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Issue #30 - 10.9.07
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Structuring Effective Covenants
Structuring an enforceable covenant-not–to-compete is necessary for protecting both an established and growing practices when an associate is about to be hired.
For states in which such covenants are legal, the “plain vanilla” covenant-not-to-compete will typically work for the younger associate who has been with the practice for a short period of time or has undergone recent extensive training by the employer. But as an associate matures, and begins to develop a loyal following, enforcement of the covenant becomes more problematic.
Why Covenants Fail
As the associate gains experience and builds goodwill in a practice, the legal power of covenant weakens. This dilution over time, of the power of the covenant, flows from the fact that covenants are, by definition, anti-competitive. Courts typically only enforce a covenant in circumstances where: (a) the employer has a protectable, legitimate business interest; (b) the covenant is no broader than is necessary to protect that interest; and (c) enforcing the covenant would not create an undue hardship for the departing dentist.
Enforcement of the covenant against an experienced associate may flounder under the first prong of these criteria — whether the employer has a legitimate business interest to protect. As the professional responsible for patient care, an experienced associate can make the convincing argument that the patients who will be leaving with the associate are not the employer’s patients any longer. Patients, one can argue, are free to choose their own dentist. This line of reasoning is not compelling when the associate is fresh out of dental school; however, the argument takes on considerable force when an associate has developed a reputation in the community after being fully trained by an owner dentist.
Over the last ten years, legal scholars have been attacking the validity of covenants-not-to-compete in the health care professions. Their primary assertion suggests that blocking the continuation of a patient-physician relationship between the departing associate and patients, served by that associate, may be injurious to patient welfare. While the trend is not uniform, courts are increasingly receptive to these arguments. In fact, the ADA’s own Principle of Ethics and Code of Professional Conduct emphasizes that patient welfare comes first.
The ultimate consequence of these trends is that a covenant-not-to-compete may not provide security for an employer. The associate dentist may leave the employer’s practice and, within the covenant area, set up his or her own practice or, in rarer instances, join an already-existing dental practice with a large book of business.
The senior member, employer may mistakenly rely on a covenant that fails to offer the protection that is needed. Unfortunately, an owner who pursues legal action with a poorly structured covenant may be left with little, if any, compensation or legal recourse.
The Covenant Buyout: A Viable Option
One solution to this dilemma is the so-called “covenant buyout.” The covenant buyout offers an experienced associate the option of purchasing out of a covenant-not-to-compete. If the associate elects to not buy out of the covenant, the covenant is by its terms enforceable; if the associate does elect to buy out of the covenant, the covenant is waived and is no longer enforceable. Ideally, the associate will pay a higher price for the buyout when leaving a practice voluntarily, and a lower price if asked to leave for reasons other than “for cause.” Note that the covenant buy-out does not create a covenant in the Associate’s favor: patients can remain with the Employer or go with the Associate, at their choice.
Of course, merely stating that a buyout is possible does not ensure success. A buyout price which is fair, reasonable and adequate to protect the interests of an employer must be established. Setting a price too low will hardly discourage an associate from leaving, and does little to mitigate against potentially devastating consequences if departure occurs. Setting the price too high risks the possibility that the courts will view the price as prohibitive to buyout and that the buyout right is illusory.
To set a fair price, one must first measure the loss to the employer if an experienced associate were to leave with a significant number of patients. If an associate who has been employed for a period of time, leaves with a significant number of patients and establishes a practice within a covenant area, the economic loss to the employer will be severe.
Summary:
This column excerpted from an excessive manuscript on this topic, co- authored with H. Thomas Hunt, Esquire, and an attorney with over twenty years of experience in advising Dental Professionals.
It is important that you confer with an attorney with healthcare experience when preparing an employment agreement that contains a covenant not to compete, and terms for an effective covenant buyout.
The Snyder Group provides comprehensive employment agreement contract templates. Please visit our website for details.
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