A Too-Tough Noncompete Clause Could Defeat Its Own Purpose

Neil Caesar, J.D.

Managed care is forcing physician groups to guard their alliances zealously, and one way to do this is with noncompete clauses in physician contracts. Such clauses can help medical groups protect themselves generally against the threat of a physician employee departing with a host of patients that he or she acquired only through the group’s own visibility.

It is important for the prohibition in the noncompete clause to be of reasonable duration. If the covenant’s purpose is to prevent a departed physician from utilizing the special connections gained from employment to the detriment of the employer, the covenant should not last any longer than the likely lifespan of those special connections. A physician who waits one or two years before competing will probably find that he has little leverage remaining from his group association. I rarely recommend that physicians impose a noncompete provision of greater than two years, and one year is often sufficient. Again, a documented effort toward reasonableness will go a long way toward ensuring enforceability.

There are other considerations. Practices should be cautious if they wish to prevent the departing physician from maintaining active staff privileges at area hospitals. Hospital privileges are still an essential element of most physicians’ practices. Denying access to a key hospital effectively eliminates the physician’s ability to stay in the area. Remember, you are not supposed to prevent the doctor from working after termination. Rather, you simply want to ensure that he or she doesn’t compete unfairly in your market. Thus, declaring the hospital completely off limits runs some risk that a judge will find this to be an unfair penalty and strike the entire noncompete clause.

(I realize that many contracts say that a noncompete provision that is partially invalid will nonetheless be allowed to stand, to the extent the remainder is valid. However, if the courts perceive a punitive attitude on the part of the employer, they often will strike that carve-out provision as well.)

The need to be reasonable

The noncompete clause should prevent the physician from providing services in the prohibited geographical area. However, it is not wise to bar the physician from drawing patients from that area. If a patient is willing to travel to an office outside the proscribed area, that should be sufficient.

In addition, a group needs to be reasonable in the scope of services it chooses to specify in a noncompete clause. It is dangerous, for example, to prohibit a cardiologist from practicing primary care medicine within the restricted area. After all, the special leverage that the medical group offered to that cardiologist was primarily tied to the physician’s specialty. A court may find it unfair to prevent that physician from staying in the area and practicing outside the field of cardiology, assuming that noncardiology procedures were not included in his or her original practice.

Finally, the penalties imposed for violation of the covenant should also be reasonable. Often, an injunction is the only way to prevent the medical group from being irreparably harmed by unfair competition. Sometimes, though, it is sufficient to give the de- parted physician an opportunity to buy out of the prohibition by paying what is known as liquidated damages. This is essentially a mutually agreed payment, derived by some sort of reasonable formula, to reflect an agreed approximation of the cost of the harm to the medical practice from the competition.

Sometimes liquidated damages are a flat fee. I often favor liquidated damages based on a formula — say, one-quarter to one-half of the physician’s compensation, for the prior one or two years. When applying this formula approach, it is often advisable to have a ceiling on the amount of damages that would be payable under the formula. Liquidated damages for physicians range from $25,000 or less to $150,000 or more. What is fair depends on the individual circumstances.

Many groups are willing to compromise on their noncompete provisions. When I represent physician employees, I often negotiate such compromises. But I also resist them strongly when representing an established medical group.

Here is my reasoning. The enforceability of a noncompete provision is directly related to its reasonableness. Part of what makes the covenant reasonable is that it is necessary to prevent the departed physician from taking something (the group’s market leverage) that would harm the medical group. But if the medical group starts allowing exceptions to the noncompete clause, it effectively has stated that the employee’s departure is not harmful to the group, or that the harm is O.K. in certain circumstances. This is dangerous, because it suggests that the noncompete clause may not be an essential protection for the group, increasing the chances that a court may find it inappropriate and thus unenforceable. There certainly are reasons why this vulnerability may not apply in certain circumstances, or why this vulnerability may otherwise be acceptable. But weigh the issues carefully before you agree to compromise.

A medical group that is open to compromise has a number of options to consider. A covenant may only apply if the employee physician is terminated for cause, or departs the group without cause. (Be sure to define “cause” carefully!) Or the covenant may only preclude independent medical practice, so that the departed physician may become a hospital employee. Or the noncompete provision may disappear or change its focus after a certain period of continued employment. There are many permutations. In general, though, an employer should only agree to compromises that can be justified in the contract as both fair and consistent with the premise that underlies the covenant.

Remember also that your ability to enforce a noncompete clause will directly relate to how consistently you have enforced it. If all of your physicians have noncompetes and three of them left without your challenging their subsequent competition, it will be harder to argue that the covenant should be enforced for the physician who next departs. In other words, a noncompete provision should be only as restrictive as you are willing to enforce, and then should be enforced vigorously.

I recently have begun to see an interesting variation on physician noncompete provisions in employment agreements. Instead of the standard noncompete provisions, the contract lists specific physicians from whom a departing employee may not accept referrals. Often, this list is so extensive as to virtually prevent the physician from remaining in the area. All of the same cautions and advice I discuss above for standard noncompete provisions apply to such “end-run” prohibitions.

Neil B. Caesar is president of The Health Law Center (Neil B. Caesar Law Associates, PA), a national health law/consulting practice in Greenville, S.C.

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