Lesson three
Restrictive covenants
Read:
READ “an intro to restrictive covenants”
An Introduction to Restrictive Covenants
Some employers seek from their employees an agreement that limits what an employee can do after the employee has left the employ of the employer. These agreements are referred to as restrictive covenants or non-compete agreements.
Restrictive covenants are unusual in that most employment agreements focus on what the parties expect out of each other during the period of employment.* As an example agreements customarily lay out what the employee’s work responsibilities are and what the employer’s obligations are with regard to pay and benefits.
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A restrictive covenant in an employment agreement may look like this:
“Dr. X agrees that upon termination of her employment with the Omega
Dental Center she will not work in Warren County, Kentucky as a
dentist for a period of 36 months.”
Legislators, courts and professional organizations that draft ethics rules for their respective professions have all struggled with what to do with restrictive covenants. On their face these agreements appear one sided and unfair. Legislatures in some states have outlawed or severely limited restrictive covenants. Many restrictive covenants have been found to be unenforceable by the courts. Some professions, (most notably the legal profession), have made the use of restrictive covenants in professional employment contracts unethical. Having said all of this, the simple fact is that restrictive covenants are legal in most states and will, if they are well drafted, be enforced by the courts.
The tug of war can be summarized as follows: employers want to be protected from having the goodwill they have paid to develop pirated; employees want to be free to practice their chosen career without interference from their former employer. Courts that support
*Unusual only in that they deal with after employment obligations of the employee. In the world of physicians contracts they are not unusual. In 2003 the American Society of Colon and Rectal Surgeons surveyed members who had begun employment in the proceeding 5 years. Of those with written contracts 53% had restrictive covenants. In 2016 the U.S. Treasury Department estimated that 18 percent of American workers were subject to restrictive covenants. This number has been challenged by others who believe that the Treasury Department’s estimate significantly overstates the actual number.
restrictive covenants generally point out that parties should be free to reach whatever contractual arrangements they want to make with each other so long as the terms don’t call for an illegal act. Courts that don’t approve restrictive covenants generally point to the anti-competitive nature of such agreements.
Twenty -six states have some type of legislation regulating restrictive covenants in some way. The other half leave it up to the courts to work out. California, North Dakota, Montana and Oklahoma ban nearly all restrictive covenants. The California statute provides that; “Except as otherwise provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void”. (California business and professional code section 16600). Other states have attempted by statute to create rules and tests for the courts to use in analyzing the enforceability of restrictive covenants. Florida has taken three stabs at it legislatively. The Florida legislature created rules in 1953 which it then amended significantly in 1990 which it then modified again in 1996. Tennessee had a statute that it passed in 2007 that it then modified in 2008, modified again in 2010 and then modified again in 2011. It seems like a sizable number of constituents are never happy with the legislatures’ attempts to codify the rules.
Some states, (Delaware 6 Del Code §2707), Colorado Colo. Rev. Stat. §8-2-113(3))), prohibit restrictive covenants for physicians and other healthcare professionals. Texas has severe restrictions on the ability of employers to restrict post-employment conduct of health care professionals.
Oregon takes the unusual approach, (ORS 653.295), of allowing employers to use restrictive covenants, but it requires the employer to pay the employee the greater of 50% of their wage while they are being restricted, or 50% of the median family income for a family of four as calculated by the US Census Bureau. This sometimes referred to as “garden leave”.
. Most states allow the courts to deal with the issue, with the legislatures staying out of the fray. For a brief period of time Kentucky addressed the question of restrictive covenants for doctors with a statute that made restrictive covenants with a duration of over 364 days unenforceable. That statute remained on the books for less than one year. After its repeal Kentucky reverted to an approach which is like that found in most states—leaving the issue for the courts rather than the legislature.
When there is no statutory rule, and this is the case in most states, the courts that are asked to enforce restrictive covenants deal with the cases on a case by case basis. This is referred to as the “common law approach. This makes knowing what the rule is in a particular jurisdiction difficult at best. When courts are asked to enforce restrictive covenants there are a variety of factors that the courts consider. By far the two most important are duration and geographic scope. Courts will not enforce covenants that they view as being too broad in geographic scope or too long in duration. Clearly the two are related to each other. The broader the geographic scope the more limited the covenant has to be in terms of time. The longer the duration of the covenant, the more the court is going to want to see a smaller geographic scope. As an example, it may be reasonable to prevent someone from competing on the same city block for a period of 5 years, but that length of time may be unreasonable if geographic scope encompasses the entire state. Kentucky courts reviewing employment contracts for physicians have found covenants of 3 years and a single county to be reasonable, in another case the courts found a 2 year covenant that covered a 50 mile radius from the former site of employment reasonable.
