Covenants regarding non-compete are loved by employers and loathed by employees. Behind many medical turf battles, however, another battle exists — the enforcement of a restrictive covenant, which is not so much to prevent a physician from competing against his or her former employer but to extract a monetary cost for doing so.
Restrictive covenants generally prohibit a former employee from competing against his or her former employer within a specified market area and for a stated period of time. While urban myth would have you believe that covenants are not enforceable, that’s not true if they are reasonable in duration and geographic scope. And it’s especially true for covenants involving physicians because physicians are deemed to have unique, extraordinary skills.
Most restrictive covenants provide for the remedy of injunctive relief (a court order prohibiting the physician from violating the covenant) or monetary damages, often in the form of liquidated damages. An injunction will only be granted if a violation of the covenant will cause irreparable harm that cannot be adequately compensated by an award of monetary damages. For example, if I have a contract to buy the Mona Lisa and the seller breaches the contract, I can ask the court for an injunction in the form of an order compelling the sale because the Mona Lisa is unique and irreplaceable.
But in the case of a physician competing against the former employer, one can argue that money should be an adequate remedy for the aggrieved employer, thus the prevalence of the liquidated damages clause. The clause is an agreement by the parties to estimate and fix the amount of monetary damages in the event of a breach. Provisions for liquidated damages are common in situations where it would be difficult, if not impossible, to calculate the amount of actual damage.
For example, a restrictive covenant might fix the amount of liquidated damages for a breach at $200,000, $1000 a day or a percentage of the physician’s compensation package or productivity. However, a provision that requires, in the event of a contractual breach, the payment of a sum of money grossly disproportionate to the amount of actual damages provides for a penalty and is not enforceable.
Typically, in a breach of contract case the aggrieved party will seek damages for the loss of its bargain, often in the form of lost profits. Profits are measured as revenue minus expenses. If an employed physician in a medical group were to produce $500,000 of revenue, and receive $400,000 in compensation and benefits, the employer made a net profit on the physician of $100,000 and the damages for a year of competition in violation of a restrictive covenant would be $100,000.
In our example, what if the restrictive covenant said that upon a breach of the covenant the physician would owe, as liquidated damages, the amount of revenue generated by the physician in the prior year ($500,000) or the compensation and benefits paid to the physician ($400,000)? Is there a rational relationship between those elements and lost profits? Does the compensation paid to the physician represent a good faith estimate by the parties as to the actual damages that might ensue from a breach? The employer may claim that it should receive restitution from the former employee, but doesn’t that ignore the fact that the physician was not merely an expense of the medical practice, but also produced revenue? In other words, is a calculation of the expense for the physician looking at only one side of the lost profits equation?
It is difficult to predict how a court will rule on the enforceability of a particular liquidated damages provision. In one recent case, an appellate court upheld a liquidated damages clause of $50,000 or 50% of the physician’s last year of productivity or salary (whichever was greater), while in another recent appellate case the court struck down a provision requiring the payment of 150% of the physician’s W-2 gross income and bonus for his last year of employment (grossly disproportionate to the defendant’s anticipated loss). In many instances, the real value of the liquidated damages clause will be one of deterrence.
Bruce Wood is a member at CCB Law, a boutique law firm focused on providing counsel to physicians and healthcare professionals. He can be reached at 315-477-6292 or firstname.lastname@example.org.