Restrictive Covenants – Enforceable Beyond A Written Agreement?

By Douglas J. Good,
Chair, Litigation
and Keshia B. Haskins,
Health Law

 
May 8, 2001
Our traditional notions of freedom make it difficult to legally restrict a party’s freedom to choose where and for whom she will work.  Yet, among healthcare professionals “restrictive covenants” are commonly utilized, and, when properly drafted, are often respected and enforced in court.  A “restrictive covenant” is a contractual promise by an employee that she will not practice her trade within a certain geographic proximity of a former employer, for a certain period of time.  Restrictive covenants (also referred to as non-compete and non-solicitation agreements) often appear in employment agreements, shareholder agreements, and contracts for the sale and purchase of professional practices.  

A restrictive covenant can be an important part of an employment relationship, but its utility and limitations must be understood.  From an employer’s perspective, a restrictive covenant is valuable because it can prohibit unfair competition by a former employee luring away clientele and referral sources.  From an employee’s perspective, a restrictive covenant should be carefully negotiated so that an employee’s freedom to practice her profession is not unduly restricted.  No firm rules exist to determine in advance whether a restrictive covenant is enforceable; rather, when a dispute arises, courts will make a case-by-case determination depending on the facts and circumstances of each particular situation.

In New York, a restrictive covenant among healthcare professionals will be enforceable only if: (1) it is reasonably limited in time and geographical scope, to protect the legitimate interest of the employer; (2) it does not impose undue hardship on the employee; and (3) it is not injurious to the public.  Thus, in deciding whether to enforce a restrictive covenant, the court will balance the protection of the employer against the freedom of the employee (and in addition, will consider the interests of the general public). 

This article will discuss whether restrictive covenants are enforceable where the term of the employment agreement that contained a restrictive covenant has expired and the employment relationship continues without a new written agreement.  Commonly, an employment relationship starts with a written agreement, for a stated term.  Once the term expires – be it a year, or two, or three – the parties may feel they “know” each other and no longer have the need for a formal, written contract.  The employer may believe the restrictive covenant continues, just as other terms of the prior contract, such as duties, salary, vacation time, etc.  The employee may think that he has, by continued employment without a new contract, avoided a future restriction in his activities.   

Because an individual’s freedom to practice his or her profession is so important, a New York court will not automatically enforce a restrictive covenant where an employer and employee continue an employment relationship after their written employment agreement has expired.  New York courts have confronted situations where an employment relationship was extended beyond the expiration of a prior written employment agreement.  In Borne Chemical Co., Inc. v. Dictrow, a New York appellate court enforced a restrictive covenant to its terms, even though the employee had continued to be employed for more than three years after the expiration of his employment agreement, without signing a new written agreement.  In Hubbell v. Hubbell Highway Signs, where the facts resembled those of Dictrow, a different New York appellate court did not enforce the restrictive covenant, finding that its term had expired by the time the employee left his position, because he worked for three years without a new contract.   

How can these apparently conflicting decisions be reconciled?  What makes one restrictive covenant enforceable and another unenforceable?  The parties’ intentions, as evidenced largely by the agreement language, will bear heavily on the outcome.  The following scenario will help to illustrate the answer to this question. 

Dr. A works for Dr. Jones, P.C. pursuant to a written employment agreement.  The agreement is effective January 1, 1995 with a two-year term.  This agreement contains a restrictive covenant providing that for two years following the termination of the employment agreement between Dr. A and Dr. Jones, P.C., Dr. A may not practice medicine within a two (2) mile radius of Dr. Jones, P.C.  Two years pass, and Dr. A continues to work for Dr. Jones, P.C. for an additional two years after the December 1996 expiration of the contract without a new agreement.  On December 31, 1998, Dr. A leaves Dr. Jones and accepts a position with Dr. Smith, P.C. located across the street from Dr. Jones.  Has Dr. A violated the restrictive covenant? Or was the restrictive covenant effective for the two-year period from 1997-1998, after the expiration of Dr. A’s contract, during which time he continued to work at Dr. Jones, P.C.?   

Dr. Jones would argue that the restrictive covenant only started to be effective on January 1, 1999, and operates to limit Dr. A’s activities for a full two years after leaving Dr. Jones’ employ.  After all, the logic behind the restrictive covenant is to protect an employer for a period of time commencing immediately after the cessation of an employment relationship with a particular employee.  Clearly, Dr. Jones would not need a restrictive covenant to stop Dr. A from competing with the P.C. while he is still employed by the P.C.  If a court agreed with Dr. Jones, it could enjoin Dr. A from working at Dr. Smith, P.C.   

Dr. A would argue that the restrictive covenant was triggered on or about January 1, 1997, when the term of his employment agreement expired.  The parties’ election not to sign a new agreement, and to continue in the employment in any event, is no reason to change the date the restrictive covenant starts – when the term of the original employment ended, i.e., December 31, 1996.  Dr. A would further claim that he obeyed the covenant – he did not compete with Dr. Jones, P.C. for two years after the term of his initial written contract expired – of course not, he continued to work for Dr. Jones.  If a court agreed, Dr. A could work for Dr. Smith, P.C., immediately after leaving Dr. Jones on December 31, 1998, without worrying about the restrictive covenant. 

Dr. Jones’ argument will likely prevail if the written employment agreement clearly provides that the restrictive covenant is triggered by the ultimate severance of the employment relationship between Dr. A. and Dr. Jones.  Dr. A’s argument will likely prevail if the written employment agreement provides that the restrictive covenant applies upon the expiration of the term of the employment agreement.  The strongest support for either party’s argument will be the language in the employment agreement. 

If the restrictive covenant language does not clearly resolve the issue, a court will consider evidence outside of the language of the written agreement.  In another New York appellate case, Thur v. IPCO Corp., the parties extended the employment relationship beyond the expiration of a written employment agreement.  There, the New York court indicated that the plaintiff’s (employee’s) actions were important evidence of the parties’ intentions that the restrictive covenant be triggered at the end of the employment relationship instead of at the expiration of the written employment agreement.
It is helpful for parties to an employment agreement to know that a court will consider evidence in addition to the language of the restrictive covenant when determining the point in time at which a restrictive covenant has been triggered.  However, parties will be best protected if they: (1) carefully and clearly draft the restrictive covenant in the first instance; (2) seriously consider drafting a new or “extension” agreement when the term of a prior employment agreement expires; and (3) gather and preserve evidence that supports their interpretation of the restrictive covenant.  The participation of competent counsel is advisable.  If this all sounds confusing to you, try explaining brain surgery to a lawyer.

Douglas Good is Partner and Chair of the Litigation Department at Ruskin Moscou Faltischek, P.C.  He can be reached at 516-663-6630 or dgood@rmfpc.aw-develop.com. Keshia Haskins is an associate in the Health Law Department. She can be reached at 516-663-6635 or khaskins@rmfpc.aw-develop.com.
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