By Angela Humphreys, Bob Horton and Lymari Cromwell, Bass, Berry & Sims
You’re acquiring a physician practice in one of “those” states that prohibit noncompetes against physicians in the employment law context. But you still have a five-year noncompete in the purchase agreement, a noncompete with a two-year tail attached to the rollover equity, and you have chosen Delaware as governing law. All set – right? Not necessarily. Below we examine traps for the unwary when enforcing noncompetes in PE-backed physician practice transactions.
Be mindful of purchase agreement scope and sunset
Although courts are more likely to enforce a noncompete in a purchase agreement for the sale of a business, courts may limit enforcement to ownership or investment in a competing business rather than pure employment. In addition, those purchase agreement restrictions typically sunset within a five-year post-closing window, which can be right around the time of a planned exit, making the other noncompete provisions even more critical.
Choice of law provisions may not be recognized
Contractually agreed upon governing law provisions may not be applied if the state in which the physician resides and/or is employed has a stronger connection to the contract than the state chosen for governing law. A restricted party may seek to avoid agreed upon governing law and/or venue provisions by filing a motion for declaratory judgment in that party’s state of residence or employment. Note that state courts have the discretion to ignore the choice of law and venue provisions of an agreement of the parties based on public policy grounds if the law of the state chosen by the parties is significantly different, that is – less protective of the employee, than the state in which the employee resides and works.
Arbitration provisions may save the day
If the noncompete laws of the state in which the physician resides/works are significantly less favorable to the employer, consider adding an arbitration agreement with a venue for arbitration outside the unfavorable state. An arbitrator may be more likely to honor the choice of law agreement. Note that often the parties agree that injunctive relief may be sought in court despite the arbitration provision, which thwarts the effort to use the arbitration agreement to resolve the potential choice of law dilemma. However, the parties can also agree that the arbitrator will make decisions regarding motions for injunctive relief and that the arbitrator’s decision will be final. Ultimately, however, an employer will likely have to request a state court to enforce the arbitrator’s decision regarding injunctive relief, giving the state court an opportunity at that point to refuse to follow the state law agreed upon by the parties. But if the parties have gone through arbitration and the parties have agreed that the arbitrator’s decision will be final, the court may be more reluctant to insert itself into a choice of law issue/dispute at that juncture.
Include penalties that may be enforced
To the greatest extent possible, provide in the applicable contract for the imposition of penalties on an employee who fails to follow the agreement of the parties regarding restrictive covenants, such as forfeiture of equity, loss of severance or, in some states, liquidated damages. Some judges in states with unfavorable statutory restrictions on noncompete agreements will still enforce the contractually agreed upon penalties for breach of the non-competition terms agreed to by the parties. Note that some states require that the physician be permitted to buy out a noncompete for a predetermined amount.
Make sure the noncompete covers your real concern
When considering the scope of a noncompete, make sure that the noncompete is tailored to address your real concern. Having a noncompete within a 25-mile radius of any facility at which the physician practices may be enforceable but may not address your real concerns if the majority of your business if derived from telehealth. Make certain the terms of the noncompete provide adequate protection, including unique market considerations, such as telehealth, remote monitoring and other emerging capabilities.
Given the significant investment by PE firms in the physician practice space, ensuring maximum ability to enforce negotiated noncompete provisions is key to protecting your investment. Although there is no guarantee that a court will enforce these provisions in all cases, being mindful of the potential pitfalls and planning accordingly can help mitigate potential challenges.
Angela Humphreys is a member at Bass, Berry & Sims, where she serves as chair of the Healthcare Practice Group and co-chair of the Healthcare Private Equity Team. She can be reached at firstname.lastname@example.org.