A win-win alternative to noncompete clauses

For both groups and their employed doctors, there's now a fair and legal alternative to restrictive covenants.

By Berkeley Rice
Senior Editor

When a medical group hires a new physician, chances are the contract will include a "noncompete clause" that bars him from quitting and going into direct competition within the same area for a specific time period. Some clauses also prohibit the departing doctor from soliciting patients or staff from his former group.

But restrictive covenants often don't stand up in court. Some judges have ruled that they violate public policy by limiting access to medical care. Others have found that by preventing physicians from practicing in their own communities, these clauses constitute "restraint of trade." As a result of such concerns, they have been expressly prohibited in some states and ruled unenforceable in others.

Even where restrictive covenants are upheld, groups may hesitate to invoke them because going to court to stop a former member from practicing creates bad publicity in the local medical community. "I don't think you should try to force physicians to practice together if they don't want to," says Troy Smith Jr., an attorney in New Bern, NC. "If a partner wants to quit, but feels he can't because of a restrictive covenant, it's a recipe for disaster."

Because of these problems, many groups have replaced the noncompete clause with a legal tool called "liquidated damages" because it's more likely to hold up in court, and fairer for both sides. For a physician who wants to quit, it provides a way to go into practice nearby if he's willing to pay for that right. For his former group, it provides a way to protect itself by demanding reimbursement for the investment it made in hiring and training him, and then "lost" when he left.

Court battles may still arise. When clinical oncologist Anna Faidas joined the multispecialty Eastern Carolina Internal Medicine group in New Bern, NC, in 1996, her contract included a "liquidated damages" clause. It would kick in if Faidas left the group to practice—on her own or with another group or hospital—anywhere in the surrounding three-county area within one year of her departure.

While ECIM's liquidated damages clause didn't actually prohibit Faidas from practicing in the same town, it required her to reimburse the group for the loss it would suffer if she quit: the cost of her recruitment and training, the cost of recruiting and training her replacement, and the loss of revenue due to her departure. Instead of using those difficult-to-measure expenses, the damages would be calculated according to a "cost-sharing" formula that amounted to 25 percent of her share of the group's total operating expenses for the fiscal year preceding her departure.

Three years later, Faidas did leave and opened her own oncology practice in New Bern (pop. 23,000), about a mile away from her former group. Invoking her employment contract, ECIM told Faidas she'd have to pay $109,000 in liquidated damages. She refused. In March 2001, after attempts at negotiation failed, ECIM filed a breach of contract suit against her.

The damages clause gets put to a court test

Faidas argued that the liquidated damages provision was actually a noncompete covenant in disguise, and constituted an unreasonable restraint of trade by limiting her ability to practice her profession. The trial judge disagreed, and ordered her to pay the $109,000 plus interest. She appealed.

In a 2-1 decision issued last year and later affirmed by the state's supreme court, the appellate court upheld the trial judge's ruling. As a result, Faidas ended up paying not only the $109,000 in damages, but an estimated $100,000 or more in accrued interest and legal fees. (Neither Faidas nor her attorney would comment on the case or the verdict.)

According to the appellate majority, "Liquidated damages clauses which are reasonable in amount are enforceable as part of a contract." By signing the contract, Faidas had agreed that its cost-sharing formula for calculating the damages was a reasonable estimate of the economic loss the group would suffer if she quit, and that she would reimburse the group for that loss if she left and went into competition with it.

The court reasoned that "the employer recruits the employee, markets the employee, provides the necessary facilities, and establishes a client base for the employee." The liquidated damages provision would not penalize a physician who simply left the group to practice outside the three-county area. "The crucial fact here," the court noted, "is that defendant was only required to pay the liquidated damages upon breaching her promise not to compete."

The amount of damages must be reasonable

If a practice decides to include a liquidated damages clause in its contract, it's important to have an experienced attorney draft it. "You've got to have the lid screwed on real tight or you won't get the benefit of the doubt from the courts," says attorney Troy Smith Jr., whose firm represented Eastern Carolina Internal Medicine and drafted its liquidated damages clause.

The most important factor is how the damages are calculated. To hold up in court, the amount must be based on a fair estimate of the financial loss the group would suffer if the physician quits, says Smith. If the amount is unreasonably high, a court may invalidate the clause on the grounds that it effectively prevents a doctor from leaving, or penalizes him too harshly if he does.

More and more health care attorneys and practice management consultants are recommending liquidated damages clauses. "I think they're a great idea," says Carl Khalil, a Virginia Beach, VA, attorney who's knowledgeable about restrictive covenants. "Everybody agrees beforehand what will happen, so there's less chance of litigation, as there often is when a group tries to get a court injunction based on a noncompete clause, and the doctor claims the restriction is unfair."

Michael Brown, a practice management consultant in Indianapolis, includes a liquidated damages clause in every employment contract for his medical group clients. "The amount of the damages is usually $200,000 to $250,000, or two times the doctor's base salary. If he's willing to pay that sum, he can go on his way and immediately begin practicing with another group in the same area."

Brown urges job applicants to read a liquidated damages clause carefully before signing a contract. "Make sure you understand the parameters of how it restricts your opportunities if you quit," he says. "If the damages are expressed as a cost-sharing formula, ask how much it would amount to in dollars. If it's a percentage of your salary, and you can live with it, fine. If you can't, try to negotiate the percentage, or the terms of the restrictions.

"Some doctors may be put off by a liquidated damages clause, or any form of restrictive covenant," Brown admits. "In that case, the group might lose a good candidate, but most groups are willing to take that chance. After all, they're not in business to train potential competitors."

 

Berkeley Rice. A win-win alternative to noncompete clauses. Medical Economics Aug. 8, 2003;80:56.