Paying the piper

One of the more vexing problems for new, younger doctors and the senior doctors who employ them concerns restrictive covenants. Most states allow them unless they are found to be unreasonable for any number of reasons. In that case, courts can dismiss them or modify them to conform to legally accepted requisites. When they are properly drawn and constructed, they are not paper tigers and often have some nasty teeth. Kansas is as good a representative state as any for understanding the nuances associated with restrictive covenants, also known as covenants not to compete.

The facts of Weber v Tillman , 913 P2d 84, Supreme Court of Kansas (1996), are straightforward. Dr Weber (Senior) had been practicing dermatology in 2 small towns, one in the northwest part of Kansas and the other in the north-central part of the state. After 15 years, he decided he needed an associate. He recruited Dr Tillman (Junior), and they entered into an employment contract. The contract noted among other things that either party could call it quits with 60 days’ notice. So far, this is not too different from many contracts between older and younger orthodontists. The paragraph pertaining to the restrictive covenant noted that, while employed and for 2 years thereafter, regardless of the reason, Junior would not be allowed to practice dermatology on behalf of himself or any other employer, including hospitals, within a 30-mile radius of either of Senior’s 2 offices. Again, not too much different from what we encounter in our specialty, except for the hospital part. The contract included another provision of note: if Junior wanted to breach the contract and practice in the proscribed area within the prohibited time frame, he could do so if he paid Senior the equivalent of 6 months’ salary plus any bonus. This is known as a liquidated-damages clause. In other words, the parties agreed, in advance, on an amount that would compensate Senior in case of a breach by Junior. Okay, fine.

Junior’s first-year salary was $120,000 plus a bonus that was calculated every 6 months based on a specific formula. Again, sounds familiar, not unlike orthodontics. The first 6-month bonus was about $12,500. The bonus for the next 6 months was approximately $20,000. Junior’s salary for year 2 was $144,000, and his first 6-month bonus was $14,000. Sometime into year 2, Junior gave Senior notice that he would leave in 3 months. So far, so good. Immediately upon leaving, Junior opened a practice right in the middle of town. Not so good. Junior did not pay the liquidated-damages amount. Senior sued and asked for either an injunction prohibiting Junior from practicing in the proscribed area or the money owed under the liquidated-damages provision—about $82,000. Fair enough. At the trial, Junior gave the court many reasons for justifying his leaving and reopening in disregard to the covenant, but the court said that all excuses were meaningless because the employment contract allowed either party to leave for any reason. Junior had to either pay up or shut up—which in this case was to literally close his doors, since he was enjoined from practicing for the 2-year period. Junior appealed. The court of appeals also found in favor of Senior. Junior appealed again, this time to the Kansas Supreme Court, and its decision was based on the following findings.

Junior argued that the contract was unenforceable because it was against public policy because (1) it is difficult to recruit young, new doctors to rural areas; (2) if he were precluded from practicing, the dermatologic needs of a large rural population would be underserved; and (3) if he were prevented from practicing, it would essentially create a monopoly regarding dermatology services for Senior, resulting in a lack of professional competition in the area to the public’s detriment.

The court first addressed the public policy issue by noting that “A noncompetition covenant . . . is valid and enforceable if the restraint is reasonable under the circumstances and not adverse to public policy.” In reiterating the law, the court stated that “[I]t is well settled that only a legitimate business interest may be protected by a noncompetition covenant. If the sole purpose is to avoid ordinary competition, it is unreasonable and unenforceable.” The court cited holdings in many other states; however, all in all, it came down to focusing on reasonableness. Following this line of thinking, the court stated:

The analysis of whether the noncompetition clause is reasonable evaluates these factors: (1) Does the covenant protect a legitimate business interest of the employer? (2) Does the covenant create an undue burden on the employee? (3) Is the covenant injurious to the public welfare? (4) Are the time and territorial limitations contained in the covenant reasonable? The determination of reasonableness is made on the particular facts and circumstances of each case.

