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July/August 2004

 
Practice Perfect: Business Operations
Restrictive Covenants:
Does Your Noncompete Clause Have Claws?
By Chris McDonagh, Associate Editor
 
 

The physicians of Argus Eye Care* had spent many years building a patient base, cultivating referral relationships and establishing their practice’s reputation, and they were determined to protect those assets. So when they brought a new doctor aboard, they included several restrictive covenants in his employment contract —but how much protection would that really provide?

“There is a lot of lore that circulates in the physician community about restrictive covenants; and then there is the law,” said Robert A. Wade, JD, a founder and managing partner of Wade, Goldstein, Landau and Abruzzo, a health care law firm in Berwyn, Pa. “There is some overlap between lore and law, but not as much as you might expect.” By knowing the law, you can craft a noncompete clause that tilts the scales of justice in your favor.

Restrictive Covenants
Under a restrictive covenant, individuals who join a practice agree to restrict their future activities. Such covenants fall into three main categories:

The noncompete covenant restricts an individual from pursuing a particular activity within a given geographic area for a specific period of time after termination of the employment relationship.

The nondisclosure covenant—sometimes known as a confidentiality agreement—recognizes that certain types of information (such as patient lists) are proprietary to the practice. The individual cannot reveal this information to others or take it to his or her next practice after termination of the current employment relationship.

The nonsolicitation covenant—also known as the nonpiracy agreement—prevents an individual who has left the practice from poaching the practice’s staff, referral sources, patients or patients’ immediate family members.

Restrictive covenants often outline the remedies that are available to the practice if the physician breaches the terms of the agreement.

The Covenant Not to Compete
“Courts have no problem upholding nonsolicitation and nondisclosure agreements,” said Mr. Wade. “The real fight is over the covenant not to compete.” Most states will consider enforcing a physician noncompete agreement (see “State Laws Vary”), but only if it incorporates the following elements:

  • There must be a valid contract. To create a contract, each party must give consideration (i.e., something of value) to the other; typically, the physician’s promise not to compete and the practice’s offer of employment would suffice. However, problems arise when the employee signs an employment contract that lacks a noncompete clause and sometime later is asked to sign a noncompete agreement. In those circumstances, the practice must provide new consideration—such as a salary increase—in order to create a valid contract.
  • There must be a protectable business interest. “Typically, this isn’t problem,” said Mr. Wade, because the physicians have invested a lot of time and money in developing the practice.
  • The duration of the restriction must be reasonable. The shorter the duration of the noncompete agreement, the more likely the courts are to enforce it. Most range in duration from one to three years. “We tend to think in terms of two years,” said Mr. Wade. “Not many people can sit around for two years and not practice their profession—so the chances are that they will go someplace else.”
  • The geographic scope of the restriction must be reasonable. “This can vary dramatically by virtue of the demographics,” said Mr. Wade. “In Manhattan, a reasonable geographic limitation might be several blocks; in suburban Philadelphia, several miles; and in Montana, whole counties.” The court also may take the physician’s subspecialty into account and consider whether the community is short of those subspecialists —which may, for instance, be evidenced by long waiting lists.

Even when you appear to have included all these elements in your noncompete clause, you cannot guarantee that the courts will enforce it—there are just too many variables, said Mr. Wade. This is partly because the courts don’t just look at the legal technicalities of these cases; they also consider public policy issues and the question of fairness.

State Laws Vary
The law relating to noncompete covenants varies from state to state, as the following examples demonstrate:

  • Under Delaware law, noncompete covenants are allowed but payment of damages or liquidated damages is the only permitted remedy.
  • In Texas, noncompete covenants are only enforceable if there is a buyout option.
  • In California and Massachusetts, the courts will not enforce a physician-noncompete agreement against a former employee.
  • In some states, courts frown upon any but the narrowest of restrictions.

Avoid Court Costs
If the dispute ends up in court, the cost to your practice may go beyond the legal fees and lost hours. Because the judge takes issues of fairness into account, the disputants may emphasize instances in which the other party has acted improperly. “If you have skeletons in your closet, they may come dancing out,” warned Mr. Wade.

To avoid these costs, look for solutions that both parties can live with. “If individuals feel that their restrictive covenants are too burdensome, then they will be tempted to contest them,” said Mr. Wade. The initial contract negotiations provide a good opportunity to look for areas of compromise; if you wait for a dispute to occur, both parties may have become more reluctant to offer concessions.

And if a physician does threaten to breach a noncompete clause, the practice may be able to protect its patient base without going to court. “Spend some money in helping them to move; help them find a job,” advised Mr. Wade. “You may spend $50,000 in helping them to relocate, but that’s better than spending $250,000 in court.”

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*Fictitious practice name.
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This article gives an overview of features that are common to many states, but it should not be construed as legal advice or as pertaining to specific factual situations.  If you need legal advice, consult an attorney who is familiar with the law in your state.

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The Enforcement Process

If a physician leaves a practice and—despite having signed a noncompete agreement—decides to open an office down the street, what recourse would the former employer have? Typically, the courts will only rule on matters that are currently in dispute, which means that the former employee must commit an apparent breach of the noncompete agreement before you can sue him. One exception to that rule is the declaratory judgment, where the court declares in advance of the breach that it would enforce the restrictive covenant. “If the breach is imminent—say, for instance, that the former employee has signed
a lease, hired staff and will be opening the office in two day’s time—then that might be a situation that’s ripe for a declaratory judgment,” said Mr. Wade.

Once the physician opens a new practice, the former employer can seek a temporary restraining order. “In essence, this is a minihearing in which the party that is moving for enforcement of the restrictive covenant must prove that they will suffer irreparable harm immediately if the court does not issue a temporary restraining order,” said Mr. Wade. “You must prove enough to satisfy the judge with clear and convincing evidence—which is different from the normal standard of proof in civil litigation—that you will suffer ‘irreparable harm.’” And since “irreparable harm” means that no amount of money would make up for the harm that is being done, this is a very tough standard to meet, he said.

The next step would be to seek a preliminary injunction. “This is close to a full-blown hearing on the merits,” said Mr. Wade. Testimony may take a couple of days, with both parties calling expert witnesses to analyze the contract. After hearing the evidence, the judge will decide on the case. This isn’t necessarily the final ruling—the parties may yet decide to opt for a full-blown trial—but this is where most litigation stops, he said. “By now, the parties have put forth most of the evidence that they have and have also spent a lot of money, perhaps $25,000 to $50,000 each. So most people are ready to settle or give up at this point.”

If the parties opt to go all the way—which would include a permanent injunction hearing and then appeals—the case may cost hundreds of thousands of dollars.