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Liquidated damages or unenforceable penalty? (Rx for Physicians Caveat).

CASE ON POINT: Eastern Carolina Internal Medicine, P.A. v. Faidas, 564 S.E.2d 53--NC (2002)

ISSUE: In crafting a "covenant not to compete," one must be extraordinarily careful to ensure that the time period is not too long and the geographical area is not too broad. If either the time is too long or area too broad, the entire covenant not to compete may be void. In this unusual North Carolina case, a physician sued a group with which she was formerly associated. She sued for a precise amount of liquidated damages. The damages were calculated pursuant to a formula in an agreement which covered the issues as to how compensation might be paid upon severance. If the amount were considered to be a penalty, would the courts of North Carolina refuse to recognize the agreement? Conversely, if the amount were perceived to be liquidated damages, how would the courts of North Carolina react?

CASE FACTS: On March 21, 2000, the plaintiff filed a complaint alleging the breach of an employment contract between the parties. The contract was dated July 22, 1996. The plaintiff sought liquidated damages in the amount of $109,029.04 from the defendant. The defendant denied the claim asserting that the liquidated damages provision in the contract was an unenforceable penalty and that the provision was actually a covenant not to compete and thus void as against public policy. Both parties filed motions for summary judgment. The Craven County Superior Court found that there was no genuine issue of material fact and denied the defendant's motion for summary judgment, granted the plaintiffs motion for summary judgment, and entered judgment for the plaintiff in the amount of $109,029.04, plus interest. On January 25, 2001, the defendant moved for a new trial and/or amendment of the judgment pursuant to North Carolina Rules of Civil Procedure. The trial court denied the motion. The defendant appealed.

COURT'S OPINION: The Court of Appeals of North Carolina affirmed the judgment of the lower court. The court recognized that the sole issue was whether the trial court erred in granting the plaintiffs motion for summary judgment and denying the defendant's motion for summary judgment. The court noted that there was a "Cost Sharing" provision in the contract between the parties. The court observed that the parties recognized a provision in the contract pursuant to which they agreed that termination of the employee would result in economic damage to the employer and that, under the circumstances, a reasonable estimate of such damage and equitable reimbursement to the employer by the employee is the Cost Share. There was another provision that in the event the employee, within one (1) year following termination of her employment with her employer for any reason shall (a) engage in the practice of medicine within the geographical boundaries of Jones, Pamlico, or Craven Counties, North Carolina, etc., the employee shall pay to the employer an amount equal to the Cost Share. The contract went on to provide a formula for calculating the Cost Share with respect to the termination of employment. The court rejected the defendant's contention that the "Cost Sharing" provision was void as an unreasonable restraint and against public policy. The provision in the contract for "forfeiture" of any salary or commission beyond the employee's base salary did not constitute a covenant not to compete. A "forfeiture, unlike a restraint, included in an employment contract, is not a prohibition on the employee's engaging in competitive work." A restriction in the contract which does not preclude the employee from engaging in competitive activity, but simply provides for the loss of rights or privileges if he does so is not in restraint of trade ..."

LEGAL COMMENTARY: The court concluded that the contract did not prohibit the physician from engaging in the practice of her profession but only provided that if she did so within the three-county area described, she would be required to pay a sum certain for making this choice. Accordingly, the court held that the "Cost Sharing" provision was not a covenant not to compete. The court did not subject it to strict scrutiny as to reasonableness and public policy as would be the case with a covenant not to compete. Liquidated damage clauses which are reasonable in amount are enforceable as part of a contract and are not treated as penalty clauses. A stipulated sum is for liquidated damages only (1) where the damages which the parties reasonably anticipate are difficult to ascertain because of their indefiniteness or uncertainty and (2) where the amount stipulated is either a reasonable estimate of the damages which would probably be caused by a breach or is reasonably proportionate to the damages which have actually been caused by the breach. Considering the nature of the contract, the intention of the parties, the sophistication of the parties, the stipulation of the parties, the fact that the parties are better able than anyone to determine the reasonable compensation for a breach, and the fact that the damages were difficult to ascertain, the court concluded that the liquidated damages stipulated were not a penalty.

A. David Tammelleo, JD, is a nationally recognized authority on health care law. Practicing law for nearly 40 years, he concentrates in health care law with the Rhode Island law firm of A. David Tammelleo & Associates. He has presented seminars on medical, nursing and hospital law throughout the United States. In addition to his writing as Editor of Medical Law's, Nursing Law's & Hospital Law's Reagan Reports, his legal articles have been published in the most prestigious health law journals. A prolific writer, his thousands of articles, as well as his achievements as an attorney and lecturer, have won him recognition in Martindale-Hubbell's Bar Register of Preeminent Lawyers and Marquis Who's Who in American Law.
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Author:Tammelleo, A. David
Publication:Medical Law's Regan Report
Geographic Code:1U5NC
Date:Oct 1, 2002
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