The court then discussed each factor, although not in the order presented above.

Looking at the temporal and territorial restrictions first, the court noted that territorial restrictions can be applied only to offices that Senior owned when Junior’s employment terminated and not to any offices that he might subsequently open. The court stated that, in a previous case, a 10-year, 100-mile restriction was reasonable in regard to the temporal portion only, and it reduced the proscribed radius to 5 miles. This decision is often a factually based determination made according to population densities, transportation access, and so on. The court in the case at hand found 30 miles to be reasonable, since this was the geographic area from which Senior drew most of his patients. In addition, it found the 2-year period also reasonable because it represented the amount of time required to “obliterate in the minds of the public the identification of [Junior] with [Senior’s] practice and for [Senior] to reestablish his relationship with patients referred to [Junior].” In other words, the temporal and geographic restrictions were legitimate business interests and not designed to prevent ordinary competition.

As to the undue burden on the employee, the court noted that Junior was not being restricted from practicing medicine; he was only being restricted from practicing dermatology. He was totally free to practice any other area of medicine in the proscribed temporal and territorial limitations. In addition, he could still practice his chosen specialty, although, if that was to be the case, he must adhere to the 2-year and 30-mile limitations. Finally, if Junior wanted to practice in the proscribed limitations, he still had 2 options. He could practice elsewhere and return after 2 years, or he could pay the liquidated-damages amount. The court determined that there was no undue burden; once again, the covenant was found to be reasonable.

The court then addressed what constituted a legitimate business interest. It was quick to note that “the restrictions must be no greater than necessary to protect the employer’s [legitimate] interests.” Looking at prior Kansas cases as well as those from other jurisdictions, the court noted that the following have been held to be legitimate business interests of an employer: customer contacts, special training of the employee, trade secrets, confidential business information, loss of clients, goodwill, reputation, ensuring the continuation of existing contracts with clients, and referral sources. The court stated that the practice of medicine also has some unique business interests worth protecting and developed a 2-part test to make this determination. The first part is whether the employer has a near-permanent relationship with his customers (patients). The second part is whether or not the employee would have come into contact with the current patients but for his employment with his employer. Some courts have determined that the existing patient base is often a practice’s most valuable asset.

Looking at the protection of this asset, the court noted that, while protecting one’s patient base from a new doctor moving into town and opening a practice is patently not a legitimate business interest, it is quite something else if a former employee decides to abscond with part of his employer’s current patients, resulting in the employee’s having an unfair business advantage over his former employer. This would stem from the former employee’s identification with the employer’s goodwill. Additional factors to be considered are that, in many cases, it is the act of actively soliciting former patients that can be legally prohibited because patients always have the freedom to seek treatment from anyone they choose; the fact that the employee brought no patients into his association with the employer, as opposed to when 2 practices merge; the fact that the employee often has no ties to the community before associating with the employer and only becomes known or recognized in the community because of his employment; the fact that quite often Junior has little practical or clinical practice experience before learning the ins and outs of his profession through his relationship with his employer; and finally that without the opportunity of employment that Senior has bestowed, the beginning years of practice building are often hard and lean, and this is 1 reason that many new doctors seek associate employee positions rather than opening their own offices from scratch.

Senior argued that the purpose of filing suit was to recoup his investment of the years spent, the practical education and experience gained, the effort expended, and all costs related to establishing his practice over the 15-year period before he took Junior under his wing; all of these were viable business interests worthy of protection. In addition, he noted that Junior brought no patients with him and, instead, upon leaving, took some of Senior’s patients to his new practice. Junior even testified at trial that he benefited greatly by starting his career in an established practiced rather than opening up cold.

