Restraints on Physician Competition in Georgia

November 8, 2013

I. Introduction

Many Georgia physicians are bound by contractual covenants that seek to restrict their ability to compete (non-compete covenants), to solicit patients or referral sources (non-solicitation covenants), to solicit co-workers (non-recruitment covenants), or to use or disclose confidential information (non-disclosure covenants). Restrictive covenants may appear in physicians’ employment agreements,1 partnership agreements,2 medical director contracts,3 agreements executed upon the sale of a medical practice,4 and even real estate leases.5 Their enforceability will depend in large part upon four factors: (1) the effective date of the agreement containing the covenants; (2) the type of agreement in which they appear; (3) the breadth of the restrictions imposed (time, territory and scope of activities); and (4) for newer covenants, the discretion of a judge.6

This article is designed to give physicians (and their advisors) a general appreciation of legal issues associated with physician restrictive covenants in Georgia; it is not intended as a substitute for competent legal advice that considers a physician’s unique circumstances. Section II describes the various types of restrictive covenants. Section III provides a brief overview of Georgia’s restrictive covenants law prior to the 2011 effective date of the Georgia Restrictive Covenants Act (the “Act” or the “new law”). Section IV describes the sweeping changes brought forth by the Act. Section V analyzes how Georgia courts are likely to treat covenants affecting physicians. Section VI addresses some issues that may arise in litigation involving physician restrictive covenants.

II. Description of the Various Covenants

A. Non-Compete Covenant

A covenant not to compete prohibits the employee from performing competitive activities in a certain geographic area for a certain period of time, thereby protecting the employer’s “investment of time and money in developing the employee’s skills.”7 Thus, a non-compete may prevent an employee from working for a competitor or from accepting competing business (whether solicited or not) from any of the employer’s clients (whether previously contacted by him or not) within a given territory.8

B. Customer Non-Solicitation Covenant

A covenant not to solicit prohibits an employee from soliciting some or all of the employer’s clients, thereby protecting the employer’s investment of time and money in developing customer relationships and goodwill.9 A non-solicitation covenant that seeks to restrain the former employee from accepting unsolicited business from restricted customers is unreasonable.10

C. Employee Non-Solicitation Covenant

Many employers require their employees to covenant that they will not solicit or hire away employees of the employer. Like a non-compete covenant, a “non-recruitment covenant” covenant protects the employer’s investment in the development of its employees.11

D. Non-Disclosure Covenant

A non-disclosure covenant places a restraint on the use of confidential business information.12 It enables employers to protect confidential information beyond that which is already protected by the Georgia Trade Secrets Act.13 A trade secret is “information, without regard to form, including, but not limited to, technical or nontechnical data, a formula, a pattern, a compilation, a program, a device, a method, a technique, a drawing, a process, financial data, financial plans, product plans, or a list of actual or potential customers or suppliers which is not commonly known by or available to the public.”14 In order to be a trade secret the information must derive economic value and be subject to reasonable efforts to maintain its secrecy.15

III. Pre-Statutory Restrictive Covenants Law

In 2011, the Georgia General Assembly adopted the Georgia Restrictive Covenants Act as a comprehensive statutory framework applicable to restrictive covenants.16 The Act in many ways legislatively overrules the large body of law developed by the Georgia courts on this subject (the “old law”). The General Assembly adopted the Act in response to the perception that Georgia courts’ hostility towards restrictive covenants was placing Georgia at a competitive disadvantage with other states. Because the new law was a reaction to the old law, and because the old law still applies to contracts executed before the effective date of the new law (May 11, 2011), a discussion of the old law is warranted.

The Georgia Constitution declares void on public policy grounds any contract which “may have the effect of or which is intended to have the effect of defeating or lessening competition.”17 Although restrictive covenants lessen competition to some degree by their very nature, they do not violate the Georgia Constitution in all cases.18 Accordingly, Georgia courts will enforce restrictive covenants that are: (1) reasonable in scope; (2) supported by consideration; (3) reasonably necessary to protect the restraining party’s interests; and (4) not unduly prejudicial to the interests of the public.19

The reasonableness of a restrictive covenant has always been a question of law for the court, considering the nature and extent of the trade or business, the situation of the parties, and all other relevant circumstances.20 “A three-element test of duration, territorial coverage, and scope of activityhas evolved as a ‘helpful tool’ in examining the reasonableness of the particular factual setting to which it is applied.”21 This is a flexible and imprecise test. For example, if a non-solicit is narrowly drawn to prevent a former employee from soliciting only those customers with whom he had contact and only for the purpose of competing with the former employer, a court will be more indulgent of a longer durational limit or larger geographic restriction.22

The single most important factor in the analysis of restrictive covenants under the old law is the level of scrutiny applied by the court because that often dictates whether an overbroad covenant will be struck down or judicially modified.

