67, are husband and wife whose residence was Woodside, San Mateo County, Calif., when their petition was filed. They also filed a joint Federal income tax return for the 1963 calendar year with the district director of internal revenue, San Francisco, Calif. Schmitz and Throndson are both dentists specializing in the practice of oral surgery. Both doctors belong to local and national professional dental societies. Throndson was 61 years old at the time of the trial herein in January 1968.

From 1946 through 1962, Throndson and Schmitz were equal partners in the practice of dentistry (hereinafter sometimes referred to as the partnership). A written partnership agreement was first consummated by them on May 15, 1951, and subsequently modified on September 21, 1955, and February 20, 1956.

The practice of the partnership was exclusively from referrals by other dentists, medical doctors, and from patients. Referral slips were printed up by the partnership for the convenience of the referring doctors. Patients were generally referred to the firm rather than to either of the individual doctors personally and any given patient might be treated by either doctor. If the procedure required more than one visit the patient was often treated by both Schmitz and Throndson on the successive occasions.

At the commencement of the partnership in 1946, both Schmitz and Throndson practiced in one office in San Francisco, Calif. Schmitz resided in San Francisco and Throndson resided in Woodside. In 1950 Schmitz moved to Kentfield in Marin County, Calif.

On or about June 8, 1953, the partnership opened an additional office on Greenfield Avenue, San Rafael, Marin County, Calif. This office was rented by the partnership. In December of 1957 Schmitz and Throndson purchased land and built an office building on Fifth Avenue in San Rafael, and the practice on Greenfield Avenue was then moved to the new building on Fifth Avenue. This building and the land upon which it was constructed was jointly owned by Schmitz and Mrs. Schmitz and Throndson and Mrs. Throndson at all times prior to the termination of the partnership in 1962.

Both Schmitz and Throndson treated patients at both the San Rafael and San Francisco offices. Since Schmitz lived in San Rafael he practiced 3 days of a 5-day week at the San Rafael office; the other 2 days he practiced at San Francisco. Throndson did exactly the opposite. All records relevant to the San Rafael practice were kept at the San Rafael office.

The net profits from both offices of the partnership for the years 1958 through 1962 were as follows:

Toward the end of 1962, Schmitz and Throndson had a disagreement over the effort being expended by each party and Throndson suggested an adjustment in their financial arrangement. An adjustment was unacceptable to Schmitz and he suggested that the partnership dissolve. As a result of this discussion Throndson retained Edward J. Reidy (hereinafter sometimes referred to as Reidy) as his attorney. Throndson did not execute either a power of attorney or a written contract of employment with Reidy. A covenant not to compete was never discussed between Throndson and Reidy.

Schmitz retained Joseph L. Alioto (hereinafter sometimes referred to as Alioto) as his attorney. Schmitz stated to Alioto that it was his "firm intention" to continue practicing in Marin County.

On Tuesday, December 11, and Friday, December 14, 1962, both Schmitz and Throndson and their respective attorneys met in the offices of Alioto for the purpose of dissolving the partnership. At the December 11 meeting both Schmitz and Throndson expressed a desire for the Marin County practice in San Rafael. Alioto mentioned an agreement for Throndson not to practice in Marin County if Schmitz were to get the practice at San Rafael, but because Schmitz had previously stated that it was his "firm intention" to continue to practice in Marin County, regardless of what happened, the parties did not discuss the matter further or attempt to negotiate a covenant not to compete. The December 11 meeting was inconclusive because of friction between the doctors. Neither at such meeting nor at any other time, did Throndson define the extent of Reidy's authority.

At the second meeting held in Alioto's office on Friday, December 14, Reidy did not take an active role in the discussions. For the purpose of negotiations Throndson had obtained appraisals on the San Rafael Medical Building supporting a value of $127,000 and a loan value of $80,000. Schmitz had obtained an appraisal supporting a value of $100,000 (a net value of $68,000, since the property was encumbered by a $32,000 mortgage) from the bank in which his brother-in-law was a manager.

Throndson stated at the December 14 meeting that he would allow Schmitz to take the entire building and the Marin County practice at San Rafael, on payment of $90,000, but that if Throndson were to take the entire building and the Marin County practice, he would only be willing to pay $50,000.

Throndson's explanation for the difference between these bid and asked prices was that Alioto had previously stated that: (1) His client, Schmitz, would under no circumstances leave Marin County or the practice of dentistry there; (2) had stated further that if Throndson were successful in outbidding Schmitz for such building and practice, Schmitz would exercise an option he had already taken on another space and continue to practice in San Rafael and (3) Schmitz, if successful in the bidding, would have the advantage of the building and established goodwill in the form of an uninterrupted practice.

Throndson's proposal for $90,000 was rejected by Schmitz. Throndson then argued, in the negotiations, that there was an element of goodwill attributable to the continuity of practice and the established referrals. It was believed by Throndson that the referrals would continue for sometime at San Rafael even if one of the doctor's names were to be deleted from the partnership.

Alioto finally conceded that there was some element of goodwill present and therefore suggested that another meeting be tentatively scheduled for the following Friday, at which time Schmitz and Throndson would come prepared to bid, with the lowest bidder having the first option to rebid, alternate rebidding to continue in increments of at least $1,000 until one party dropped out.

On Saturday, December 15, 1962, the day after the second meeting, Reidy, who was at his office, received a telephone call from Alioto who informed him that he had been authorized by Schmitz to submit a bid of $70,000: $34,000 immediately and $12,000 a year for 3 years.

