounting, appraisal, and restitution. The proper procedure depends first on whether the venture is an unincorporated partnership or joint venture, or a corporation governed by the Revised Corporation Code.

Which Legal Structure Governs the Dispute?

The first question is whether the founders operated as partners, co-venturers, or stockholders of a corporation. A business described informally as a “company” may legally be a partnership if the parties contributed money, property, or industry to a common fund with the intention of dividing profits.

If the venture was incorporated, its assets belong to the corporation and not directly to the founders. The dispute must ordinarily be resolved through corporate accounting, asset disposition, liquidation, or other corporate remedies. A private agreement cannot ordinarily convert corporate property into the personal property of individual stockholders.

For an incorporated venture, the principal statute is the Revised Corporation Code of the Philippines, or R.A. No. 11232. For a partnership, the relevant provisions are found in Book IV, Title IX of the Civil Code of the Philippines, or R.A. No. 386.

How Are Partnership Goods and Equipment Appraised?

Article 1787 of the Civil Code provides that when a partner contributes goods as capital, the appraisal must follow the method stated in the partnership agreement. If the agreement is silent, the partners must select experts to conduct the appraisal using current prices.

This rule is particularly relevant where one founder contributed merchandise, raw materials, vehicles, tools, machinery, or other equipment instead of cash. The valuation should identify the goods and determine their value at the time of contribution, unless the partnership agreement adopts another valuation date or method.

The appraisal should ordinarily consider the goods’ condition, age, quantity, marketability, obsolescence, damage, storage costs, and whether the items remain usable in the business. A book value appearing in an accounting record is not necessarily the same as the asset’s current sale value or liquidation value.

Who Bears the Risk of the Goods?

Article 1795 of the Civil Code distinguishes between goods contributed for use and goods contributed for sale or consumption.

Where specific and determinate non-fungible property is contributed only for the common use and enjoyment of the partnership, the partner who owns it generally bears the risk of loss. Examples include a particular delivery truck, identified machine, or specific piece of equipment that remains owned by the contributing partner.

By contrast, the partnership generally bears the risk when the goods are fungible, likely to deteriorate, contributed for sale, or included in an inventory after appraisal. Examples include retail merchandise, raw materials, fuel, food products, and interchangeable warehouse stock.

The parties should therefore determine whether the items were transferred to the partnership as ownership or merely made available for use. This distinction can substantially affect the amount credited to a founder during liquidation.

What Evidence Is Needed for Inventory Valuation?

A reliable valuation begins with a complete physical inventory. The parties should jointly prepare or commission a schedule identifying each item, its quantity, location, condition, serial number where applicable, acquisition date, recorded cost, and proposed liquidation value.

Useful records include purchase invoices, delivery receipts, warehouse reports, stock cards, sales records, depreciation schedules, insurance documents, importation papers, repair records, and photographs. Bank records and supplier confirmations may also help establish whether the assets were purchased by the venture or contributed by a founder.

Where the parties cannot agree, an independent appraiser or qualified accounting professional may be appointed by agreement or by the court. The appraiser should be given a written scope, including the valuation date, valuation basis, treatment of damaged or obsolete stock, and method for verifying the physical inventory.

Market Value and Liquidation Value Are Different

Market value generally refers to the price an asset may command in an orderly transaction. Liquidation value may be lower, particularly when the business must sell quickly, dispose of excess inventory, or close a warehouse.

The valuation method should match the purpose of the proceeding. If the business will continue operating and one founder will buy out another, fair market value may be more appropriate. If the enterprise is being wound up and assets must be sold to pay creditors, expected net liquidation proceeds may be the more relevant measure.

The appraisal should also deduct reasonable expenses of sale, transportation, storage, taxes, commissions, and necessary repairs when the objective is to determine the amount actually available for distribution.

How Does Corporate Liquidation Affect Inventory and Equipment?

Under Section 39 of R.A. No. 11232, a corporation may dispose of its property and assets upon authorization by its board of directors or trustees, subject to the statutory requirements. A disposition involving all or substantially all corporate assets requires approval by stockholders representing at least two-thirds of the outstanding capital stock, or by at least two-thirds of the members in a nonstock corporation.

The statute also measures whether a disposition involves substantially all corporate assets by reference to the corporation’s net asset value as shown in its latest financial statements. A sale is considered to cover substantially all assets if it would leave the corporation unable to continue its business or accomplish its corporate purpose.

Accordingly, founders cannot ordinarily divide warehouse stock or equipment among themselves merely because they hold equal shares. The corporation must first account for its assets and liabilities, observe the required corporate approvals, and protect the rights of creditors.

What Happens During Liquidation?

Liquidation requires the business to identify and collect its assets, pay its debts and liabilities, resolve outstanding claims, and distribute the remaining balance according to the applicable agreement, ownership interests, or legal rules.

The Securities and Exchange Commission has described liquidation as the winding up of corporate affairs through collection of assets, payment of creditors, and distribution of remaining assets among stockholders according to their contracts or, in the absence of a special agreement, their respective interests. This principle is reflected in SEC-OGC Opinion No. 19-60.

For a partnership, the accounting should similarly determine the partnership’s assets, liabilities, profits, losses, and each partner’s resulting share. The value of contributed inventory or equipment should not be considered in isolation from obligations owed to suppliers, lenders, employees, lessors, and government agencies.

