Noncompetition Provisions in Physician Employment Agreements Following Farber

Without a doubt, one of the most contentious issues that can arise out of a physician employment agreement is the enforceability of a noncompetition provision. Such provisions are routinely included in employment agreements offered to prospective hires, but they are seldom the focus of pre-employment negotiations. After all, when newly-minted physicians are entering into private practice, their focus is on the geographic location of the practice, the starting salary, and other working conditions; little attention is given to the restrictions that could be imposed on the physician in the future if he or she chooses (or is forced) to leave the practice. Contractual restrictions on the physician’s future conduct can include such things as a prohibition against soliciting the practice’s patients, referral sources, or employees; a confidentiality requirement protecting the practice’s trade secrets or other confidential information; or a noncompetition provision that limits where the physician can practice medicine after he leaves the practice.  These types of provisions are frequently referred to as “restrictive covenants”.

In contrast to the newly-minted physician, an established medical practice (or its attorney) will almost certainly be aware that not all new physicians will be a good long-term fit with the practice and that some of the practice’s hires will eventually leave, either voluntarily or otherwise. The practice will want to protect its perceived “goodwill” by preventing departing physicians from poaching its patients or referral sources. One of the principal tools for doing this is the inclusion of a noncompetition provision among the restrictive covenants contained in its physician employment agreements.

Fast forward a few years–the physician is now well-established, and his or her family are fully entrenched in the local community. The physician is offered an extremely attractive position with another group, or wishes to form a new practice. The physician decides to pursue the new opportunity, but there is a wrinkle—taking the new opportunity will require the physician to violate the terms of the noncompetition provision in his or her employment agreement. Concerned, the physician consults with a colleague and is told that the Arizona Supreme Court has decided that noncompetition covenants “probably are not enforceable for Arizona physicians” but suggests that the physician should consult with an attorney to be sure. Does the colleague know what he is talking about?

THE FARBER DECISION

In 1985, Valley Medical Specialists (“VMS”), a multi-disciplinary medical practice hired Dr. Steven S. Farber, an internist and pulmonologist who, among other things, treated AIDS and HIV-positive patients.  In 1991, Dr. Farber entered into a new employment agreement with VMS that contained a noncompetition provision that precluded Dr. Farber from owning or working for a competing group  within a “restricted area” consisting of a 5 mile radius of any office maintained or utilized by VMS for a period of 3 years after the termination of his employment agreement. In 1994, Dr. Farber left VMS and began practicing within the restricted area. Shortly thereafter, VMS filed suit to enforce the noncompetition covenant.

Following 6 days of testimony and argument, the trial court denied VMS’s request for a preliminary injunction to enforce the noncompetition covenant on the grounds that it violated public policy or, alternatively, because it was too broad. VMS appealed this ruling to the Arizona Court of Appeals, which concluded that a modified version of the covenant was reasonable and reversed the trial court. The Arizona Supreme Court then granted review, and in June 1999 issued its widely-discussed Opinion in Valley Medical Specialists v. Farber, 194 Ariz. 363 (1999), in which it “vacated” the Court of Appeals’ decision and held that the covenant not to compete between Dr. Farber and VMS could not be enforced because VMS’s “interest in enforcing the restriction [was] outweighed by the likely injury to patients and the public in general.” However, the Supreme Court “stop[ped] short of holding that restrictive covenants between physicians will never be enforced, but caution[ed] that such restrictions will be strictly construed.”

NONCOMPETITION COVENANTS FOLLOWING FARBER

Contrary to popular myth, the Farber Opinion did not bring an end to the use of noncompetition covenants in physician employment agreements. If anything, it has made an already-uncertain area of the law even more unpredictable going forward. Both before and after Farber, the principal “rules” for evaluating the enforceability of physician noncompetition covenants can be summarized as follows:

1. Noncompetition covenants will be “strictly construed” against enforcement. As a practical matter, this means that all close calls will be decided in favor of the physician.
2. Noncompetition covenants will not be enforced if the restraint imposed is greater than what is necessary to protect the employer’s legitimate interest.
3. Alternatively, noncompetition covenants will not be enforced if the employer’s interest in enforcement is outweighed by the hardship to the employee or the likely injury to the public.
4. Determining issues 2 and 3 requires a fact-intensive inquiry that depends on the totality of the circumstances.

The court in Farber recognized that employers have a “protectable interest” in its patients and referral sources, but this interest is not without limitation. The idea is to give the employer a reasonable amount of time to overcome the former employee’s loss, usually by hiring a replacement and giving that replacement time to establish a working relationship with patients and referral sources. On the other hand, patients have an independent right to see the doctor of their choice, and this right is also entitled to “substantial protection”.

The “reasonableness” of a physician noncompetition covenant is based upon three factors—its duration, its geographical area, and the specific activities that are prohibited. If any one of these factors is deemed over-broad and unreasonable, then the entire covenant will be unenforceable. Moreover, because Farber has held that reasonableness “is a fact-intensive inquiry that depends on the totality of the circumstances”, the enforceability of a physician noncompetition covenant will typically be decided by the trial court judge who is assigned to your case. Consequently, aside from always making sure that a noncompetition covenant is carefully limited to the employed physician’s specific medical specialty or to the specific types of procedures that the physician will be performing, there are only a few things that an employer can do to ensure the covenant will be held enforceable by an unknown future judge evaluating unknown future circumstances.

The best tool available to employers to increase the chances that a court will enforce a physician noncompetition covenant is the use of so-called step-down provisions when describing the duration and geographical area of the covenant. Step-down provisions take advantage of the rule–specifically recognized in Farber—that “Arizona courts will ‘blue pencil’ restrictive covenants, eliminating grammatically severable unreasonable provisions” to provide a future trial judge with several possible options to choose from. For example, the covenant might provide that the restriction will be effective “for a period of 24 months from the termination date; but if a court with jurisdiction finds that 24 months is unreasonable, then for a period of 18 months from the termination date; but if a court with jurisdiction finds that 18 months is unreasonable, then for a period of 12 months . . .”. A similar drafting technique can also be used to give the court multiple options regarding the maximum geographical area encompassed by the covenant

Following Farber, the drafting of physician noncompetition covenants has been converted into a legal version of the “Price is Right” gameshow, where the objective is to provide for the largest possible restriction that will be adjudged “reasonable” by a future court without becoming “unreasonable” and, therefore, unenforceable. Although unwieldy to draft, step-down provisions provide the best available tool to accomplish this objective.

On the other hand, physicians wishing to avoid future restrictions on their ability to practice their medical specialty if they leave their current employer really have only two options. First, they can use whatever negotiating leverage that they may have with future employers to require the elimination or reduction of noncompetition provisions contained in the employment agreements that they are offered. Second, and perhaps counterintuitively, they can simply ignore over-broad and facially unreasonable covenants in the hope that they will be “strictly construed” by a future court.