Restrictive Covenants

Tuesday, March 1, 2005 - 00:00

Are you subject to a restrictive covenant? Does your company impose one on its high level employees? Does your physician have a restrictive covenant in his employment contract? Do you want him to?

Restrictive covenants are a provision in employment agreements in which an employee agrees not to compete with the employer in the event he leaves that employment. They are usually measured in miles (the minimum distance from the present site of business to which the employee must relocate) and years in which they remain in effect. Despite being anti-competitive, restrictive covenants are typically legal if they are reasonable "in scope and duration." A year or two are commonly accepted durations, and even five years can sometimes pass muster. Distances of 10-50 miles are common, but larger distances can be enforced depending on the underlying business. Many courts require the covenants be provided in return for a salary increase or other benefit, but the quid for the quo is rarely explicit. They are typically entered into prior to actual employment, or when ascending to a higher level position, when the thought that this marriage might not last forever is the last thought on anyone's mind.

Businesses acquiring another business also use restrictive covenants to prevent the former owner from making his money from the sale of the old business and then starting a new one. If you are buying "Jones's Hot Dogs" or "Smith's Real Estate," you don't want Jones or Smith opening up that same business nearby. You want to make sure that the customers and the staff of the business you are buying stay where they are. Restrictive covenants that are ancillary to the sale of a business typically get heightened protection from courts because the non-compete was an integral part of the deal and the seller typically was richly rewarded for his efforts.

Court decisions on restrictive covenants typically began in businesses in which customers had little interest in whether the covenants existed. In Pennsylvania, the first significant round of cases, from the 1950's to the 1970's, involved a mall-based ear-piercing franchise; the door-to-door sales of household articles; the manufacture and sale of packing materials, and the sale of industrial machinery and tools. They have since been used as a way to keep high level business employees from straying, or requiring them to stray far away or after a long vacation.

Now we move from ear piercing to the practice of medicine, but restrictive covenants come along. As physician practices have gotten larger, as investment in practices becomes greater, and as practices come to be managed more and more as businesses, physician partners often want the comfort of knowing their partners can't easily leave. As health systems purchase physician practices, they want to make certain that their investment results in the stream of income to be generated by present and future patients they anticipate. In some instances, a health system may have to make substantial investments in technology, staff, and marketing over a considerable period of time to make a practice succeed. It wants to lock up the talent to guarantee the return on that investment. A physician who leaves, sets up practice nearby, and takes patients with her threatens that profitability.

Is it good business? Probably. Is it good medicine? Probably not. Should the rules approving and enforcing restrictive covenants be applied to physicians? No. Many people have very casual relationships with physicians, with little more than an annual check-up or even less. Whether their prior physician or someone else is there for the next check-up is of little concern. But people who have serious and/or ongoing illnesses, or who have children with serious and/or ongoing illnesses, often have a different view. They interact with their physicians frequently. They know their physicians, and the physicians know them and their history. They know that not all physicians are alike, and there is comfort, amidst the serious medical concerns, in having a physician they know and trust. They have spent time creating a history, and they don't want to do it again.

Restrictive covenants are designed to destroy that relationship and disrupt continuity of care. The very goal of the mileage restrictions is to make it too far and thus too inconvenient for patients to travel, and to get them to accept staying with their physician's former practice, albeit with a new caretaker. If patients will travel 25 or even 50 miles to see their doctor, then the covenant was too leniently written. It is the rare physician indeed, or any professional, who can wait out the time period in a covenant, forgo practice for a year or two, and pick right up again. Physicians leave practices for many reasons, some better than others. But inevitably they leave because they are unhappy practicing where they are. The question is whether the consequences of that decision should be allowed to harm patients. The facts below, drawn from a real Pennsylvania case, Nolan v. West Penn Health System, illustrate how covenants develop and the way they affect patients.

Dr. Nolan was an oncologist-hematologist and, by all accounts, an excellent one, well liked by patients, and well regarded by other oncologists and by primary care physicians who referred their patients to her. An oncologist's practice involves both office-based and hospital-based care. Patients are most commonly seen in the physician's office, but are hospitalized when their condition and/or a procedure being performed requires it. Oncologists refer patients to other providers for necessary ancillary care, some of which may be performed by staff within the oncologist's practice and some by non-affiliated physicians in other specialties, such as surgeons, radiologists, and laboratories.

A cancer diagnosis inevitably brings great stress into a patient's life. Treatment is typically intensive, at least initially, and may extend for a substantial number of years on a less intensive basis. Cancer patients often develop deep and close relationships with their oncologist, relying on them for support, as well as treatment.