With the confusion that all of this creates, many states have adopted what is called the “blue pencil rule”. The blue pencil rule allows the courts to simply strike out of contracts provisions which are too broad. More common is the approach taken by Kentucky and at least 25 other states. In these states, the courts review the covenants, and exercise the courts inherent equitable powers to modify or reform the contracts to make them fit within the general rule that covenants may not be overly broad. This may mean reducing the geographic scope or reducing the duration or reducing both.
When courts are asked to enforce restrictive covenants they are ordinarily asked to use what are known as the courts equitable powers. Courts have both legal power and equitable power. In most contract cases we see courts using their legal power; this is what is done when the court reviews a contract case and determines that one party has breached the contract and owes the other party money for the breach. In restrictive covenant cases the plaintiff, (the party that files the suit), will ordinarily ask the court not for money damages, (a legal remedy), but instead will ask the court for an injunction (an equitable remedy). The plaintiff wants an the court to issue an injunction that prohibits the defendant from working in a particular place at a particular time.
All of this makes giving good advice about restrictive covenants extremely difficult. A few simple guidelines are the best I can do.
1. Know what the rules are for the jurisdiction you are in.
2. If you are the employee, try to avoid having a restrictive covenant.
3. If you have to have one try to;
a) make it short in time and short in duration.
b) have a provision that lets you earn it away, –something like if I leave in the first five years there is a restrictive covenant, but if I stay longer it will not be required.
c) have a buy out provision that lets you buy your way out of the restrictive covenant for a set amount. Get the employer who insists on a restrictive covenant to try to create a meaningful value, as an example 3 months pay.
4. If you are the employer remember that courts don’t like restrictive covenants so don’t get greedy by going too big or too long. This will hurt you. In blue pencil jurisdictions, where if you are reasonable or close to reasonable the court will probably leave it alone, but if you are too greedy you run the risk that the entire covenant will be voided. In jurisdictions where the court can re-write the covenant to be reasonable suppose if you will a judge that believes that a covenant shouldn’t extend more than 50 miles, further suppose that the covenant being reviewed is one calling for a restriction covering the county of employment and adjoining counties. In such a case it is unlikely that court step in to “rewrite” the covenant even if part of some adjoining counties were 60 miles away from the place of business, but if the employer got greedy and had a covenant that called for restrictive covenants of 200 miles the court would in all likelihood step in and cut it back to what the court thought was reasonable, (50 miles). Over reaching invites intervention.
In 2016 the Obama administration issued what it referred to as a “call to action” asking states to reform the laws relating to restrictive covenants by either reducing their applicability or eliminating them altogether. No meaningful state legislation followed this call to action. In September of 2016 the Kentucky Medical Association adopted the following resolution:
2016-5 RESOLUTION Subject: Restrictive Covenants
Submitted by: Greater Louisville Medical Society Referred to: Reference Committee —————————————————————
– WHEREAS,
a restrictive covenant (also referred to as a non-compete agreement or a covenant not to compete) limits or prevents a physician’s practice of medicine, usually within a defined geographic region for a specified amount of time with a particular business interest; and
WHEREAS,
restrictive covenants are subject to state law, with some states wholly disallowing non-compete agreements in physician contracts and others placing limitations on what stipulations may be considered reasonable in non-compete agreements; and
WHEREAS,
the American Medical Association, in a Medical Ethics Opinion, states that restrictive covenants have the potential to restrict competition, disrupt continuity of care, and deprive the public of medical services; and
WHEREAS,
in a state such as Kentucky where physician shortages are common in large geographic areas, and a restrictive covenant could force a physician to leave an already underserved area in order to seek new employment, furthermore, the case of Charles T. Creech v. Brown from the KY Supreme Court case in 2014 further limited restrictive covenants; now, therefore, be it
RESOLVED, that the Kentucky Medical Association work with the Kentucky Hospital Association, the individual hospitals and health care systems to eliminate restrictive covenants from their employed physician contracts; and be it further RESOLVED, that if the Kentucky Medical Association’s efforts to eliminate restrictive covenants with employed physicians contracted by hospital and health care systems are unsuccessful, the Kentucky Medical Association will then pursue legislative action.
