Medical Practice Competition Restrictions
Bill Constangy*
The landscape is rapidly changing in North Carolina for the enforceability of employment contract restrictions on medical practice competition. The proliferation of medical practice employment contract covenants not to compete is consistent with the expanding use of such covenants to protect employers’ legitimate business interests in a multitude of businesses. Specifically in regard to medical practice, it has also been accelerated in North Carolina by the increased accessibility of medical specialty and other medical services throughout the state and the continuing rise of integrated health care systems.
It has become common for such health care systems, employing many physicians, and smaller medical practices to employ physicians bound by employment contract physician services agreements including covenants not to compete during employment and for a limited period of time after termination in a restricted physical area.
Such contracts often contain forfeiture clauses by which the offending physician agrees to give up certain retirement or other benefits, such as severance pay or pension rights, that the physician would otherwise receive. They also may contain even broader liquidated damage clauses that require the physician who violates the restrictions to pay a predetermined fixed sum based on a mathematical formula to compensate the employer medical practice for anticipated economic loss caused by the physician’s decision to remain in the restricted area and compete after termination of employment.
The inherent nature of medical services and the potential for harm to public health, raises significant public policy concerns in relation to the enforcement of such restrictions.
The North Carolina Court of Appeals noted in the 1988 case of Iredell Digestive Disease Clinic v Petrozza that “medical doctors are by no means immune from such agreements.” However, the court held that “[i]f ordering the covenantor to honor his contractual obligation would create a substantial question of potential harm to the public health, then the public interest outweighs the contract interests of the covenantee, and the court will refuse to enforce the covenant.” The court found that “public health and welfare would be harmed” by enforcing the covenant and leaving “only one gastroenterologist in Statesville.” Holding that covenant was unenforceable, the court noted that “[t]he doctor-patient relationship is a personal one and we are extremely hesitant to deny the patient-consumer any choice whatsoever.”
Interference with patient choice by physician non-compete agreements continues to be a major public policy concern. In November, 2014, the American Medical Association issued Opinion 9.02 in accordance with their Code of Medical Ethics concerning such restrictive covenants stating that “[c]ovenants-not-to-compete restrict competition, can disrupt continuity of care, and may limit access to care. Furthermore, the opinion urges physicians not to “enter into covenants that: (a) unreasonably restrict the right of a physician to practice medicine for a specified period of time or in a specified geographic area on termination of a contractual relationship; and (b) do not make reasonable accommodation for patients’ choice of physician.”
The issue of the “the effect of AMA's Code of Medical Ethics on validity of the restrictive covenants” was raised in Calhoun v. WHA Medical Clinic, a 2006 case heard by the North Carolina Court of Appeals. Two of the five physician employment contract covenants not to compete contained the following language: “no provision of this Agreement shall be enforceable by Company or Physician or any court of competent jurisdiction where local, state or federal laws and regulations and/or the AMA Code of Professional Ethics prohibits and/or discourages the conduct described in or intent of the provision(s) sought to be enforced.”
Technical evidentiary and assignment of error issues on appeal precluded the court from deciding this important question of the effect of a provision in the covenant making such covenant unenforceable if in violation of the AMA Code.
North Carolina courts have carefully distinguished substantial risk of harm to the public and mere inconvenience. The court in Statesville Medical Group. v. Dickey, a 1992 North Carolina Court of Appeals case, sets forth the following determinative risk factors: “the shortage of specialists in the field in the restricted area, the impact of ... establishing a monopoly ... in the area, including the impact on fees in the future and the availability of a doctor at all times for emergencies, and the public interest in having a choice in the selection of a physician.”
In Dickey, the court held that a 2 year restrictive covenant with “the only endocrinologist living and practicing in Iredell County” was unenforceable because it “would create a substantial question of potential harm to the public health.” The court concluded that if the restrictive covenant were enforced patients would have to travel forty-five minutes to Charlotte or Winston-Salem for treatment and “that [t]he distance between the two locations may very well impact on the availability of a doctor at all times for an emergency.” The court also considered the fact that since the plaintiff would be contracting with a part-time specialist from Charlotte to provide such services in Statesville one-half day per week that the plaintiff would have a monopoly on endocrinologist services in Iredell County and there would be no fee competition.
Public policy issues, which are central to the strict scrutiny analysis and reasonableness requirement for all enforceable covenants not to compete, have taken a backseat in the North Carolina appellate courts’ determination of the enforceability of forfeiture and liquidated damages clauses related to medical practice non-competition.
