Should You Use a
Cost-Sharing Agreement?

L et’s say that just over a year ago you recruited a physician to relocate and join your practice. Finally, you have someone to help carry the load and to help you reach the profit potential your practice was ready for. This new welcome addition did not come without substantial costs, however — bonus, relocation reimbursement and recruitment fees, just to name a few. But it will all be worth it when you turn over the reins and sell the practice to this new young gun in a few years. Unfortunately, things didn’t work out as planned. Now, your associate has left your practice and opened his own new practice down the street — and, he’s stealing some of your patients. To add to your distress, your attorney is telling you that the covenant-not-to-compete clause that you had included in your associate’s employment agreement may not be as iron clad as you thought. For many years, employers have tried to protect their “business interests” by prohibiting their employees from competing against them. The covenant-not-to-compete clause in contracts became the tool of choice in providing this protection for the employer. Unfortunately, some of these covenants were too broadly written and have been considered by the courts to be an illegal “restraint on trade.” The Legality of the Covenant-Not-To-Compete Clause In the last 20 years, the courts have scrutinized these agreements to see if they were properly entered into and reasonably constructed. While it seems every state has a slightly different standard, the states that do accept covenants-not-to-compete look to the following factors. Consideration. To be valid, covenant-not-to-compete agreements must be based on sufficient and valuable consideration. A covenant-not-to-compete agreement signed at the beginning of employment is considered acceptable because the courts consider the employment itself to be of sufficient value. If the employee is asked to sign a covenant-not-to-compete agreement after being hired, the courts have held that the employee must be given new and additional consideration in exchange for signing the agreement. This is a mistake many practices make when implementing a policy of having existing employees sign employment agreements with covenant-not-to-compete clauses. Reasonable. To justify a covenant not to compete, the employer must show that the agreement is necessary to protect its legitimate business interests. Duration. A covenant-not-to-compete agreement also must be reasonable with respect to the duration it is in effect. Generally, the longer the duration the less likely the courts are to validate the agreement. The duration of a covenant not to compete for a new hire will rarely be enforceable if it is more than 2 years in length. Most experts recommend 1 year or less. The courts are much more generous as to the duration of a covenant not to compete, if it arises in the course of buying a practice. Covenants of up to 5 years will generally be enforceable against the selling physician. Geography. Finally, a covenant not to compete must be reasonable with respect to its geographic scope. The agreement shouldn’t restrict the employee from an area larger than where he or she would be able to establish contact with the employer’s patients. If any part of a non-compete agreement is unreasonable, some courts will declare the entire document null and void. Other courts will simply “blue pencil” the document, meaning that they’ll strike only what’s unreasonable while enforcing the rest. Unfortunately, what was considered reasonable when a covenant was drafted is not necessarily reasonable when the time comes to enforce it. For certain specialties, such as dermatology, some courts are even becoming sympathetic to a “Public Policy” argument that looks at the public’s interest in allowing the denial of a physician right to work in an area that is in need of that particular specialty. Alternate Plans So, is there an alternative to the covenant-not-to-compete clause that can provide the protection you need? The answer is “yes,” but the technique has only been tested in the courts in North Carolina. The State Supreme Court of North Carolina recently confirmed the enforceability of a “cost-sharing agreement.” In a cost-sharing agreement, the employer and employee enter into an agreement that if the employee competes in a given geographic area, the employer is entitled to an equitable reimbursement for the hiring, training and termination of the employee. The methods for determining these damages need to be described in specific terms and both parties need to agree that those terms are reasonable. It should be noted in the agreement that the intent of the agreement to is not to keep the employee from competing with you, but to make them pay for the decision to do so. In the North Carolina case, the state’s Court of Appeals stated specifically: “We hold that the cost sharing provision is not a covenant not to compete, and we do not subject it to the strict scrutiny as to reasonableness and public policy required with a covenant not to compete. The cost sharing provision at issue here is designed to protect plaintiff against competition by defendant within the three counties described. The contract does not prohibit defendant from engaging in the practice of her profession, but only provides that if she does so within the described three county area, she will pay a certain sum for making this choice.” What is Your Best Defense? Unless you happen to practice in North Carolina, a well drafted employment agreement with a covenant-not-to-compete clause is still probably your best defense against former employees competing with you. But, we recommend you keep an eye out to see if cost-sharing agreements start to gain favor in your area. With the courts continuing to restrict the effectiveness of a covenant-not-to-compete agreement, you may need an alternative sooner than you think.