This resolution was also followed by no legislative action.
READ 2. Drinker Biddle article
http://files.drinkerbiddle.com/Templates/media/files/publications/2002/the-effectiveness-of-restrictive-covenants-in-physician-contracts.pdf
READ 3.AMA hedged view is revealed in the 2014 report from its Council on Ethical and
Judicial Affairs
https://kcmedicine.org/wp-content/uploads/2015/08/AMA-policy-on-restrictive-covenants.pdf
READ 4. Tennessee’s legislature can’t seem to leave the law of restrictive covenants alone. The legislature made changes to the law in 2007, 2008, 2010 and again in 2011. Please read the Tennessee statute which follows; it is current as of August 18, 2020.
Tenn. Code Ann. § 63-1-148
(a) (1) A restriction on the right of an employed or contracted healthcare provider to practice the healthcare provider’s profession upon termination or conclusion of the employment or contractual relationship shall be deemed reasonable if:
(A) The restriction is set forth in an employment agreement or other written document signed by the healthcare provider and the employing or contracting entity; and
(B) The duration of the restriction is two (2) years or less and either:
(i) The maximum allowable geographic restriction is the greater of:
(a) A ten-mile radius from the primary practice site of the healthcare provider while employed or contracted; or
(b) The county in which the primary practice of the healthcare provider while employed or contracted is located; or
(ii) There is no geographic restriction, but the healthcare provider is restricted from practicing the healthcare provider’s profession at any facility at which the employing or contracting entity provided services while the healthcare provider was employed or contracted with the employing or contracting entity.
(b) An agreement entered into in conjunction with the purchase or sale of a healthcare provider’s practice, or all or substantially all of the assets of the healthcare provider’s practice, may restrict the healthcare provider’s right to practice the healthcare provider’s profession; provided, that the duration of the restriction and the allowable area of the restriction are reasonable under the circumstances. There shall be a rebuttable presumption that the duration and area of restriction agreed upon by the parties in such an agreement are reasonable.
(c) This section shall apply to healthcare providers licensed under chapters 3, 4, 5, 6, 8, 9 and 11* of this title.
(d) This section shall not apply to physicians who specialize in the practice of emergency medicine.
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NOTE * The professionals referenced by chapters 3,4,5,6, 8 and 9 are podiatrists, chiropractors, dentists, physicians, optometrists, and psychologists. Not covered by the statutes are nurses and other health professionals.
READ What follows is the current Texas statute.
TEXAS Business and commercial code
Sec. 15.50. CRITERIA FOR ENFORCEABILITY OF COVENANTS NOT TO COMPETE. (a) Notwithstanding Section 15.05 of this code, and subject to any applicable provision of Subsection (b), a covenant not to compete is enforceable if it is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made to the extent that it contains limitations as to time, geographical area, and scope of activity to be restrained that are reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee.*
(b) A covenant not to compete relating to the practice of medicine is enforceable against a person licensed as a physician by the Texas Medical Board if such covenant complies with the following requirements:
(1) the covenant must:
(A) not deny the physician access to a list of his patients whom he had seen or treated within one year of termination of the contract or employment;
(B) provide access to medical records of the physician’s patients upon authorization of the patient and any copies of medical records for a reasonable fee as established by the Texas Medical Board under Section 159.008, Occupations Code; and
(C) provide that any access to a list of patients or to patients’ medical records after termination of the contract or employment shall not require such list or records to be provided in a format different than that by which such records are maintained except by mutual consent of the parties to the contract;
*a promisee is the legal word for someone to whom a promise is made; in this context, the promisee would be the employer.
(2) the covenant must provide for a buy out of the covenant by the physician at a reasonable price or, at the option of either party, as determined by a mutually agreed upon arbitrator or, in the case of an inability to agree, an arbitrator of the court whose decision shall be binding on the parties; and
(3) the covenant must provide that the physician will not be prohibited from providing continuing care and treatment to a specific patient or patients during the course of an acute illness even after the contract or employment has been terminated.
(c) Subsection (b) does not apply to a physician’s business ownership interest in a licensed hospital or licensed ambulatory surgical center.
ASSIGNMENT THREE
Question 1 If you were in the state legislature what approach would you take and why? Would that approach have a different rule for physicians than it would for other employees?
