Finance leaders should be prepared for the increasing role restrictive covenants are likely to play in protecting a healthcare provider organization’s competitive edge.
At a Glance
- In recent years, many states have shown a greater inclination to enforce restrictive covenant provisions in contracts involving healthcare organizations and their employees, physicians, or other contacting parties.
- In general, an enforceable restrictive covenant is one that is deemed to have been reasonably drafted to do no more than to protect the company’s legitimate business interest.
- Key areas of concern in health care that often fall under the protection of restrictive covenants include patient referral sources and relationships with patients.
Restrictive covenants have become increasingly important for healthcare organizations lately, given the current state of the economy and the need for healthcare organizations to maintain a competitive advantage in the marketplace. With competition at an all-time high, healthcare organizations often need to include such provisions in their contracts to protect their competitive edge and legitimate business interests.
A restrictive covenant is a contractual provision entered into between a company and a contracting party (e.g., an employee, shareholder, or independent contractor) that prohibits the contracting party from engaging in certain conduct during the relationship with the company within a certain geographic area for a certain amount of time. Examples include non-compete agreements, non-solicitation agreements, and confidentiality agreements.
In health care, non-compete clauses and similar restrictive covenants are quite common in contracts with employees—and with physicians, in particular. When carefully drafted and properly tailored, such agreements can be a highly effective means for protecting a healthcare provider’s competitive interests.
Key Considerations for Enforceable Restrictive Covenants
In recent years, the courts have tended to find restrictive covenants to be valid and enforceable on the basis of either statute or case law. Nonetheless, finance leaders of healthcare organizations should be mindful that courts will enforce only those covenants deemed to have been reasonably drafted and to have a scope and duration limited to what is required to protect the company’s legitimate business interest. Finance leaders also should be mindful that what may be deemed reasonable varies from state to state.
Simply put, it is critically important for healthcare finance executives to understand their organizations’ enforcement rights, whether the organization is the enforcing party or potentially breaching party, to avoid the pitfalls and potential exposure associated with these non-compete, non-solicitation, and confidentiality agreements. Also, even if there is not a written restrictive covenant involved with a transaction or arrangement, certain enforcement rights and liability exposure could apply under state common law theories.
Generally, to bring a claim to enforce a restrictive covenant, such as a non-compete provision, a party must establish that:
- The covenant is in writing and signed by the person against whom enforcement is sought
- The covenant is justified by at least one legitimate business interest
- The restraint is reasonably necessary to protect the legitimate business interest of the enforcing party
Once a plaintiff establishes these factors, the burden shifts to the defendant to show that the restriction is overbroad, overlong, or otherwise not reasonably necessary to protect the interests of the plaintiff.
In reviewing whether a particular restrictive covenant is enforceable, courts will consider the nature of the specific restrictions imposed by the covenant. In particular, covenants aimed at preventing former physician shareholders or employee from engaging in directly competitive business activities will be generally upheld as reasonable.
In general, reasonable restrictive covenants in health care may prohibit:
- Former physician employees or physician shareholders from engaging in the practice of a specific specialty of medicine in a certain geographic area
- Former business development managers (employees who develop and maintain streams of patients visitations) from soliciting and/or contacting customers, clients, or patients who they served while employed by the party enforcing the covenant
- Certain employees from accepting an offer for subsequent employment from a direct competitor in a defined geographic market
Because restrictive covenant law is somewhat in flux and requirements vary from state to state, it also is important to avoid using boilerplate restrictive covenant provisions, especially if the healthcare organization has employees, shareholders, and/or independent contracts in different states. With guidance from legal counsel, restrictive covenant provisions should be tailored specifically to state law and periodically reexecuted to ensure compliance with current law. Drafters of such provisions also should keep in mind that, depending on the applicable state law, new “consideration” or some form of new remuneration may be required in executing a new and updated restrictive covenant agreement. For example, continued employment may not constitute new “consideration” for purposes of reexecuting a restrictive covenant. Rather, some other financial or other form of remuneration or value must be provided.
