Courtesy of lexology.com and author Mark Wiletsky:
Are physician noncompete agreements enforceable? They can be, depending on the circumstances, though there are few reported decisions in Colorado analyzing such agreements. In one recent case, the Colorado Court of Appeals concluded that, following a merger, the surviving physicians entity could not enforce a noncompete provision against a dissenting shareholder-physician. The Court also concluded that an amount of damages calculated under a liquidated damages clause in the agreement must be reasonably related to an actual injury suffered by the entity as a result of the physician’s departure and competition, not simply a prospective injury estimated at the time the contract was created. Crocker v. Greater Colorado Anesthesia, P.C., 2018 COA 33.
Noncompete and Liquidated Damages Provision
Anesthesiologist Michael Crocker was a shareholder in, and employee of, Greater Colorado Anesthesia, P.C. (Old GCA). In April 2013, Dr. Crocker signed a shareholder employment agreement with Old GCA that contained a noncompete provision. In relevant part, the noncompete stated that if Dr. Crocker competed with Old GCA by participating in the practice of anesthesia within fifteen miles of a hospital serviced by Old GCA in the two years following termination of the agreement, he would be liable for liquidated damages as calculated by a stated formula. The restricted geographic area included nearly all of the Denver metro area, from Broomfield on the north to Castle Rock on the south. The agreement further stated that the liquidated damages provision would survive termination of the agreement for a period of two years, or until all amounts due by the employee to the company were paid in full.
Physician Objects To Merger
In January 2015, the shareholder-physicians of Old GCA faced a vote on whether to approve a merger that would result in a 90-doctor corporation. In exchange for accepting a 21.3% reduction in pay and making a five-year employment commitment, the shareholder-physicians would receive a substantial lump sum of cash plus stock. Dr. Crocker voted against the merger and provided notice under Colorado law that he would demand payment for his share of Old GCA in exercise of his dissenter’s rights. The other shareholder-physicians approved the merger resulting in a new corporation (New GCA).
Dr. Crocker never worked at New GCA. In March 2015, he signed an employment agreement with a different anesthesia group that included providing services at Parker Adventist Hospital, which was within GCA’s noncompete restricted area. Old GCA sent him $100 for his share in the group, which he refused. New GCA sought to enforce Dr. Crocker’s noncompete provision, seeking liquidated damages under the stated formula, while Dr. Crocker sought a higher valuation of his share in Old GCA.
Physician’s Shareholder Rights Were Intertwined With Employee Rights
The Colorado Court of Appeals noted that generally, a noncompete provision will survive a merger, allowing the surviving entity to enforce the noncompete restrictions. But it drew a line in Dr. Crocker’s scenario, finding that his shareholder rights were wed to his rights as an employee. He could not be an employee without being a shareholder, and he could not be a shareholder without being an employee. Consequently, when he exercised his dissenter’s rights in opposing the merger and sought payment for his share in Old GCA, Dr. Crocker was forced to quit his employment with GCA. Therefore, the Court stated that it could not construe the enforceability of the noncompete provision without consideration of Dr. Crocker’s rights as a dissenter. Finding no prior authority evaluating a noncompete under such circumstances, the Court decided that it could only enforce the noncompete if it is reasonable, and to be reasonable, it must not impose hardship on the employee.
Noncompete Unreasonable Due to Hardship on Employee
Because an anesthesiologist must live within approximately 30 minutes of where he or she works, enforcement of the Old GCA noncompete provision against Dr. Crocker would require that he either move outside of the restricted geographic area or pay liquidated damages to GCA. The Court stated that enforcement in that circumstance would “further penalize [Dr.] Crocker’s exercise of his right to dissent, rather than protect him from the conduct of the majority.” The Court ruled that the noncompete provision imposed a hardship on Dr. Crocker and therefore was unreasonable.
Liquidated Damages Formula Not Reasonably Related to Any Injury
The Court went on to reject New GCA’s claim for liquidated damages under the noncompete provision. The Court stated that even if it were to conclude that the noncompete was enforceable, New GCA would not be entitled to any damages under the liquidated damages formula. Colorado’s noncompete statute, C.R.S. §8-2-113(3), states that a physician noncompete may require the payment of damages in an amount that is reasonably related to the injury suffered by reason of termination of the agreement. (Italics added.) Here, the noncompete applied a liquidated damages formula equivalent to: (1) the three-year annual average of the gross revenues produced by the departing physician’s practice, (2) less the three-year annual average of Old GCA’s direct costs of employing the physician (such as physician compensation and expenses paid on the physician’s behalf), multiplied by two, to reflect two years of competition, plus $30,000 to cover the estimated costs to terminate and replace the physician.
The Court stated that there was no evidence presented that Old GCA suffered any injury because of Dr. Crocker’s departure. Although Old GCA claimed $207,755 in damages for Dr. Crocker’s alleged violation of the noncompete provision (based on the above formula), the Court stated that “there is no reasonable relationship – none – between the actual injury suffered and the $207,755 calculated by GCA per its liquidated damages formula.” Therefore, on that ground too, the Court affirmed the district court’s ruling that the noncompete provision was not enforceable against Dr. Crocker.
Impact of Decision
It is unclear whether this case will be appealed to the Colorado Supreme Court. Unless and until it is, physician groups should take a look at the unique set of facts that undercut GCA’s ability to enforce its noncompete against Dr. Crocker. In situations where shareholder rights are tied to employee rights, physician entities should revisit what options are available if a shareholder-physician exercises his or her rights to dissent to corporate action. If a noncompete is imposed on the dissenter, it should be written narrowly so as not to impose a hardship on the physician.
In addition, the Court’s analysis of the liquidated damages presents some practical difficulties for physician groups and hospitals attempting to craft enforceable noncompete agreements. Based on this case, liquidated damages clause should be reasonably related to the actual injury anticipated because of the physician’s departure, not on an arbitrary formula or fixed sum. Therefore, if you have or are subject to a physician noncompete, it’s a good idea to review that agreement in light of this decision. Noncompetes often present unique enforcement challenges and the Colorado Court of Appeals just added a new wrinkle when dealing with physician noncompetes.