Ask Our Lawyer: Covenant-Not-To-Compete Issues in Employment Contracts

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Michigan Medicine - May/June 2016

by Daniel J. Schulte, JD, MSMS Legal Counsel

QUESTION:

A potential employer has offered me an employment agreement containing a covenant-not-to-compete. The employer is a large group practice with two offices. Can the covenant-not-to-compete prohibit me from starting or joining a medical practice near either office? How do I know if the ten mile radius be enforced against me? The agreement states that if I breach the covenant-not-to-compete I will automatically be liable and must pay the employer liquidated damages of $40,000. Is such a penalty enforceable?

ANSWER:

Can The Covenant-Not-To-Compete Apply To Two Offices When The Employee Primarily Works At Only One?

Yes. Courts looking at these types of restrictions have held that if they are expressly provided for in the employment agreement they can be enforced. If you believe that the employer's competitive interests are adequately protected without the geographic radius encompassing both offices you should negotiate this up front because you will likely not be able to argue it following a termination of the employment agreement.

Is A Ten Mile Radius From Each Practice Location Enforceable?

Probably. Michigan's Antitrust Reform Act, MCL 445.771 et seq. and many Michigan court decisions have established a commonly understood rule that a covenant-not-to-compete will be deemed reasonable if tailored to protect an employer's reasonable competitive business interests and the protection provided to the employer in terms of the covenant-not-to-compete's duration, geographic scope and the type of employment or line of business prohibited are expressly provided for in and agreement and are "reasonable". In a medical practice setting, a covenant-not-to-compete can reasonably protect against unfair competition from the departing employee resulting from the loss of patients following the departing employee to a new practice location. The courts have also recognized as reasonable the protection of the employer's investment in the training of the employee and protecting the employer's patient lists.

The reasonableness of a specific geographic restriction will depend on the facts and circumstances of each case. However, the courts have routinely confirmed the reasonableness of a common approach to determining a reasonable geographic restriction to be used in medical practice covenant-not-to-compete agreements. This method involves determining where the medical practice's patients are located and basing the geographic restriction on that particular area.

Is A Covenant-Not-To-Compete Unenforceable If It Violates A Professional Code of Ethics?

No. The Michigan Court of Appeals has held that a covenant not to compete in an employment agreement is enforceable even when it violates the American Medical Association's Principles of Medical Ethics. The same would be true if complying with a covenant not to compete would violate the ethical rules of another organization the employee belongs to.

Will A Penalty Clause Be Enforced?

No, but a liquidated damage clause may be. A liquidated damages provision will be enforced if the amount is reasonable in relation to the possible injury suffered by the employer upon the employee's breach of the covenant-not-to-compete. Liquidated damage amounts that are "unconscionable" or "excessive" and therefore are merely penalties will not be enforced. The amount of a liquidated damages provision in a medical practice covenant-not-to-compete must bear some reasonable relation to the expected loss of patient revenue arising from the employee's breach of the covenant-not-to-compete. Damages in breaches of covenant not to compete cases in physician employment agreement cases are typically capable of reasonable determination - they equal the profit lost on post termination patient encounters with the breaching physician. Therefore, there is rarely a need for a liquidated damages provision in this context.