Covenants Not to Compete Part 1 – Podcast
Listen to the Podcast
- Covenants Not to Compete, Part 1
Hello. This is Scott McDonald and welcome to the Perfect Place to Put a Practice Podcast.
Unfortunately, this is going to be a little longer session than others but it is very important to many professionals so I will just have to beg your indulgence.
Almost every professional must deal with covenants not to compete at some time. You may be a practice owner implementing a covenant with an associate or you may be a doctor who wants to challenge a covenant area. In spite of what you may have heard, these covenants ARE enforceable in almost every state and they ARE limited. In other words, you cannot simply say that Dr. Joe Murphy, my former employee cannot practice in Indiana because it would harm my practice. The principle at work here is the “restraint of trade.” If the covenant area does not have a rational basis, it can be tossed out of court as being unenforceable. As with most contracts, there are exceptions and regulations that must be considered. Having a good attorney on your side who has dealt with these issues makes a great deal of sense. I am not an attorney and I will not be giving you any legal advice in this podcast. Rather, I will share with you some things I have told my attorney friends who ask me to consult me on this issue.
Now, I am a specialist in the area of practice boundaries. There are some excellent reasons to have someone who is a specialist on this issue give you an opinion (most often through your attorney) because you want the covenant area that you bring to your employees to be enforceable and, on the other side of the table, you want the covenant area to be rational and not overly broad.
One of the things that makes a professional practice different from other kinds of businesses will be the impact of the professional upon the community in which the practice resides. With that in mind, there is a strong “cultural impact” of the professional upon the brand or identity of the practice. Many practices carry the names of the owners of the practice, for example. The credibility of the practice is often tied to the identity and reputation of the owner(s) and manager(s) of the practice. The point is that the professional (most often an owner) is an inextricable part of the practice identity or brand. This forms an important part of what is referred to as “good will” of the practice.
At this point, we have to take in the research that has been done regarding what “good will” means to a practice. This has been done most thoroughly in the field of public relations. Researchers in Mass Communications have long tried to illustrate where the locus of power in business relationships can be found and how to increase the strength of these relationships among stake holders. The theory that covers this is referred to as the “Personal Influence Model,” The authors of the model have researched the idea that relationships are all important in facilitating behaviors that are favorable or desirable for all stake holders (including professionals, customers, and patients). This includes relationships in any and all professional practice types. Those who use the services of a professional do not have the capability of determining the competency of a practitioner objectively because they don’t know enough about the profession to do so. Competence and reliability are almost entirely defined by the perception of the consumer’s belief that the professional knows what they are doing. A physician may have a patient die during treatment but this may have nothing to do with their competence. An attorney may lose a case but this is not necessarily a reflection on their abilities or hard work. And so it goes with all professions. But if there is a belief that the professional is competent, it will accrue positively on the practice. This belief is a reflection of the trust earned by the professional over time and through reputation gained while working with others. The source of this confidence can be described in the Personal Influence Model. It is as though there is a reserve of good will for one’s professional service provider if the relationship (as described in the model) is strong.
It is for this reason that the idea that a professional can be trusted that allows them to function. The trust and credibility are created and enhanced based upon these factors. If we are to discuss the concept of “good will” within a practice, this is a necessary discussion. And when it comes to clearly defining a rational covenant area (or an area in which former partners, associates, or others should not be permitted to practice as a competitor), we have to consider these issues.
To summarize the primary point, an individual professional is really promoting their credibility to their customer or patient base. This takes time and has real importance to the value of a practice. When a practice is sold or “transitioned” to another professional, the “good will” will hopefully be transferred along with Client and Patient records, equipment, processes, and other proprietary information. A professional who is hired from outside the area and given an opportunity to treat or service patients or customers in an existing practice starts by “borrowing” the credibility of the practice that was established before their employment started. The trust they use is not their own. Most of the time, however, any doubts that consumers might have are mitigated by this association with the image or brand of the practice they are joining, even if it is not on the basis of ownership. This is all true regardless of why the existing owners or managers of a practice built a relationship with a new professional. Thus, even if the relationship is based upon ownership, associateship, or simple “hired hands,” the practice puts itself at risk by bringing in someone new under their brand identity and trust. If this new person does not enhance this brand, it degrades its value.
On the other hand, it is necessary for a professional to use their personal skills to build their personal credibility to enhance the brand of the practice they are joining with in their relationship. This is one of the primary purposes for adding a professional to a practice. Simply put, using the personal influence of the professional to build the practice is part of their job.