Alioto also stated that Schmitz would retain the accounts receivable and equipment at San Rafael and Throndson would retain the accounts receivable and equipment at San Francisco, cash in the bank would be divided equally, and adjustment was to be made between the doctors for the differential in hours worked by each of them in 1962.

Shortly after receiving Alioto's telephone call, Reidy telephoned Throndson and informed him of the offer. Throndson, after a brief discussion with his wife, told Reidy to accept it.

Either before or after Alioto called Reidy, on Saturday, December 15, 1962, Alioto contacted Schmitz and told him that he (Schmitz) would pay $34,000 for Throndson's interest in the real property and $36,000 over a 3-year period for a covenant not to compete. Schmitz at first thought that this amount was excessive, however, Alioto explained that while it was a large amount of money, Schmitz would have the sole right to practice without competition from Throndson in Marin County, and that the agreement not to compete would be tax deductible.

After Alioto explained to Schmitz the tax effects of a covenant not to compete Schmitz said: "Well, if that is the case, this sounds all right with me. Go ahead and see what you can do as far as contacting Throndson and Reidy and getting a formal agreement."

Sometime on Monday, December 17, 1962, Reidy telephoned Alioto and informed him that his client, Throndson, had agreed to the terms of the offer, that is, Schmitz would be given the building (subject to the mortgage) and the practice at San Rafael, while Throndson would keep the San Francisco practice and also receive a total of $70,000 from Schmitz, $34,000 being paid immediately, with the $36,000 remainder being paid at $12,000 a year over the next 3 years.

Alioto then asked Reidy to draft a letter confirming the terms of the agreement and stating that the $12,000 a year for 3 years be spe cifically included in the letter as payment for a covenant not to compete. Reidy was led to believe by Alioto that this letter was to be used to assist Alioto's client in arranging financing.

Reidy was unaware of the tax consequences of allocating a part of the purchase price to a covenant not to compete and agreed to Alioto's request. He did so because he believed that the letter was to be used in assisting Schmitz in financing the transaction, although he did not know why this would be so, and also because Throndson had indicated to him, after the second meeting, that he preferred to practice in San Francisco. Reidy then wrote and mailed the following letter:

MR. JOSEPH ALIOTO,

Attorney at Law,

111 Sutter Street,

DECEMBER 17, 1962

San Francsco 4,

California.

DEAR MR. ALIOTO:

This is to confirm the terms of the settlement of the partnership termination of Doctors Throndsen [sic] and Schmitz.

Dr. Schmitz will pay $34,000.00 for Dr. Throndsen's interest in the real property and $12,000.00 per year payable January 2, 1963, 1964 and 1965 for a covenant for Dr. Throndsen not to practice in Marin County.

Dr. Throndsen will also take the San Francisco practice together with the accounts receivable therein. Dr. Schmitz will have the practice and accounts receivable in San Rafael.

It is understood that the cash in the bank will be divided equally and that no expenditures will be made from either office pending the termination of the partnership which will probably conclude this week.

I will have Dr. Throndsen execute and forward a signed copy of this agreement to you.

Yours very truly,

(Signed) Edward J. Reidy EDWARD J. REIDY

EJR/fk

1 The correct spelling throughout the letter should be Throndson.

Throndson was not aware of the contents of Reidy's letter until 1965 when his tax returns were audited.

On Monday, December 17, 1962, Alioto telephoned his client and informed him that the "deal had been consummated," and again reiterated the terms. Shortly thereafter Alioto sent Schmitz a copy of Reidy's letter of December 17, 1962.

Alioto instructed Schmitz that he was to deposit $34,000 in escrow with a title company for the purchase of the property and that the three annual payments would begin on January 1, 1963. The three annual installments were to be, and were, evidenced by a note which was secured by a lien on the San Rafael building, which note was delivered to Throndson during 1963.

Reidy, still unaware of the tax consequences, began to prepare a contract for Throndson's signature, including provisions for the respective practices, equipment, accounts receivable, time differential, and the covenant not to compete. He started to write this agreement out in longhand on December 18, writing over the typewritten office copy of his December 17 letter to Alioto. While doing so he telephoned Alioto to discuss the status of the time differential, but Alioto told Reidy that everything had been worked out between the parties and "was fine.” Therefore Reidy never completed the work, and no agreement was ever signed by Throndson.

On December 21, 1962, December 11, 1963, and December 18, 1964, Schmitz sent checks for $12,000 each to Alioto with an accompanying letter. The 1962 letter referred to the money as a "covenant payment." Both the 1963 and 1964 letters referred to the money as payments in the matter of "dissolution and settlement."

Alioto forwarded all three checks to Reidy and in his first two accompanying transmittal letters Alioto referred to the payments as being for the covenant. His third and last transmittal letter referred to the $12,000 as the third and final payment in the dissolution and settlement of the partnership. Throndson was not aware of the contents of Alioto's three transmittal letters until shortly before the commencement of this litigation. Reidy forwarded only the checks to Throndson and did not inform him of the contents of the letters. At no time did Reidy refer to the checks as being in payment for a covenant not to compete.

Since January 1, 1963, Schmitz has engaged in the practice of oral surgery at the San Rafael office and Throndson has engaged in the practice of oral surgery at San Francisco. Schmitz, in his income tax return for 1963, deducted the $12,000 paid to Throndson in 1963 as

2 The letter of Dec. 21, 1962, sent to Alioto by Schmitz, contained a check dated Jan. 3, 1963, payable to the order of Throndson. This check was sent to Reidy, Throndson's attorney, by Alioto on Jan. 3, 1963.