A.1. The Three Levels of Scrutiny

Georgia courts have traditionally applied three levels of scrutiny to restrictive covenants. As a general rule, they apply strict scrutiny to covenants contained in employment agreements, mid-level scrutiny to covenants contained in partnership agreements, and slight scrutiny to covenants contained in agreements concerning the purchase or sale of an interest in a business.23 Covenants in independent contractor agreements are treated like covenants in employment agreements,24 and covenants in medical director agreements are subject to the same mid-level scrutiny as partnership agreements.25

The different levels of scrutiny are intended to correspond to the differences in the parties’ bargaining power. A physician who is merely seeking employment with a medical practice is presumed to have less bargaining power than a physician who is negotiating for an interest in a partnership, and even less still than a physician who is selling his practice to a purchaser.26 The inquiry into the parties’ relative bargaining power is often fact intensive. In West Coast Cambridge, Inc. v. Rice, for example, the Court of Appeals applied slight scrutiny to covenants in a physician partnership agreement because it found that the affected physician did not actively practice medicine and, as such, was more like a passive investor in the partnership.27

The more complex the relationships between the parties, the more difficult it becomes to navigate the scrutiny levels. What happens, for example, if a physician sells his or her interest in a practice but agrees to become a practice employee? In that situation, the physician may execute an asset sale agreement and an employment agreement as a part of the same transaction. And what happens if there is a covenant in one agreement but not the other, or if the two agreements contain inconsistent covenants? As shown below, the case law was hopelessly inconsistent.

Example 1: A stock purchase agreement and employment agreement executed simultaneously as a part of the same transaction, but only the employment agreement contained restrictive covenants. The Court of Appeals applied slight scrutiny – even though the covenants were contained in an employment agreement – because the employee had considerable bargaining power and he delivered the covenants as a precondition to the stock purchase agreement.28 In so ruling, the court mentioned, but did not overrule, an earlier case in which it applied strict scrutiny on the very same facts.29

Example 2: Asset purchase agreement (containing non-compete) and employment agreement (expressly incorporating non-compete and adding additional non-solicit and non-disclosure covenants) are executed simultaneously as a part of the same transaction. Applying Georgia law, the Eleventh Circuit applied slight scrutiny to all of the covenants because the asset sale was conditioned upon the subsequent employment and because all of the covenants “were a part of a unitary contractual scheme.”30

Example 3: Asset purchase agreement and employment agreement are executed as a part of the same transaction, but they contain conflicting non-compete covenants (i.e., the scope of the competing covenants is different). The court applied strict scrutiny to the covenants in the employment agreement and slight scrutiny to the covenants in the asset purchase agreement.31

Example 4: Physician’s wife sells dialysis clinic and, at the same time, her husband executes a medical director agreement with the purchaser. The asset purchase agreement restricts the wife’s ability to operate a competing facility for 10 years within a 40 mile radius, and the medical director agreement precludes the physician from operating a dialysis center for 2 years within a 40 mile radius. Although a medical director agreement by itself would be subject to mid-level scrutiny, the court applied slight scrutiny to all of the covenants because they were a part of the same transaction and the physician was “integral to the continued success” of the facility.32

Perhaps the only lesson to be learned from these irreconcilable holdings is that it is difficult to predict the scrutiny level in these types of hybrid transactions. On the one hand, a mechanical application of the scrutiny level based upon type of agreement (employment agreement, partnership agreement or business sale agreement) may offer some predictability to the parties. But on the other hand, that methodology undercuts the very reason for having different scrutiny levels in the first place – to level the playing field in differences in the parties’ relative bargaining power. It is difficult to conceive that a physician who sells his or her interest in a medical practice and simultaneously executes an employment agreement with the buyer has more bargaining power in the first agreement than in the second. While this uncertainty may keep transactional lawyers awake at night, it is a boon for litigators.