Consequences of Restrictive Covenant Violations
If a restrictive covenant is deemed enforceable, the applicable law may provide for temporary and permanent injunctions (which can restrain a party from engaging in specified acts) as an appropriate remedy to enforce non-compete and non-solicitation provisions. In some instances where such potent remedies are used, a healthcare business or provider that has been found to have violated an enforceable non-compete or non-solicitation provision can actually be required to cease certain crucial business operations.
As an alternative, many states allow a damaged party to recover monetary damages for a breach of non-compete or non-solicitation provision. Typically, such monetary damages are based on evidence establishing actual lost revenue and profits resulting from improper competitive activities.
Another Layer of Complexity
As noted previously, the law in many states requires that restrictive covenants be supported by a legitimate business interest to be enforceable. The aim is to ensure that such provisions do not unfairly stifle free competition and access to health care. Although the interpretation of what constitutes a legitimate business interest differs from state to state, examples include:
- Trade secret information (see the sidebar below)
- Valuable confidential business or professional information that does not otherwise qualify as trade secrets
- Substantial relationships with specific prospective or existing customers, patients, or clients
- Customer, patient, or client goodwill associated with an ongoing business or professional practice
- Extraordinary or specialized training
In health care, the matter of patient referrals also introduces an added layer of complexity concerning what satisfies the legitimate business interest requirement, particularly with respect to relationships with the referring physicians. Patient referrals can account for a substantial portion of a provider organization’s revenue, and these organizations expend substantial time and money to identify, cultivate, and maintain their valuable relationships with referral sources. Whether a referral source is a legitimate business interest, however, is an often-litigated legal issue. When analyzing the legitimate business interest issue, and when drafting restrictive covenants, it is important to keep in mind the varying legal paradigms that exist from state to state and the differences in case law with respect to accepting or rejecting referral sources as a legitimate business interest.
In addition to relationships with referring physicians, healthcare organizations may have other legitimate business interests that require protection under restrictive covenants. Noteworthy examples include an existing patient base and relationships with specific prospective patients.
Special Concerns Regarding the Protection of Trade Secrets
Even with the protections afforded by a valid restrictive covenant, extensive damage may still result from the unlawful misappropriation of a healthcare organization’s confidential, proprietary, and trade-secret business information. Moreover, healthcare employers face extensive liability for the acts of new employees who may have misappropriated information from their previous employers, and such liability may include the disgorgement of any profits and/or revenues derived from the use of such information. Healthcare organizations should take practical steps to avoid loss in either scenario.
Healthcare finance leaders should make sure their organizations employ “reasonable” measures to protect their trade secrets, in accordance with applicable law. Such measures may include:
- Requiring employees to enter into confidentiality agreements containing disclosure restrictions, both during and after employment
- Requiring employees to contractually agree to return all confidential or trade-secret business information after employment
- Using password-protected computers and email systems
- Storing hard-copy information in secured cabinets and offices
Organizations that recruit employees of their competitors should be equally proactive in ensuring that new recruits do not use any trade-secret information obtained in previous employment. Employment contracts should include language whereby a new employee acknowledges that he or she has not misappropriated trade-secret or confidential information from his or her previous employer and has disclosed any restrictive covenants still in force.
Avoiding Exposure to Potential Liability
Even in the absence of a written restrictive covenant, individuals and organizations should be prudent in their dealings to avoid legal pitfalls and potential liability. Indeed, whenever a company engages in recruitment efforts or business development efforts, there is the potential for exposure to claims for tortious interference with business relationships and other common law causes of action. Moreover, former employees (or other business parties) may also be subject to limitations imposed by confidentiality provisions. In short, finance leaders should make sure that their organizations have taken the necessary steps to be in full compliance with all underlying confidentiality agreements to avoid exposure to potential liability.
With respect to tortious interference claims, many states recognize the tort of interference with business relationships to include the following elements:
- The existence of a business relationship, not necessarily evidenced by an enforceable contract
- Knowledge of the relationship on the part of the defendant
- An intentional and unjustified interference with the relationship by the defendant
- Damage to the plaintiff as a result of the breach of the relationship
Although these elements seem relatively straightforward, there is a degree of complexity and legal uncertainty associated with claims for tortious interference. For example, if a contracting party is bound to a contract with a second party for a fixed period of time that cannot be terminated at will, any third party that intentionally induces the contracting party to breach its contractual obligations with second party can reasonably be deemed liable for tortious interference—generally without regard to economic or competitive motive.
