So, you finally hire an associate. After a few months, you notice that things are working out wonderfully, and you both decide to continue the arrangement: you because you like the freedom it bestows, and your associate because she likes the money. After a few more months, you realize that this young doctor is the cat’s meow. She’s quick and smart, has good hands, patients love her, and so on. This is someone to whom you would feel comfortable transitioning your practice at some future time; in the meanwhile, she is providing a terrific boost to your bottom line from a practice-building perspective. The one downside is that if, for whatever reason, sometime down the road, this doctor ever leaves your employ, she could take a good hunk of your practice with her. Hurray, the fog has finally lifted, and you now realize that it’s high time to have her sign a restrictive covenant, also known as a covenant not to compete. You give her a noncompete agreement that essentially says that in exchange for continued employment, she agrees not to…you know the rest of it.
Guess what, the road has finally come to an end. It could be for any number of reasons, none of which are resolvable, but the upshot is that the two of you decide to part ways. Sure enough, your worst fears are recognized. Your associate breaches the agreement, soliciting your patients, entertaining your referrers, seducing your staff, and so on. You of course can’t tolerate such traitorous activity, and you seek an injunction and whatever other legal remedies and penalties you believe you are entitled to under the agreement, to prevent her from any further looting. She naturally opposes you, claiming that the agreement you both signed is illegal and thus unenforceable. You get your injunction, she appeals, and a trial on the matter occurs not much later. This is what Access Organics, Inc. v Hernandez (Supreme Court of Montana, No. DA 07-0115, Jan 2008) is all about.
The facts of the Hernandez case show that he was presented with a noncompete agreement about 4 months after he started employment. The document essentially stated that for good consideration (not defined in the agreement) and as an inducement for continued employment, Hernandez agreed that if he no longer worked for Access, he would not compete with it for a given period of time and within a given geographic area. In addition, he would not take its customer lists, work for other competitors, or open his own competing business—the whole 9 yards. As it turns out, he did open a competing venture within the proscribed time period and geographic area, and Access sought injunctive relief including a temporary restraining order, which was granted.
There was no dispute that the agreement was violated, but Hernandez claimed that he did so because it was illegal due to lack of consideration. Access claimed that Hernandez’s continued employment was the consideration, the value exchanged for the promise of continued employment. The district court sided with Access, upholding the injunction, and this appeal ensued. The question for the Supreme Court was whether the offer of continued employment constituted adequate consideration to support the agreement.
Before we get to the Court’s decision, it’s time for a quick review of Contracts 101. For any contract to be valid, there must first be an offer and an acceptance: something such as “If you want me to straighten your teeth, the cost is $5,000.” The second party responds “Okay, that’s fine, go ahead.” You now have an offer and an acceptance.
Second, something of value must be exchanged that supports the offer and acceptance; this is called the consideration. It can be a benefit for each person, such as you buying a car and the dealership getting your money, or it may be something you have a right to do but choose to forgo, such as “I know I ordered out the wrong tooth and that you have the right to sue me, but if you let me treat you for free and make everything right, you will agree to forgo your legal rights against me” (free treatment for no lawsuit). In other words, consideration is either a promise to do something you don’t have to do or a promise not to do something that you have a legal right to do; each party is promising something of value, be it tangible or promissory.
What is not considered a valid consideration? The first example is a promise to do something you are already obligated to do. An example would be that as part of your treatment of a patient, you promise to abide by the rules and regulations of your state’s dental practice act. This promise would not be a valid consideration because you are already obligated to follow these administrative laws. A second example is if the promise made is in the form of a gift. If I tell my brother-in-law that I will be happy to treat his son for free, and when the time comes to perform I decide that I want him to pay the laboratory costs, he can’t claim to enforce the “contract” because the offer to perform was not supported by a consideration, since the promise was a gift of free treatment. A third example would be when the promise is given in exchange for past consideration. You converted from hard-copy records to electronic ones, and over the past year, your office manager came in on many of her days off to scan certain records into digital format. If you say “I recognize that you didn’t have to do that, and I’m going to give you X dollars as a bonus because you did,” that promise is unenforceable because the performance was not bargained for before or contemporaneous with the time it was performed. Finally, consideration is deemed to be invalid if it was based on an illusory or illegal premise. You tell your neighbor, who is the president of a large union, to go out and solicit patients for you, and in exchange you will pay him a fee for every patient he brings in. The consideration of X dollars per head for referrals is illegal fee splitting and therefore can’t support the promise made.