The North Carolina appellate courts have taken a softer approach to such clauses and opened the door widely for an alternative approach to damages incurred by the employer as a result of post-termination competition. In a series of cases the courts held that such clauses are not covenants not to compete and are not subject to covenant not to compete enforceability standards.
In 1975, the North Carolina Supreme Court in Hudson v. North Carolina Farm Bureau Mutual Insurance upheld a forfeiture clause in an insurance agency employment contract with an agency manager. Pursuant to the contract the employee forfeited, that is, gave up, his rights to pension plan solely funded by the employer as a result of violation the post-termination non-competition restrictions in the contract. The court concluded that “the forfeiture, unlike the restraint included in an employment contract is not a prohibition on the employee engaging in competitive work but is merely a denial of the right to participate in the retirement plan if he does so engage.”
This rationale has been applied to such clauses in medical practice employment contracts.
The Court of Appeals in the 1987 case of Newman v. Raleigh Internal Medicine Associates, upheld a “limitation of practice” forfeiture clause in which a cardiologist gave up 90 days of post-termination benefits including a productivity bonus and a portion of his base salary by engaging in a similar practice in Raleigh.
In Nalle Clinic v. Parker, a 1991 North Carolina Court of Appeals case, reversed the trial and refused to enforce a “practice limitation clause” including a covenant not to compete and a liquidated damage clause. The court found that there would be substantial risk of harm to the public by enforcing a 2 year covenant prohibiting the only full-time practicing pediatric endocrinologist from practicing medicine or surgery in Mecklenburg County. The liquidated damages provision, which was cumulative and not an alternative to any other damages for violation, such as injunctive relief or loss of profits, would have required the physician to pay 50% of his monthly compensation for each month of the breach in addition to any other remedies.
In the 2002 North Carolina Court of Appeals case, Eastern Carolina Internal Medicine v. Faidas, which was appealed and affirmed by the North Carolina Supreme Court, the court enforced a stand-alone “cost sharing” liquidated damages clause that was not in addition to a traditional non-compete provision. The clause required the physician who chose to continue practice in Jones, Craven or Pamlico Counties to pay a “reasonable estimate” of the prospective damages pursuant to a mathematical formula. The court held that the provision was not an unenforceable penalty and was not a covenant not to compete.
In the 2006 Calhoun case, even though medical specialists were involved, the NC Court of Appeals unanimously held that the liquidated damages clauses were enforceable. The non-compete covenants at issue involved five cardiologists employed by a sixty physician multi-specialty group covering seven North Carolina counties. Upon termination the five employees were prohibited from practicing medicine in those counties. The liquidated damages clause contained a formula for assessing damages if the physicians chose to violate the restrictions and continue practicing in any or all of seven counties. The clause also included a provision requiring the physicians to pay back certain payouts that they otherwise received under the employment contract. The court held that there would be substantial risk of harm to public safety by enforcing the covenant if there were no provision allowing the physician to continue practicing in the restricted area. However, the court found that the liquidated damage clauses provided an alternative, allowing the physicians to compete upon compliance. The court held that such provisions are not considered to be a covenant not to compete and consequently not subject to the same scrutiny and enforceability factors as covenants not to compete.
Without denominating it as such, the North Carolina appellate courts appear to have adopted the “employee choice doctrine” applied by the Court of Appeals of New York in the 2006 case of Morris v. Schroder Capital Management. The rationale for this doctrine is explained in Morris, as follows:
We have recognized an exception to the general disfavor of non-compete provisions, however, in the “employee choice” doctrine. This exception applies in cases where an employer conditions receipt of post-employment benefits upon compliance with a restrictive covenant. The doctrine rests on the premise that if the employee is given the choice of preserving his rights under his contract by refraining from competition or risking forfeiture of such rights by exercising his right to compete, there is no unreasonable restraint upon an employee's liberty to earn a living. It assumes that an employee who leaves his employer makes an informed choice between forfeiting his benefit or retaining the benefit by avoiding competitive employment.
However, it should be noted that the Court of Appeals has extended the enforcement of such clauses beyond traditional forfeiture clauses which consists of giving up a benefit, such as the pension in Hudson, the progenitor of North Carolina’s forfeiture clause exception, to include broader liquidated damages clauses that involve payments of specific sums of money. Also, even under the New York “employee choice doctrine”, the New York courts refuse to apply this exception to at will or fixed term employees who are involuntarily terminated.
The Calhoun court did not differentiate between enforcement of the clause in regard to the one cardiologist who was involuntarily terminated the day before he intended to resign and the other four cardiologists who voluntarily resigned.
*Bill Constangy is a retired Superior Court Judge in Charlotte, an arbitrator and mediator, the author of a law book and numerous articles on employment law and other legal subjects.
