A new look at restrictive covenants.

3 While the restrictive covenant issue most often arises in medical group practices with the announcement of a physician's departure, addressing this issue in the planning phase of a group's operation will produce dividends for years to come. It allows preventive planning on these issues to be made in a less emotional context.

The critical document governing the relationship between the individual physician and the group is the employment contract. The contract provision that often receives the most attention in a departure situation is the restrictive covenant clause. Restrictive covenants usually prohibit the physician from practicing medicine within a certain area for a given period. When a physician announces his or her departure, the medical group often asks whether the covenant is enforceable. The departing physician often asks whether he or she can open an office across the street.

When an established group hires a new physician and establishes that physician in the practice, the medical group confers a great benefit on the new physician. The medical group obviously has an interest in preserving the practice that it has created. A properly drafted restrictive covenant can allow the group to prevent the physician from using the group's goodwill to establish a competitive practice. Physicians have debated long and hard concerning the appropriateness, from an ethical perspective, of restricting another physician from seeing patients with whom he or she has established a physician/patient relationship. Each group must decide for itself whether it desires to prohibit its members from engaging in a competitive practice upon leaving the group.

Once the group decides to include a reastrictive covenant in the employment agreement, it must draft the clause to maximize its enforceability. In most states, to be enforceable the covenant must be connected to the employment contract, must be entered into in exchange for something of value, and must be reasonable. In some states, specific statutes may prohibit the enforcement of a restrictive covenant except in narrowly defined circumstances. The group executives must be not only familiar with the statutes in the state in which the group is located, but also aware of cases that have been decided in the state in order to determine specific guidelines concerning the enforceability of a covenant. The process of determining enforceability has been affected by competing policies surrounding restrictive covenants. On the one hand, the courts must consider the public policy in favor of allowing people to work and contribute their skills and abilities to the community. On the other hand, they must consider the general principle of freedom of contract and the public policy in favor of encouraging skilled and established physicians and others to hire and train those new to the profession or the community.

A considerable body of case law has developed governing the interpretation and enforcement of restrictive covenants. In determining whether a covenant is reasonable and therefore enforceable, the courts have applied a number of rules. The following guidelines should be used, in conjunction with specific decisions in the state in question:

Oral restrictive covenants are not enforceable

in some states. In any event,

it is critical from the executive's viewpoint

that the covenant be in writing and signed by the physician-employee. Otherwise no reliable way of establishing the terms of the covenant is possible. The covenant must be related to protection of the legitimate business interests of the medical group and must be entered into as part of the employment relationship. Examples of a legitimate business interest are the patient relationships and name recognition developed through the investment of the group's time, efforts, and resources. The covenant must be limited to protecting this interest.

The covenant must be supported by valuable consideration. An individual physician cannot merely agree to refrain from practice. The promise will not be enforceable, because it lacks the legal concept known as "consideration." In exchange for agreeing to refrain from practice, the physician must receive something with an economic benefit, such as a salary or other payment,a portion of which can be thought of as being given in exchange for the covenant. In the medical contract context, this legally sufficient consideration generally exists when the physician enters into an employment contract in connection with accepting the offer of employment and before beginning work. Any deviation from that procedure, however, may result in a court finding that the covenant is unenforceable. For instance, courts have invalidated covenants entered into after the employment relationship had commenced. While covenants may be enforceable when new value" (such as a raise in salary) is given after employment commences, this practice is risky. The only safe way of meeting the consideration requirement is to have the employment contract with the restrictive covenant executed in advance of the commencement of work by the physician and at the time the employment agreement is created.

The covenant must be reasonable with regard to the scope of activity prohibited. In order to be reasonable, a covenant must be drafted so that it only restricts the physician from a reasonable scope of activity. The standard of what is reasonable varies from state to state. Regardless of the specific standard, physician executives should consider the following guidelines. Multispecialty groups should consider whether the group needs protection over the full range of practice encompassed in the phrase practice of medicine" or whether a restriction limiting the physician from practicing only in a specialty is sufficient. Executives of multispecialty groups should determine what interests of the group need to be protected. Often this interest involves the group's goodwill, its patient relationships, and its financial well-being. It is prudent for the multispecialty group to consider restricting the physician from practicing only in the area in which the physician worked while employed with the medical group. While a broad prohibition against the departing physician may be enforceable in a particular state, the added protection of this broad prohibition may not be worth the uncertainty it raises in today's specialized practice of medicine. For single specialty groups, limiting the departing physician's practice to the specialty being practiced is strongly recommended. The covenant must be reasonable as to the time of the restriction. Recent cases across the country have indicated that courts have narrowed the period that is considered reasonable. Periods beyond 2 or 3 years following the termination of the agreement may be increasingly viewed as being too long to protect the

legitimate interests of the medical

group. While the exact period may

vary from state to state, medical executives

should be conservative. The main

purpose of this restriction is to disrupt

the practice of a physician who leaves

a group and thereby make it impossible

to transfer the goodwill" in the patient

population to the new practice. A 1 - to

2-year period should be sufficient for

this purpose.

