Reasonableness of a covenant not to compete entails four considerations:
- whether the covenant protects a legitimate business interest of the employer,
- whether the covenant creates an undue burden on the employee
- whether the covenant is injurious to the public welfare, and
- whether the time and territorial limitations contained in the covenant are reasonable.
Further, a non-compete cannot be enforced unless it is supported by valid consideration and it is merely ancillary to the main purpose of a lawful contract. In Wichita Clinic v. Louis, there is “no dispute that the restrictive covenant in the employment agreement between Michelle M. Louis, DO, and the clinic was supported by adequate consideration,” writes the court.
Under the contract, Dr. Louis was to furnish medical services for the Wichita Clinic for two years at a guaranteed salary of $80,000 annually, plus other benefits, for two years. The contract also contained a non-competition and liquidated damages clause that reads as follows:
“Upon termination of this Agreement, DOCTOR agrees that he/she will not, for a period of three (3) years thereafter, directly or indirectly engage in the practice of DOCTOR’s profession in Sedgwick County, Kansas. DOCTOR further agrees that if DOCTOR should leave the employment of the CLINIC for any reason and continue the practice of his/her profession in Sedgwick County, Kansas, during said three year period DOCTOR shall pay the CLINIC, as liquidated damages and not as a penalty, 25% of all earnings collected from such practice during such period; provided, however, that CLINIC shall waive any claim for liquidated damages for that part of the earning collected in competition with CLINIC that is not in excess of Ten Thousand Dollars ($10,000) a year (or an amount annually that is equal to fifteen percent (15%) of the gross income paid DOCTOR in the last full year of his/her employment with CLINIC, whichever is more) if the separation from employment occurs after DOCTOR has reached sixty-two years (62) years of age. The parties agree that during said three-year period the CLINIC shall have the right and opportunity to audit or cause to be audited the DOCTOR’s books and records at reasonable times and upon reasonable notice. The CLINIC shall pay for the audit by a certified public accountant of the CLINIC’s choice; provided, however, that if such audit should uncover a variance in gross earnings in the DOCTOR’s favor of two percent or more, the DOCTOR shall pay the reasonable costs of such audit.”
Dr. Louis terminated her employment with the clinic about 13 years later and began working with Lakepoint Family Physicians. The Wichita Clinic filed a petition for breach of the agreement because Dr. Louis had continued to practice in Sedgwick County and had failed to pay liquidated damages in violation of the restrictive covenant.
Dr. Louis’s continued employment by the clinic during a 13-year period constitutes sufficient consideration to support the restrictive covenant, says the appeals court and, “the clinic agreed to employ Dr. Louis in exchange for the restrictive covenant. As a result, the restrictive covenant was ancillary to the written contract of employment.” The initial trial court, which determined the non-compete clause to be unreasonable and unenforceable, did determine that the territorial limit of Sedgwick County was reasonable and that the provision was not injurious to the public because there were a number of family practice physicians; the clinic would have absorbed Dr. Louis’ patients, and the patients were not prevented from having quality medical care.
At issue for the appeals court was whether the restrictive covenant protected a legitimate business interest, whether the three-year time restriction was unreasonable because it created an undue burden on Dr. Louis, and whether the liquidated damages provision had a reasonable basis other than to avoid ordinary competition.
Whether a legitimate business interest was being protected. Here, the appeals court’s discussion determined that the clinic had a legitimate business interest in its referral system, patient base and goodwill, and that prior case law had recognized these factors as legitimate business interests. Therefore, the clinic was protecting a legitimate business interest.
Whether the three-year time restriction was reasonable. “The territorial restriction prohibiting Dr. Louis from practicing in Sedgwick County for three years does not seem unreasonable,” writes the appeals court. “The protection given by the covenant was only coextensive with the area from which the clinic drew most of its patients. As a result, the protection extended only to the periphery of the area covered by the clinic’s business. ? there is no factual basis for finding that the time and territory restrictions of the restrictive covenant are unreasonable.”
Whether the three-year time restriction created an undue burden. “The restrictive covenant does not prevent Dr. Louis from practicing medicine anywhere ? only in Sedgwick County for three years,” writes the court. “Based on these facts, we determine that the restrictive covenant did not impose an undue burden on Dr. Louis.”
Whether the liquidated damages provision was reasonable. “The provision seemed to be a reasonable estimate of loss, as agreed to by the parties when contracting, to be enforced whether the later actual loss was more, as demonstrated by the clinic, or less than the advance estimate,” says the court. “Because the breach would produce damages uncertain in amount and difficult to prove, we cannot say that the provision was inherently arbitrary or unreasonable. As a result, we determine that the liquidated damages provision was not a penalty and will be enforced.”
The appeals court therefore determined that the non-compete was not unreasonable in its application, and reversed the trial court’s decision. For the full case, go here (free registration required).
