Unique Considerations For Restrictive Covenants in Physician Employment Agreements

In order to protect legitimate business interests and prevent unfair competition, many employers utilize what are known as “restrictive covenants.”  A restrictive covenant is a provision, often included in an employment agreement, that limits a worker’s ability to compete with a former employer.

Restrictive covenants may prohibit a departing worker from engaging in competitive activities such as soliciting a former employer’s customers, clients, and/or employees and from revealing information that is proprietary or confidential.  Restrictive covenants also may limit the time frame and geographic area in which an employee may work after leaving a job.  These restrictions are known as noncompete provisions.

Although restrictive covenants are popular, an employer’s ability to enforce them is limited.  In Arizona, restrictions on an employee’s post-employment activities must be reasonable and limited in geographic and temporal scope.  Also, restrictive covenants imposed on physicians are scrutinized more aggressively than in other industries.  Despite the freedom to contract, Arizona law does not favor restrictive covenants, and this bias is particularly strong for restrictive covenants governing health care professionals. The Arizona Supreme Court in Valley Medical Specialists v. Farber affirmed this concept and established rules for the use of restrictive covenants in medical practices.

In 1985, Valley Medical Specialists (VMS) hired Dr. Steven S. Farber, an internist and pulmonologist, and eventually entered into an employment agreement with him that included a number of restrictions. The covenants in the agreement prohibited Dr. Farber from engaging in a number of activities, including:

1.  Requesting any present or future VMS patients to terminate their affiliation with VMS;

2.  Working in competition with VMS in the practice of medicine;

3.  Disclosing the identity of any VMS patients to any other business engaged in a medical practice similar to or in general competition with VMS;

4.  Providing medical care for any person who was a patient of VMS during Dr. Farber’s employment with the practice.

The covenants in Dr. Farber’s employment agreement restricted him for three years after his separation and within a five-mile radius of any office maintained or utilized by VMS.

VMS filed suit against Dr. Farber for violating his restrictive covenants, and the case eventually progressed to the Arizona Supreme Court. The Court ultimately concluded that the restrictions in his employment agreement were invalid because VMS’s “interest in enforcing [them was] outweighed by the likely injury to patients and the public in general.”

The Court reasoned that the temporal and geographic limitations were too broad because the covenants did not involve Dr. Farber practicing pulmonology, but rather precluded any type of practice, even in fields outside of the VMS practice.  More importantly, the Court confirmed VMS had a protectable interest in its patient referral sources but held that the interest was not sufficient enough to outweigh a patient’s freedom to choose his or her particular doctor.

Limitations imposed by a restrictive covenant are unreasonable, and thus unenforceable, if they are broader than necessary to protect the employer's legitimate interest, or if that interest is outweighed by the hardship to the employee and the likely injury to the public. In the context of medicine, a patient's right to see a doctor of choice is entitled to substantial protection. Thus, VMS’s interest in preventing competition was not outweighed by the significant public policy issues at play. 

So, given the great protection afforded to patients in choosing their own health care providers, what can a practice do to increase the likelihood that its restrictive covenants will be enforceable in Arizona?

In order to maximize the chances of enforceability, a practice should ensure that a restrictive covenant agreement is carefully drafted.  On this point, Arizona courts are permitted to “blue pencil” restrictive covenants, “eliminating grammatically severable, unreasonable provisions,” leaving the reasonable limitations intact. These severable terms are referred to as “step-down” clauses that allow a court chose from multiple options.  For example, terms like “geographic area” and “time frame” may be defined as a set of alternatives ranging from more to less restrictive.  This drafting technique permits a court to pick and choose what it concludes is reasonable without putting the entire agreement at risk.

Although the Court in Farber stopped short of holding that restrictive covenants for physicians never will be enforced, it made clear that restrictions included in provider employment agreements always will be strictly construed for reasonableness.  Since Farber, Arizona courts have continued to uphold the unique protections afforded to the doctor-patient relationship.