Using a covenant not to compete to protect your practice

April 10, 2015
The primary value of any dental practice is the continuing cash flow generated by its patient and/or referral base. If a former associate or owner acquires a nearby competitor or establishes a new practice, then takes advantage of patient and referring doctor relationships developed while associated with your practice, the effects can be financially devastating. An enforceable covenant not to compete is one of the most important tools you can use to protect your practice from unfair competition by a former owner or associate.

John K. McGill, JD, MBA, CPA

Patrick D. Craig, JD

The primary value of any dental practice is the continuing cash flow generated by its patient and/or referral base. If a former associate or owner acquires a nearby competitor or establishes a new practice, then takes advantage of patient and referring doctor relationships developed while associated with your practice, the effects can be financially devastating. An enforceable covenant not to compete is one of the most important tools you can use to protect your practice from unfair competition by a former owner or associate.

When considering the use of a covenant not to compete to protect your practice, the most important thing to keep in mind is that state law governs the enforcement of the covenant, and applicable law varies greatly from state to state. Regardless of where you practice, the ever-evolving law in this area requires obtaining specific legal advice on how to satisfy any state law provisions applicable to your circumstances.

Subject to the variation in state law, a covenant not to compete will generally be enforceable if it is in writing, is supported by adequate consideration, is reasonable in scope, and does not violate public policy. A covenant may be deemed to violate public policy if, for example, it forces a departing doctor to leave an area that will be underserved as a result of his or her departure. There is also a clear distinction in the treatment of covenants entered into in the employment context and those entered into in the practice sale context (which are generally subject to less scrutiny because they are viewed as necessary to protect the goodwill purchased by the buyer).

In the employment context, the covenant not to compete should be included in a written employment agreement, which should be signed before the associate begins working in the practice. Generally, the signing of a covenant not to compete at the inception of the employment relationship will provide sufficient consideration to support the covenant. However, when a covenant is entered into after the employment relationship has commenced, the law in some states indicates that continued employment is not sufficient consideration to support the covenant. In those states, the employer is required to provide some additional consideration (e.g., a bonus or salary increase) to the associate in exchange for signing the covenant.

In order to provide the greatest chance of enforceability, the scope of a covenant not to compete (i.e., duration and geographic restrictions) should be limited to that which is reasonably necessary to protect the patient base and referral sources of the practice. An enforceable covenant executed in the employment context will typically run no more than one or two years following the associate's departure from the practice. A longer period may be enforceable when the covenant is part of a contract for the sale of all or a portion of the practice.

Careful consideration should be given to the specific geographic area covered by the covenant. A reasonable geographic area should generally cover the majority of the practice's patient base and referral sources without including any areas where the practice does not draw many patients. Accordingly, the appropriate size of the geographic area to be covered by a covenant not to compete will vary from practice to practice, even if those practices are located within the same state.

Most states permit their courts to modify overly broad restrictions, to some extent. However, such modification is often discretionary rather than compulsory. Accordingly, care should be taken to draft a covenant that is reasonable as written, without relying on subsequent judicial modification. If your state allows modification, the covenant should provide specific language that grants the court the power to reform the contract if the court determines the restrictions are too broad.

The law governing covenants not to compete is complex and constantly evolving, and it varies greatly from state to state. Accordingly, it is crucial to consult with an attorney familiar with the applicable law in your state to discuss how a covenant not to compete can be used to protect your practice's patient and referral base from competition by former associates or owners.

Patrick D. Craig, JD, provides legal services through McGill and Hassan, PA. John K. McGill, jd, mba, CPA, provides tax and business planning exclusively for the dental profession and publishes the McGill Advisory newsletter through John K. McGill & Company, Inc. Both are members of the McGill & Hill Group, LLC, your one-stop resource for tax/business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. Visit www.mcgillhillgroup.com.

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