Now that we have discussed offer, acceptance, and consideration, the third element of a contract is that what is bargained for cannot be illegal. You can’t agree with the person who does collections in your office to split whatever is collected as a result of fraudulent billing. The next element is that the parties must have the capacity to contract. In other words, they must be of sound mind, of legal age, and not under any form of duress. The last element is that there must be a “meeting of the minds,” also called mutual assent. You agree with one of your vendors to order 200 cases of brackets every year for a discounted price, but the vendor swears that the deal was that the order would be biannually. The two of you have different ideas about an essential term of the contract; thus, it is unenforceable.
Getting back to the Hernandez decision, the court stated at the outset that covenants not to compete are basically agreements made in the restraint of trade; thus, they are generally disfavored by the courts. However, they can be legally enforced if (1) the restriction is reasonable as far as the duration of time and the proscribed geographic area are concerned; (2) the covenant is given in exchange for good consideration; (3) it affords only a fair and reasonable amount of protection to the interests of the party seeking its enforcement; and (4) it is not so overbroad in its operation that it interferes with the public interest or violates public policy considerations. The court noted that (1), (3), and (4) were fine, so the only issue to be determined was whether the consideration was adequate. Section 28-2-801 of the Montana Code states that “[a]ny benefit conferred or agreed to be conferred upon the promisor by any other person, to which the promisor is not lawfully entitled, or any prejudice suffered or agreed to be suffered by such person, other than such as he is at the time of consent lawfully bound to suffer, as an inducement to the promisor is a good consideration for a promise.”
The Court, in deciphering the legalese of this statute, opined that valid consideration exists if the employee signs the agreement at the time of hiring because it is during the preemployment negotiations that each party is hondeling for its needs and expectations that will result from the employment relationship. In legal parlance, the parties entered into a “bargained for exchange.” In simpler terms, the employer gets the noncompete agreement, and the employee gets a job. It is in essence nothing more than one of the many terms such as salary, benefits, and so on, that is bargained for when deciding to accept or reject the offered employment.
The problem was that Access tried to do this after the fact. Stating a tenet of established law on this subject, the Court noted that “past consideration is not sufficient to support a promise” and that “prior work may not serve as consideration.” Conversely, the Court also stated that “afterthought agreements,” such as the one under deliberation, are not necessarily invalid since they can attain the status of legality if they are supported by a new independent consideration. An example could be something as simple as a raise or a promotion in exchange for the signed agreement. The bottom line is that the employee must receive something, a quid pro quo, in exchange for his or her promise not to compete. In addition, one must appreciate the simple concept of requiring the parties to be on equal footing during the bargaining or negotiation process.
In the preemployment context, the employer wants to hire this employee for whatever intrinsic value he perceives that he will acquire if this person comes to work for him. The employee sees the compensation package, work environment, opportunity for advancement, and so on, that the employer will offer as beneficial and significant enough to induce him or her to accept the tendered employment. However, in the postemployment situation, the bargaining power is grossly unfair because the employer is essentially saying “You sign this, or you’re out of a job”; the bottom line is that there isn’t much bargaining going on. The Court stated in the latter situation that “We require clear evidence that the employee received good consideration in exchange for bargaining away some of his post-employment freedom to practice the profession or trade of his choice.” The Supreme Court reversed the district court’s decision and found the agreement to be unenforceable for lack of consideration.
I am continually amazed at how often I see this. Young associates call me asking whether they have to sign this type of agreement after they have been employed for a period of time. Conversely, older practitioners also drop a dime seeking guidance on how to now get Junior to sign such a document. When I ask why this was not addressed at the beginning, I receive lots of different answers, but the most common one is that they didn’t think agreements of this type were enforceable: they got bad information from somewhere.
It is true in some states that restrictive covenants and noncompete agreements are illegal regardless of the consideration issue. However, in other jurisdictions, they can be quite formidable obstacles to overcome if one considers breaching the terms of the initial contract of employment. Other common factors that create unenforceability, in addition to the issue of lack of consideration as discussed above, are the time and distance prohibitions. I see so many agreements in which one or both are unreasonable. Senior cannot prohibit Junior from practicing orthodontics in the eastern half of the country until the world implodes. That won’t stand up. Okay, I’m being facetious, but the point I’m trying to make is important. The geographic and temporal restrictions must be just enough to protect the valid interests of the employer. This will naturally vary somewhat depending on whether you are practicing in midtown Gotham City or in Smallville. In addition, the restrictions cannot be punitive or overbearing on Junior.
Many of the professional organizations to which you belong provide contract analysis services to their members. Take advantage of this benefit. Make sure you consult your attorney before signing anything. Not being informed can lead to making a costly mistake. For me, covenants not to compete are not paper tigers—you know, something without teeth. If they are appropriately constructed, when put into action and necessary to rely on, they can indeed have a formidable bite. (Only an orthodontist/attorney would say it that way.)