On the other hand, there is somewhat less protection for contractual relationships that can be terminated at will and without cause. For example, with respect to instances where a contract can be terminated at will, Florida courts have allowed for “lawful competition” by a third party subject to certain limitations (e,g., limiting the use of a previous employer’s confidential or proprietary business information). Thus, even in those circumstances where the business relationship interfered with is an at will relationship, a party cannot use improper means when competing.
Case law is limited concerning what constitutes improper means, but many courts have nonetheless repeatedly found that a party can still bring a case when another party wrongfully interferes with a contract that is terminable at will. Therefore, finance leaders should not only be aware of the potential for exposure to tortious interference claims, but also ensure the organization undertakes proactive measures to avoid such exposure before embarking on a course that could precipitate a legal challenge.
A Role for Finance
In the current highly competitive healthcare environment, healthcare organizations should anticipate the need to address restrictive covenants in many aspects of business transactions. Of course, legal counsel will be critical to ensuring that an organization’s interests are adequately protected. Finance leaders also should be aware of the legal intricacies involved with such provisions, however, and take an active part in ensuring that their organizations exercise due diligence in all situations where such covenants are likely to come into play.
Michael G. Austin, JD, is a partner, DLA Piper, Miami (email@example.com).
Matthew Grosack, JD, is an associate, DLA Piper, Miami (firstname.lastname@example.org).
The Changing Landscape for Restrictive Covenants in Health Care
Given that the enforcement of restrictive covenants in the healthcare field is an often-litigated issue, there have been a number of significant recent developments in the area of restrictive covenants, and healthcare entities need to understand the practical implications of the current state of non-compete law. In fact, it is commonplace for healthcare entities—including hospitals, physician groups, surgery centers, home health agencies, and imaging centers—to grapple with these non-compete issues in connection with employees, shareholders, independent contractors, competitors, joint ventures, and other parties.
In years past, due to public policy concerns, many states tended to favor more free and open competition, and contractual restraints on competition (such as non-compete and non-solicitation agreements) were looked upon unfavorably under the law. Many courts were reluctant to enforce non-compete agreements, and judges would interpret these types of provisions very narrowly. Even today, some states still hold that restrictive covenants are unenforceable as a matter of law in the healthcare context.
In many states, however, the public policy has changed, and reasonable contractual restraints on competition are accepted and routinely enforced in numerous jurisdictions. In fact, many states now require judges to enforce non-compete provisions in favor of providing reasonable protection, and the law from multiple jurisdictions specifically prohibits judges from too narrowly construing these types of provisions.
The significant impact that this shift in the law has had on those involved in non-compete disputes is an important point to keep in mind when determining a strategy to handle issues concerning enforcement of restrictive covenants.
Trade Secrets and Health Care
Generally speaking, confidential, proprietary, or trade secret information is any company-specific information maintained as nonpublic and relating to a company’s business or operation. Trade secrets constitute a smaller subset of confidential information that benefits from greater protection afforded by the Uniform Trade Secrets Act (UTSA)—a uniform act promulgated in an effort to provide a harmonized legal framework for the improved protection of trade secret information in all 50 states. To date, UTSA is adopted in 46 states, excluding Massachusetts, New York, North Carolina, and Texas, which have their own framework for the protection of proprietary and confidential trade secrets.
According to UTSA, trade secret refers to any information that derives independent value from not being generally known and not being readily ascertainable, and that is subject to reasonable efforts to maintain its secrecy. Common examples of healthcare-specific trade secrets are billing and payment methods, amounts billed and collected for medical services, information relating to contractual relationships with insurance companies, customer/client/patients lists, referring physician lists, proprietary software, patient medical information, marketing and business development strategies and methods, and medical equipment and supply pricing data.
Publication Date: Tuesday, January 01, 2013