A.2. Blue Pencil Rule

What do strict scrutiny, mid-level scrutiny and slight scrutiny mean in practical terms? The most readily identifiable distinction is that a court applying strict scrutiny will not “blue pencil” an overbroad covenant to make it enforceable, but will instead strike down the entire covenant.33 Under strict scrutiny, an entire non-compete is doomed even if it is only a discrete subsection of the non-compete that is overbroad.34

On the other hand, courts exercising mid-level scrutiny (partnership agreements) or slight scrutiny (business sale agreements) may limit unre asonably broad restrictions.35 There are limits to this so called “blue pencil rule,” because while courts may strike or modify offensive terms in a covenant, they may not supply missing terms to make the covenant less vague.36

It is important to note that under strict scrutiny, non-compete and non-solicitation covenants stand or fall together, while non-recruitment and nondisclosure covenants are evaluated separately from the rest of the covenants.37 For example, an invalid non-solicitation covenant would invalidate an otherwise valid non-compete, but it would not invalidate an otherwise valid non-disclosure agreement.38 A severability clause is not a panacea. While it would allow the court to excise the entire restrictive covenant in order to preserve the balance of the agreement,39 it cannot save a reasonable non-solicit from an unreasonable non-compete and vice versa.40

A.3. Other Differences in Scrutiny Levels

Aside from the blue pencil rule, there are few concrete differences between the scrutiny levels. One difference is that a non-compete covenant may be unlimited in time under both mid-level and slight scrutiny, but not under strict scrutiny.41 Another difference is that a covenant prohibiting a professional from providing similar services to any organization, whether or not that organization competes with the professional’s former employer, will fail strict scrutiny but survive mid-level scrutiny.42

A third difference is the degree to which a court will consider post-execution events when evaluating the reasonableness of the covenants. A court applying strict scrutiny will consider such evidence if it tends to show that the covenant is unreasonable.43

IV. The Restrictive Covenants Act

In 2011, the Georgia General Assembly adopted a comprehensive statutory framework applicable to restrictive covenants.44 The Act replaced the three levels of scrutiny with statutory guideposts that are rebuttably presumed to be reasonable. The Act also allows for blue penciling for any covenant deemed to be overly broad. As discussed in more detail below, covenants are more likely to survive under the new law than under the old law.

A. The Effective Date

Much has been written about the confusion surrounding the effective date of the Restrictive Covenants Act, so it will not be covered in detail here. The General Assembly originally passed a restrictive covenants bill (HB 173) in November 2009, before the bill was constitutionally authorized.45 HB 173 stated that it would become effective the day after the Georgia voters ratified a constitutional amendment authorizing the Act.46 Georgia voters ratified the amendment on November 2, 2010, but the amendment itself did not contain an effective date.47 In that situation, the Georgia Constitution provides that the amendment does not take effect until January 1 of the following year, in this case January 1, 2011.48 Thus, HB 173 became effective before the amendment authorizing the bill became effective. To remedy that problem, the General Assembly adopted a new restrictive covenants bill (HB 30) which would become effective upon the date it was signed by the Governor.49 HB 30 expressly provides that it does not apply in actions concerning covenants executed before HB 30 was signed into law.50

The Governor signed HB 30 into law on May 11, 2011. Thus, it is now clear that any agreement executed after that date is governed by Georgia’s Restrictive Covenants Act (HB 30).51 The Georgia Supreme Court has since held that the new law “does not apply to contracts entered into before May 11, 2011.”52 Thus, May 11, 2011, is a clear line drawn in the sand which separates the old and new law and, in many cases, determines the fate of the covenant. Accordingly, employers should immediately replace pre-May 11, 2011 covenants in order to take advantage of the pro-employer aspects of the new law. Some employers have asked departing employees to “reaffirm” their pre-May 11, 2011 covenants in post-May 11, 2011 severance agreements in an effort to take advantage of the new law. For this to succeed, the employer must write the covenants into the new agreement rather than merely reference the old agreement because an employee cannot “ratify” covenants that were invalid at the time of execution.53

B. Applicability

The Restrictive Covenants Act only applies to covenants between or among: (1) employers and employees; (2) distributors and manufacturers; (3) lessors and lessees; (4) partnerships and partners; (5) franchisors and franchisees; (6) sellers and purchasers of a business; and (7) two or more employers.54 Thus, the Act covers physicians who execute covenants within employment agreements, covenants within partnership agreements, and covenants within agreements to buy or sell a medical practice.