The covenant must be reasonable as to

the territory in which the activity is

prohibited. Covenants are often phrased

in terms of prohibiting practice within

a county or city, or within a specified

radius of an office or city. The exact

extent of the territory to be restricted,

however, should be based upon the

business activity of the medical group.

If the medical group draws patients

from a county or series of counties, a

restriction based upon those economic

realities is likely to be enforceable.

On the other hand, if the covenant

extends the scope of the covenant beyond

the drawing area of the medical group,

it is likely to be deemed unenforceable.

The covenant must not be against public

policy. The parties will be allowed to

make agreements between themselves

except when the public interest outweighs

this freedom to contract. This public policy concerm arises when enforcement of the covenant in question may harm the general public. Late in 1988, the North Carolina Court of Appeals considered such an issue in Iredell Digestive Disease Clinic, PA. v. Petrozza, 92 N.C. App. 21 (1988). The clinic in this case was engaged in the practice of gastroenterology and general internal medicine for patients in Iredell County, N.C., with its principal place of business in Statesville. The defendant, Dr. Petrozza, a gastroenterologist and internist, signed an employment contract when he commenced work with the clinic. The restrictive covenant provided du Dr. Petrozza would not engage in the practice of medicine for a 3-year period following the termination of the agreement in an area within 20 miles of Statesville or within 5 miles of any other hospital or office served by the medical group. When Dr. Petrozza left the employment of the clinic in 1987, the clinic filed a complaint seeking an injunction against Dr. Petrozza's practice of medicine in violation of the restrictive covenant. When this preliminary injunction was denied, the plaintiff appealed to the North Carolina Court of Appeals.

The Court of Appeals upheld the trial court's refusal to grant an injunction, basing its decision on public policy grounds. The court stated that a noncompetition covenant is not contrary to public policy as long as it is intended to protect a legitimate interest of the medical group and is not so broad as to be oppressive to the physician or the public at large. Dr.Petrozza argued that covenant was void on public grounds, because enforcing the covenant would deprive Statesville residents of necessary medical care. The court stated that, if ordering the physician to honor the contractual obligation would create a substantial question of potential harm to the public health, the public interest outweighs the contract interest of the parties and the court will refuse to enforce the covenant. If, on the other hand, ordering the physician to honor the agreement will merely inconvenience the public without causing substantial harm, the medical group is entitled to have the contract enforced. The court reviewed at length the many affidavits presented by both sides that tried to quantify the impact of enforcing the covenant upon the Statesville community. The affidavits were in conflict as to the precise impact of the departure of Dr. Petrozza. In weighing the evidence, however, the court concluded that the public's interest in obtaining adequate health care superceded the parties' freedom to contract. The critical factor in the decision was that the enforcement of the agreement would create, in the court's view, a monopoly for the clinic. Enforcing the agreement would leave only one gastroenterologist practicing in the town. The court also placed great weight on the fact that patients would be required to travel approximately 45 miles for this care if the other Statesville gastroenterologist were unavailable and that on occasions such a distance could in fact be life threatening. While this decision recognized the validity of restrictive covenants in general, it does possibly complicate the analysis of physician contracts in a number of rural areas where specialized medical care may not be readily available.

As an alternative or supplement to a restrictive covenant, physician executives should consider the use of a liquidated damage provision. A liquidated damage clause provides that a physician must reimburse the medical group for the expenses incurred by the group if the physician practices within a prohibited area. The rationale for a liquidated damage provision is that exact damages caused by the departure of a physician will be difficult to establish. Therefore a fixed amount is the only way to establish damages. As an alternative to a restrictive covenant, the liquidated damage clause will reimburse the medical group for expenses associated with the recruitment, establishment, and departure of the physician. It does not prohibit the physician from practicing in the area, however. As a supplement to a restrictive covenant clause, the liquidated damage provision adds a "damages" element to the concept of prohibiting a physician from practice.

Liquidated damage clauses may also be subject to attack. For instance, in most states, the clause cannot be a "penalty." It must be for damages suffered by the group. In addition, liquidated damages are only appropriate where the actual amount of damages is difficult to determine. These abstract concepts are difficult to establish, and disputes about the use of liquidated damage clauses are likely to occur often. Physician executives must analyze whether the goal of the group is to prevent a physician from entering into competitive practice, or whether economic concerns of the group are paramount.

Both physician executives and physicians seeking employment with groups must decide whether the practice being entered into is worthy of protection or whether the junior physician should have free mobility. Decisions made in the planning context, when no specific dispute is at hand, will help addreess these issues in a comprehensive manner. Ignoring the restrictive covenant issue or failing to periodically review restrictive covenants that are in place invites the decision to be made after a physician departure has been announced. In that context, all that can be done is to evaluate the existing covenant in light of the rapidly developing law. Certainly the chances for enforceability of a covenant are improved if the covenant is prepared with care in light of current law. C3