Dr. Nolan was one of six owners of her practice. In 1997, they sold their practice to a health system in Pittsburgh for a substantial amount. The purchaser, understandably, wanted to protect that investment; it wanted Dr. Nolan and the others to continue to practice medicine as they had and hoped they would refer their patients to both the health system's hospital and its other providers. To accomplish this, the health system insisted on restrictive covenants - 10 miles from any of the practices several offices and six years. Within eight months, Dr. Nolan resigned and began working with a competing oncology practice which was part of another health system. Dr. Nolan complied with the geographic limitation and was prepared to do so for the entire period. More than 100 of her former patients followed her.

A lawsuit seeking to enforce the restrictive covenant followed and Dr. Nolan - and her patients - lost. Ironically, the fact that Dr. Nolan's patients wanted to continue to see her was the central fact that produced that result. The Court noted that these were patients "for whose continued patronage West Penn had paid" and this "reasonably foreshadowed a continuing exodus" unless the covenant was enforced.

The Court put teeth into the covenant, by prohibiting Dr. Nolan from "practicing medicine directly or indirectly" within the prohibited area. The devil is often in the details, and the prohibition against practicing "indirectly" prevented Dr. Nolan from referring patient or admitting patients to the hospital she was then affiliated with or to any other physician or provider within the "restricted area" other than to her former practice. If the patients received care that violated those limitations, Dr. Nolan could not continue to treat them. What did that really mean? Court-approved letters to patients explained:

I have been subject to an Order ... forbidding me from continuing to serve as your oncologist should you decide to receive treatment from my present employer, Oncology Hematology Association, at Forbes Regional Hospital in Monroeville or from any other oncologist or oncology group within ten miles of Forbes Regional Hospital other than my former employer, Medical Center Clinic, P.C.

If you receive any medical treatment which is related to my continuing care of you, within 10 miles of Forbes Regional Hospital, unless that medical treatment is provided by Medical Center Clinic, P.C., I am not permitted to continue to see you as your physician. For example, if you go to Forbes Regional Hospital after June 17, 1998 to have blood work performed, or a CT Scan performed, I may no longer serve as your physician.

Cancer patients thus had to choose between and among their physician of choice, continuity of care, and substantial personal inconvenience. That was indisputably good for Dr. Nolan's former employers and bad for her patients. That Dr. Nolan's conduct contributed to the problems doesn't minimize them.

Courts do typically consider the "public interest" when evaluating restrictive covenants in physician contracts. But that analysis looks at the macro level - if enforced, will there be enough physicians to provide care in the relevant specialty and area? - and not at the micro level - the interest of a patient in continuing to see his or her doctor. Only rarely will that analysis render a covenant ineffective. One judge, dissenting in Dr. Nolan's case on appeal, would have gone further:

The rights of patients to seek ancillary medical care from other physicians is deserving of more attention from the law than [the health system's] expectation of profit from its commercial transaction with Dr. Nolan. While I recognize [the health system], like any business, can contract with others, including Dr. Nolan, in such a way as to protect its financial interests, the injunction goes beyond protecting such interests. Dr. Nolan's patients are not the property or chattel of [the health system].

Ironically, Dr. Nolan was going to appeal to the Pennsylvania Supreme Court, but the two competing health systems merged and no longer wanted to fight each other.

I am a lawyer. I provide services that I believe are important. I like to think that for some clients, at least, I am exactly the right lawyer. In Pennsylvania and in almost every state, I am free to move from firm to firm, to open up a practice next door to my old practice, and to ask my clients to follow me. Under the model rules that govern the professional conduct of lawyers, restrictive covenants are illegal and unenforceable, except in very limited circumstances. The American Bar Association's Committee on Professional Ethics, in explaining this rule, emphasized the distinctions between the business principles governing commercial enterprises and the ethical principles governing the practice of law: "clients are not merchandise[,] [l]awyers are not tradesmen," and restrictive covenants inappropriately "barter in clients." More recently, the New Jersey Supreme Court, stated it this way: "each person must have the untrammeled right to the counsel of his choice. A contrary decision would allow clients to be unknowingly treated like objects of commerce, to be bargained for and traded by merchant-attorneys like beans and potatoes."

Does it make any sense to apply those words and concepts to lawyers but not to physicians? Does the distinction between doctors and lawyers make any sense? I think not.

Robert B. Hoffman is a Partner in the Health Law Practice Group of WolfBlock and is resident in the firm's Harrisburg office. He practices in the areas of health care and civil litigation. He has represented the Pennsylvania Medical Society as an amicus curiae in two Pennsylvania appellate cases involving restrictive covenants, including the case prominently discussed in this article.

Please email the author at rhoffman@wolfblock.com with questions about this article.