It is unclear whether the Act applies to medical director agreements. Because “employer” is defined to include any person or entity that conducts business, or any person or entity that owns or controls 25 percent of such entity,55 a covenant in a medical director agreement could arguably be a covenant between “two employers.” If the medical director agreement is not covered by O.C.G.A. § 13-8-2, it would be analyzed under Georgia common law.56

C. The Blue Pencil Rule

The Restrictive Covenants Act goes to great lengths to correct perceived injustices in the common law by stating that covenants shall be interpreted “to comport with the reasonable intent and expectations of the parties.”57 In a dramatic dep arture from the common law, however, the Act gives the courts the power to “modify” or “blue pencil” overly broad covenants in employment agreements that would have been struck down altogether under the old law.58

The Act’s definition of “modification” seems to import the time-honored prohibition against reforming ambiguous covenants:

“Modification” means the limitation of a restrictive covenant to render it reasonable in light of the circumstances in which it was made. Such term shall include:

(A) Severing or removing the part of the restrictive covenant that would otherwise make the entire restrictive covenant unenforceable; and

(B) Enforcing the provisions of a restrictive covenant to the extent that the provisions are reasonable.59

In Pointenorth Ins. Group v. Zander, the district court held – in an order granting an employer a preliminary injunction under the new law – that a covenant prohibiting a former employee from soliciting any of the employer’s customers was overly broad because it was not limited to those customers with whom the employee had contact.60 The court wrote that it could “remedy that finding by blue penciling the provision to only apply to customers that the Defendant contacted and assisted with insurance.”61

V. Enforcement of Physician Restrictive Covenants

The likelihood that a Georgia court will enforce each of the four covenants is discussed below, with special emphasis devoted to unique issues likely to confront physicians.

A. Non-Compete Covenants

A.1. Time

Under the old law, two years are routinely found to be reasonable for non-compete covenants covering former employees.62 Longer periods may also be enforceable, especially if the scope of the restrictions is narrow.63 Provisions stating that covenants are tolled during the time the employee was in breach are unenforceable.64

The Restrictive Covenants Act establishes a rebuttable presumption of reasonableness for non-compete covenants lasting two years as to employees, three years as to lessees, distributors, franchisees and the like, and five years as to the sellers of partnership and business interests.65 With respect to the business or partnership interest, the length of time that the seller/partner continues to receive payments on the sale is also presumptively reasonable.66 Thus, an agreement that spreads payments out over a 10 year period could restrain competition for at least ten years.

A.2. Scope

There are a number of decisions under the old law that invalidated non-compete covenants because the scope of restricted activities was either ambiguous or overreaching. With limited exceptions, the new law does not purport to allow for broader restrictions on activities. It does, however, forgive common drafting mistakes that would have doomed covenants under the old law. As just one example, O.C.G.A. § 13-8-53(c)(2) provides that, “[a]ctivities, products, or services shall be considered sufficiently described if a reference to the activities, products, or services is provided and qualified by the phrase ‘of the type conducted, authorized, offered, or provided within two years prior to termination’ or similar language.” Such a covenant could not have survived strict scrutiny under the old law.67

O.C.G.A. § 13-8-56(3) makes one important substantive challenge in the law. It provides that “[t]he scope of competition restricted is measured by the business of the employer or other person or entity in whose favor the restrictive covenant is given.” This provision seems to legislatively overrule the line of cases that refused to enforce non-compete covenants that barred the employee from working for a competitor in any capacity.68 Perhaps the only safeguard against such overreaching is O.C.G.A. § 13-8-58(d), which allows (but does not require) the court to consider the “economic hardship imposed upon an employee by enforcement of the covenant.”

A.3. Territory

A territorial restriction has always been required for enforcement of a non-compete covenant.69 That has not changed under the new law.70 Almost everything else has.

While the old law required the territory and scope of activities to be fixed at the time the agreement was executed,71 the new law takes a much more lenient approach. Thus, the term “territory where the employee is working at the time of termination” is now sufficiently definite for enforcement.72

Under the old law, the reasonableness of a territorial restriction was measured by the territory the employee serviced during the term of his employment. For example, if a hospital has three locations that draw from patients from 10 counties, but the physician only works at a single location that draws from three counties, the hospital could only restrict the physician from competing within those three counties.73 Now, the geographic area in which the employer does business is reasonable so long as the total distance encompassed is also reasonable and/or the agreement contains a list of particular competitors that are off-limits.74 This is a substantial change because it allows for the employer to be protected even in areas the employee never serviced.