It is not unreasonable for the existing practice owner(s) to want to protect this good will that they have developed over time. It should be assumed that during the course of the association with the new professional, the current owners and managers have contributed to the increase of good will that the new professional helps develop within the community. For example, they may allow for this new associate, partner, or employee to attend chamber of commerce meetings, professional society organizations, and even school events. Whether paid or unpaid, it is presumed that they are working on behalf of the practice in building its image, brand, and community good-will. Ideally, this presents a mutually beneficial means of helping the practice and individuals in it to develop.
The protection that the existing owners want is desirable and certainly understandable but it is not absolute. It is in the nature of all business relationships that one party or another will want to change the terms of their relationship or to end them. This is where the “covenant not to compete” is put into contracts and why it is being covered in this book. Reasonable protection of the good will established before and during the time of a new professional with the practice is always acceptable when it is reasonable on two counts:
- The Nature of the Covenant should protect the practice from the loss of proprietary data such as forms, client and patient records, and processes developed by the practice.
- The geographic region in which this covenant is implemented must be rational.
On the first point, it is naïve to suggest that the professional who leaves a practice should “unlearn” what he or she has gained through experience. As an example, if the new associate has developed a form while in the pay of the practice, it should remain the “work product” of the practice and should not be used. However, there is nothing to prevent this professional from developing a form that can be used in another practice in the future. On the other hand, records are the sole property of the practice and must be treated as entirely proprietary and confidential. In healthcare, this is strengthened by laws such as HIPPA. From my experience, these issues are well settled in case law.
What is not so easily covered in case law is what we see in the second point: geographically defined covenants. What I want to do here is present a rational means whereby these boundaries can be determined. I have seen cases in which a former employer essentially wants their former employee to give up practicing entirely. This is irrational as it is a restraint of trade. This was established in Common Law as early as 1711 in Mitchel v. Reynolds.
Lord Smith said “It is the privilege of a trader in a free country, in all matters not contrary to law, to regulate his own mode of carrying it on according to his own discretion and choice. If the law has regulated or restrained his mode of doing this, the law must be obeyed. But no power short of the general law ought to restrain his free discretion.”
When it comes to the application of this principle of professional practice, there is a geographic environment that makes this reasonable to apply and a boundary beyond which it should not apply. In essence, you cannot run someone out of the profession just because you believe that the practice has unlimited boundaries that it will influence. The loss of benefit by allowing another professional who may have been associated with the practice can be defined but the definition must do so based upon an understanding of the particular type of professional practice. Let me illustrate:
A general dental practice is typically limited to a “convenience or service radius.” By my definition, this radius can be understood as that area from which 80% of patients will come from to the office for treatment. In the next chapter, I discuss the benefits of consideration of specific units of measurement to illustrate this point. But for now, we are not so concerned with the units used as the principles applied. It is impractical to say that the definition of the “convenience or service radius” must be 100%. This tends to ignore the “outliers” in the customer or patient base. In every set of data, there will always be a minority that represent the “odd ducks.” A dentist with a practice in Dallas, TX might have a brother-in-law living in Chicago who flies into town to get treatment. Certainly, the brother-in-law is a patient but it is unlikely that a practice based in Dallas should consider Chicago a fruitful place from which to draw patients. These outliers can be accounted for largely by looking at the 80% rule.
While this is usually simple on its face, there is a phenomenon in professional practice that makes the issue a little more complicated. We can call it “Historical Drift.” The longer a practice has been in operation, the greater this drift will be. This factor is ignored by professionals who purchase an existing practice at their peril. I have come up with this factor by examining databases from existing practice and it has been seen so often that it has become replicable. It starts with a simple truism that most people want the practices they use to be conveniently located. Just like a barber, there may be some who are much better than others (they get your side-burns straight or they know how to work with your particular type of hair. I am sure you get the idea.) They might not be the closest barber to your home but they are within a fairly easy distance for you to travel. Imagine, for a moment that you move your home just a few miles away. You likely would not have gone to this barber to start but now that you have a professional relationship, the extra distance does not seem so bad.
This ends Part 1. Next week, I will publish Part II. If you would like more information on this topic and my annotated research, look for my future book Practice and Place.
I know this was a long session but I hope you found it informative. For more information contact me at email@example.com and thanks for listening.