As to whether the restrictive covenant was injurious to the public’s interest or welfare, trial testimony from expert witnesses as well as the testimony of Senior himself showed that 2 or 3 more dermatologists were needed in the geographic area in question. Therefore, in this case, the court was being asked to balance the needs of the underserved rural public against those relating to the protection of Senior’s legitimate business interests. The court cited a number of cases from about 10 other jurisdictions that exemplified the types of situations in which restrictive covenants were found to be unenforceable. They all involved physicians practicing in medical specialties that “were, for lack of a better term, medically necessary” (neonatology, orthopedic surgery, gastroenterology, general surgery, otolaryngology). The court also noted that, in all of these other instances, those courts were “extremely hesitant to deny the patient-consumer any choice whatsoever.”

Junior argued that enjoining him from practicing dermatology would permit Senior to effectively “monopolize dermatology, contrary to the public’s right to a choice of physician and competitive fees.” The court found this argument unpersuasive, since Senior was not actually preventing other dermatologists from coming and competing with him; he was merely attempting to honor a contract that prevented Junior from stealing a portion of his patient base and competing with him in the proscribed temporal and territorial parameters. The court noted that:

The applicable test is not whether there is any restraint but whether the restraint is reasonable under the facts and circumstances of the particular case. . . . It is the duty of courts to sustain the legality of contracts in whole or in part when fairly entered into, if reasonably possible to do, rather than to seek loopholes and technical legal grounds for defeating their intended purpose.

The court affirmed the lower court’s rulings against Junior.

Commentary

Apparently, the court did not consider dermatology “medically necessary” enough to warrant negating or amending that covenant. There is no question which side of the line orthodontics would fall on. For the most part, we don’t even need teeth; forget about needing straight ones. However, the bottom line is that when Junior and Senior decide to get “married,” the restrictive covenant is a type of prenuptial agreement—you know, a way to protect certain assets by 1 party and to prevent an ugly trial.

There is no question that Senior had much to protect. There is no question that Junior had an obligation to acknowledge that and to respect the contractual terms that he had freely entered into. Over the years, I have seen some fair employment contracts as well as some onerous ones. As long as Junior has had the advice of legal counsel, he should be going into the relationship with his eyes wide open. If he decides to breach the contract, there is no question that he knows what he is doing: he is hoping to have his cake and eat it too.

Ask any Senior who has built a successful practice from scratch, and he will tell you that the time, effort, blood, sweat, and tears of doing that was one of his greatest professional accomplishments. His practice was his baby, and no way would he allow someone to kidnap what he had bred and reared.

You might say that $82,000 is a small price to pay, and the benefits far outweigh the costs associated with breaching the contract. If that’s true, then from a dollars-and-cents standpoint, it might be worth it for Junior to associate with Senior, intending to breach the contract at some future time and attempt to do an end-run around the trials and tribulations associated with practice building. Well, this case was tried in the early 1990s, it was decided in 1996, and 15 years before that was the late 1970s. So, in 2012, we are looking at an award computed in 20- to 25-year-old dollars. What would the figure be today? The testimony showed that Senior spent about $150,000 to open his office. What does it cost now? A cone-beam computed tomography unit alone costs about that much. Forget about the building, if free standing, the construction costs, build-outs, chairs, radiology equipment, leasehold improvements, equipment, supplies, and staff salaries until the practice builds up a sufficient patient base, not to mention what you’re going to live on. It’s not at all uncommon today to find liquidated-damage provisions to be substantially more than $82 grand.

Over the years, as our postdoctoral students leave their specialty training programs with increasing debt loads, I see more and more of them seeking employment as opposed to entrepreneurship because they want to avoid taking on more debt. The lure of having an immediate and significant cash flow that allows them to start paying down their educational investment and to start living in a manner that they hope to soon become accustomed to is strong. I believe we will see more employment contracts and, once Junior is established in a community, a greater propensity to consider the relative pluses and minuses associated with breaching those contracts. It is sad to think that it might actually be that simple an equation.

If that is the case, and I’m not advocating anything other than for both sides to know what the story is, it seems to me that for some Juniors, it really might come down to nothing more than “put up or shut up.” Hmm.

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Apr 8, 2017 | Posted by in Orthodontics | Comments Off on Paying the piper
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