What is a reasonable territorial restriction? Many physician non-compete covenants express the territory in terms of miles from a set location (typically the facilities in which the physician worked). In Pittman v. Harbin Clinic, P.A., the court upheld a covenant prohibiting the physician shareholders (midlevel scrutiny) from “practicing medicine” within 30 miles of Rome, Georgia because the clinic established that this was the region from which the clinic drew its patients.75 Importantly, the court also stated that 50 -mile restrictions on non-shareholder physicians (strict scrutiny) were not per se unreasonable, though they were unenforceable in that case because they exceeded the territory of the clinic’s practice.76

It is also permissible to restrict a physician from competing in specified counties.77 In McAlpin v. Coweta Fayette Surgical Assoc., the Court of Appeals upheld a covenant in a physician employment agreement prohibiting him from practicing competing and/or practicing medicine or surgery for two years within Coweta, Fayette, Fulton, Heard, Meriwether, Carroll, Clayton, Spalding, Troup and Pike Counties.78 The McAlpin court found the covenant reasonable because: (1) while the employer had locations in Coweta and Fayette Counties, it drew patients from all 10 restricted counties; (2) residents of the 10 restricted counties could still travel to another county for treatment by the physician; and (3) the last census revealed that the combined population of Cobb, DeKalb and Gwinnett Counties exceeded that of the 10 restricted counties.79

Thus, a physician can expect that a non-compete in an employment agreement will be upheld if it restricts the practice of medicine within 10 counties or within 50 miles of a set location.

B. Customer Non-Solicitation Covenants

Under the old law, a customer non-solicitation covenant with no geographic restriction must be limited to the customers with whom the employee had material contact. In Trujillo v. Great Southern Equipment Sales, LLC, for example, the Court of Appeals struck down a covenant that prohibited a former employee’s solicitation of customers about whom he obtained confidential information because the employee might not have had material contact with those customers.80

At first glance, O.C.G.A. § 13-8-53(b) seems to preserve the material contact requirement from the Trujillo decision by providing that an employee may agree not to solicit customers/patients with whom he or she had “material contact”. But a closer examination reveals that the Act legislatively overrules Trujillo by defining “material contact” broadly to cover situations in which employee “obtained confidential information” about the customer/patient.81 The practical effect is that a physician who merely reviews a patient’s medical records but has no direct contact with the patient can now be barred from soliciting that patient.

A typical physician non-solicitation covenant reads as follows:

During Physician’s employment and for two years thereafter, Physician shall not, directly or indirectly, solicit, divert, or take away any patients who were treated by Physician during his employment, for the purpose of providing or offering to provide medical services to those patients.

That non-solicitation covenant gives rise to several issues. First, how is the term “patient” defined? If it could be construed to include former patients, the covenant may be overly broad. In a case including restrictions on an insurance broker, the Court of Appeals held that the brokerage firm does not have a protectable interest in protecting former customers.82 The Restrictive Covenants Act does not appear to have changed this rule.83

It is much easier to distinguish between customers and former customers in the insurance business than it is in the healthcare field. In the insurance business, a former customer is one who declined to renew its insurance policies before the employee’s departure.84 If an orthopedic surgeon treats a patient’s broken leg, does the patient become a “former patient” once he is released from further treatment? Is a cancer patient who comes out of remission a former patient or a new patient? These are questions that the courts will likely have to answer.

Another question the sample non-solicitation covenant raises is what is “solicitation?” The Act does not define the term, but Georgia case law has held that solicitation requires an affirmative act beyond the mere acceptance of business.85 If a departing physician sends a notice merely apprising his patients of his new address, is that solicitation? In Robert, LTD v. Parker, the court held that a jury should decide whether a former employee’s letters to former clients and offers of assistance constituted solicitation.86 While no Georgia court has decided whether a mere notice of change of address is a solicitation, one Atlanta area hospital has taken that position. Relatedly, it is unlikely that a physician could generate patient notices without first accessing a patient list, which could expose the physician to a theft of trade secrets claim.87

The American Medical Association has addressed the issue of patient notices squarely:

The patients of a physician who leaves a group practice should be notified that the physician is leaving the group. Patients of the physician should also be informed of the physician’s new address and offered the opportunity to have their medical records forwarded to the departing physician at his or her new practice location. It is unethical to withhold such information upon request of a patient. If the responsibility of notifying patients falls to the departing physician, rather than to the group, the group should not interfere with the discharge of these duties by withholding patient lists or other necessary information. (Emphasis added)88

While AMA opinions lack the force of law, they may shame a recalcitrant hospital or practice to put patient care and professionalism above economic gain.

Continue Reading: Restraints on Physician Competition in Georgia – Part 2

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