Why Accounting Must Precede Distribution

The Supreme Court held in Sunga-Chan, et al. v. Court of Appeals, et al., G.R. No. 164401, 25 November 2008, that a partner’s share in partnership assets may constitute an unliquidated claim until an accounting, inventory, and appraisal establish the amount with reasonable certainty.

The Court explained that a claim cannot be treated as liquidated merely because it can eventually be computed mathematically. Where the exact share cannot be determined without examining the partnership’s assets and liabilities, accounting must come first.

This ruling has important consequences in a founder dispute. A founder may assert entitlement to one-half of the inventory, but the amount due cannot be reliably fixed until the inventory is verified, valued, offset against liabilities, and allocated under the partnership agreement or applicable law.

Can a Founder Demand Immediate Physical Division?

Not necessarily. Physical division may be unsuitable where the assets are indivisible, commercially integrated, subject to liens, or worth more when sold as a group. Dividing a delivery system, production line, or operating warehouse may destroy value or make continued operations impossible.

The parties may instead agree to one of several arrangements:

• sale of the assets and distribution of the net proceeds;
• transfer of particular assets to one founder with an equalization payment to the other;
• purchase by one founder of the other’s interest based on an agreed valuation;
• continued operation under a revised ownership agreement; or
• court-supervised liquidation and distribution.

The selected arrangement should account for creditor claims, taxes, storage and sale expenses, asset-specific liabilities, and the risk that the valuation will change while the dispute remains pending.

How Are Valuation Disagreements Resolved?

The governing agreement should be examined first. It may contain a valuation formula, an appraisal procedure, a buyout mechanism, an arbitration clause, or a deadlock provision. A valid contractual process should generally be followed unless it conflicts with mandatory law or the rights of third parties.

If the agreement is silent or ineffective, the parties may seek an independent appraisal and negotiate a settlement. They should preserve the inventory, maintain insurance, restrict unauthorized withdrawals, and document every sale or movement of goods during the dispute.

Where litigation is necessary, the court may require an accounting and appoint or receive evidence from an expert. The party seeking relief should clearly identify the assets, explain the proposed valuation method, and establish the legal basis for the requested distribution.

Rescission, Restitution, and Liquidation

A founder dispute may also arise from a breached pre-subscription agreement, joint venture agreement, or similar undertaking. In Ong v. Tiu, et al., G.R. No. 144476, 8 March 2002, the Supreme Court recognized that a substantial and fundamental breach of reciprocal obligations may justify rescission under Article 1191 of the Civil Code.

Rescission does not always mean that each party simply receives back the amount originally contributed. Where the venture operated for a period and generated profits, incurred losses, acquired property, or accumulated liabilities, liquidation may be required to determine the parties’ actual financial positions.

The Court distinguished restitution from liquidation. Liquidation includes the profits and losses attributable to the period of investment, while restitution is directed toward restoring the parties, as far as practicable, to their former positions.

Common Valuation Problems

Several recurring problems can distort the distribution of commercial goods and equipment:

• Double counting: inventory recorded as both a founder contribution and a corporate asset without proper reconciliation.
• Inflated contributed value: goods credited at acquisition cost despite deterioration, obsolescence, or reduced market demand.
• Unrecorded withdrawals: stock or equipment removed by a founder without documentation or corresponding credit.
• Confusion between ownership and use: equipment treated as corporate property even though the founder only allowed the business to use it.
• Ignoring liabilities: inventory divided without deducting secured obligations, supplier claims, taxes, or disposal expenses.

Recommended Procedure for Founders

Founders should first secure the assets and prevent unilateral disposal. Access to warehouses, accounting systems, inventory software, and company bank accounts should be controlled under a written interim arrangement.

Next, the parties should agree on a cutoff date and conduct a joint physical count. Each item should be tagged and reconciled with accounting records. Disputed items should be placed on a separate schedule rather than silently assigned to one party.

The parties should then appoint an independent appraiser with no financial relationship with either founder. The engagement should specify whether the appraiser will determine fair market value, replacement cost, net realizable value, or liquidation value.

After valuation, the parties should prepare a liquidation statement showing gross asset value, liabilities, selling expenses, taxes, advances, founder contributions, withdrawals, profits, and losses. Only the net amount should be considered for distribution.

If settlement fails, the initiating party should consider the appropriate remedy, which may include accounting, dissolution, liquidation, injunction, recovery of specific property, damages, or enforcement of an arbitration agreement. The facts and governing documents determine which remedy is available.

Final Observations

Disputes over commercial inventory and equipment cannot be resolved fairly by relying solely on purchase receipts, book values, or the founders’ original contribution percentages. The proper result ordinarily requires a verified inventory, an appropriate valuation date and method, recognition of ownership and risk, and deduction of liabilities and liquidation expenses.

Founders should preserve the assets, comply with the partnership or corporate agreement, obtain an independent appraisal, and complete the accounting before distributing property or proceeds. In a corporation, the board and stockholders must also observe the approval requirements of R.A. No. 11232, particularly when the transaction involves all or substantially all corporate assets.

About Nicolas and De Vega Law Offices

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