December 1998 Bulletin

Expert tells two-fold test for covenants

By Sandra E. D. McGraw

As an orthopaedist considering joining or forming a group, how can and how should you deal with an employer who requires a restrictive covenant? Expect to be required to sign one. With competition for patients on the increase, "no-compete" and "no-solicitation" clauses are the norm, not the exception.

Typically, newly hired associate physicians had restrictive covenants in their employment agreements, but you could usually negotiate down their impact or effectiveness. Now, however, many practices require their co-owners to sign noncompete agreements, because a veteran orthopaedic surgeon is liable to do even more damage by competing with his or her former group, than a less experienced/less established surgeon does. Thus, any former negotiating power has now given way to the competing needs of "standard agreements" and fairness.

A restrictive covenant is a contractual obligation under which a physician promises not to take defined "competitive" actions against his or her former group in a designated geographic area for an agreed period of time. All other things being equal, and unless prohibited by law as in some states, courts tend to enforce narrowly drawn restrictions which preserve the legitimate business interest of the group practice.

In states that do allow restrictive covenants, the courts still require that the restriction be reasonable (in scope, place and time) and necessary to preserve the legitimate interests of the group. Let's explore this two-fold test.

A restrictive covenant must be reasonable in scope, place and time. Scope is easy. As an orthopaedic surgeon, you may be prohibited from practicing orthopaedic surgery. Obviously, the broader the restriction (from orthopaedics), the more one questions the reasonableness of the restriction. For example, should you be precluded from being medical director of a rehabilitation practice? Are you really a threat in that position?

Establishing a covenant's geographic area can be tricky. For example, it is unreasonable, generally, to say you could not practice general orthopaedic surgery for a 25-mile radius from a specific site in downtown New York or Chicago. There is no way that your remaining within the 25-mile radius (along with the few hundred other competitors) would really have any impact. However, a 10- to 20-block radius that left the associate with a minimal relocation is likely enforceable. A covenant that covers the area actually served by the practice and encompasses perhaps 60 percent to 75 percent-plus of its patients is more likely to be considered reasonable.

The covenant's time length should protect the practice's interests and moderate the risk of financial injury. Typically, a covenant longer than two to three years is likely to be considered unreasonable.

The second part of the test is that the restriction must be to preserve the legitimate needs of the practice. This is where terms like "public policy" and "public good" weigh in. For example, very few courts, if any, would permit enforcement of a covenant that preserved a group's monopoly position; in that case, the court may consider the exclusion of an orthopaedist as being harmful to the public's need for adequate medical services. Likewise, if the associate brings a type of medical service or technique not commonly available (one spine surgeon in rural area) then a court might deem enforcing that covenant to be not in the public good for it denies the public access to a needed service.

Most restrictive covenants also include language specifying the "remedy" that is sought for violating the covenant. The two most common remedies are an injunction or court-imposed restriction in violation of the terms of the restriction, or liquidated damages (a predetermined financial amount due upon such violation). Other less common remedies include "money damages" where you must prove the amount of the damage, legal fees, and so on.

Under an injunctive remedy, the practice decides to take an absolute approach to restriction and convince the court that the former member who is now a competitor has damaged the practice so significantly that no payment of money damages is adequate. Because the damage caused by the competition is irreparable, the covenant must be enforced.

Alternatively, seeking liquidated damages may be acceptable, but the court must consider the damages sought to be "reasonable" and not punitive. Generally, two to three times total compensation is the maximum used.

As an orthopaedist joining, or even forming, a group practice, the time to consider restrictive covenants and non-solicitation clauses is before signing it. Most practices will insist that new associates sign the restrictive covenant (usually part of the employment agreement) before they commence employment. That is to negate the argument that the covenant was signed under duress, and without adequate consideration. (An offer of employment is usually fair consideration, but one entered into after employment has started begs the question of what the employee received in exchange for this new restriction.)

Have a health care attorney or someone with similar experience review the restrictive covenant before you sign the contract. Understand your obligations. Make sure the remedies for violation are spelled out; you may find it easier to "buy" your way out of a bad arrangement than to relocate yourself and your family.

Remember that things change, and often quickly. Make no assumptions without first checking the laws of the state.

Sandra E. D. McGraw, JD, is vice president of The Health Care Group® and head of Health Care Consulting Inc. She also is a principal attorney with Health Care Law Associates, PC Plymouth Meeting, Pa.

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