Fearnow v. Ridenour, Swenson, Cleere

• Decision Date: 18 July 2006
• Docket Number: No. CV-05-0217-PR.,CV-05-0217-PR.
• Citation: 138 P.3d 723,213 Ariz. 24
• Parties: William D. FEARNOW and Elizabeth Fearnow, Plaintiffs-Appellees, v. RIDENOUR, SWENSON, CLEERE & EVANS, P.C., Defendants-Appellants.
• Court: Arizona Supreme Court

Page 723

138 P.3d 723

213 Ariz. 24

William D. FEARNOW and Elizabeth Fearnow, Plaintiffs-Appellees, v. RIDENOUR, SWENSON, CLEERE & EVANS, P.C., Defendants-Appellants.

No. CV-05-0217-PR.

Supreme Court of Arizona, En Banc.

July 18, 2006.

Paul G. Ulrich P.C. by Paul G. Ulrich, Pamela B. Petersen, Phoenix, Attorneys for William D. and Elizabeth Fearnow.

Osborn Maledon P.A. by Mark I. Harrison, Thomas L. Hudson, Diane M. Meyers, Phoenix, Attorneys for Ridenour, Swenson, Cleere & Evans, P.C.

OPINION

HURWITZ, Justice.

¶ 1 Ethical Rule ("ER") 5.6(a) of the Arizona Rules of Professional Conduct prohibits an "agreement that restricts the right of a lawyer to practice [law] after termination of [a law firm] relationship." Ariz. R. Sup.Ct. 42 (2006). This case involves the application of ER 5.6(a) to a shareholder agreement requiring a departing lawyer to tender his stock to a professional corporation for no compensation if he thereafter competes with the corporation in the practice of law. We hold that such an agreement does not violate ER 5.6(a), but rather should be evaluated under the well-established law governing similar restrictive covenants in agreements between non-lawyers.

I.

¶ 2 In 1987, William Fearnow paid $33,674.42 for a law firm partnership interest. Four years later, the partners decided to wind down the firm. Several partners, including Fearnow, formed a new firm, Ridenour, Swenson, Cleere & Evans, P.C. ("RSCE"). See Ariz.Rev.Stat. ("A.R.S.") §§ 10-2201 to -2249 (2004) (governing professional corporations) (hereinafter "the Professional Corporations Act" or "the Act"). The former partners made no new capital contributions to RSCE; rather, their original partnership contributions were converted to stock. Fearnow was thus deemed to have paid $33,674.42 for one share of RSCE stock.

¶ 3 Fearnow and the other RSCE shareholders signed a Shareholder Agreement ("Agreement"). The Agreement generally provided for the repurchase of a lawyer's stock for the original subscription price upon disability, retirement, withdrawal, or expulsion from the firm. Separate provisions in the Agreement (collectively, the "voluntary withdrawal provisions") required a shareholder voluntarily withdrawing and thereafter competing in the firm's "geographic area for more than ten hours per week" to "tender his or her Share back to the Corporation for no compensation."¹

¶ 4 In 1998, Fearnow voluntarily left RSCE to join another Phoenix firm. Fearnow demanded $33,674.42 for his RSCE stock. RSCE refused, citing the voluntary withdrawal provisions. Fearnow sued, alleging that the provisions violated ER 5.6(a).

¶ 5 The parties filed cross-motions for summary judgment. The superior court held that the voluntary withdrawal provisions violated ER 5.6(a) and were therefore unenforceable. Because the Agreement had no severability clause, the court held the entire contract invalid. The trial court then found Fearnow to be a "disqualified person" as defined by the Professional Corporations Act, see A.R.S. § 10-2201(1), and ordered a valuation of his stock pursuant to A.R.S. § 10-2223. The superior court ordered RSCE to repurchase the stock for $86,500.

¶ 6 The court of appeals affirmed in part and reversed in part. Fearnow v. Ridenour, Swenson, Cleere & Evans, P.C., 210 Ariz. 256, 110 P.3d 357 (App.2005). The court found the voluntary withdrawal provisions unenforceable, but held that Fearnow was not a "disqualified person" entitled to redemption of his stock under the Act. Id. at 262 ¶ 32, 110 P.3d at 363.

¶ 7 Fearnow petitioned for review and RSCE filed a conditional cross-petition. We granted review of both petitions because the issues presented are of first impression and statewide importance. We have jurisdiction pursuant to Article 6, Section 5(3), of the Arizona Constitution and A.R.S. § 12-120.24 (2003).

II.

A.

¶ 8 As a general rule, a contract restricting the right of an employee to compete with an employer after termination of employment "which is not unreasonable in its limitations should be upheld in the absence of a showing of bad faith or of contravening public policy." Lassen v. Benton, 86 Ariz. 323, 328, 346 P.2d 137, 140 (1959), modified on other grounds, 87 Ariz. 72, 347 P.2d 1012 (1959); see also 15 Corbin on Contracts § 80.15 (2003) (noting that in determining the enforceability of such a provision, "reasonableness is the North Star"). Such a restrictive covenant is unreasonable if "(a) the restraint is greater than is needed to protect the promisee's legitimate interest, or (b) the promisee's need is outweighed by the hardship to the promisor and the likely injury to the public." Restatement (Second) of Contracts § 188 (1981).

¶ 9 The determination of "[r]easonableness is a fact-intensive inquiry that depends on the totality of the circumstances." Valley Med. Specialists v. Farber, 194 Ariz. 363, 369 ¶ 20, 982 P.2d 1277, 1283 (1999). "Each case hinges on its own particular facts." Bryceland v. Northey, 160 Ariz. 213, 217, 772 P.2d 36, 40 (App.1989). As the court of appeals has noted,

[w]hat is reasonable depends on the whole subject matter of the contract, the kind and character of the business, its location, the purpose to be accomplished by the restriction, and all the circumstances which show the intention of the parties.

Gann v. Morris, 122 Ariz. 517, 518, 596 P.2d 43, 44 (App.1979).

¶ 10 Most of our cases concerning the enforcement of restrictive covenants deal with "non-compete" agreements, under which an employee is prohibited from competing with the former employer in a geographic area for a period of time. See, e.g., Farber, 194 Ariz. at 365 ¶ 3, 982 P.2d at 1279 (finding unreasonable a covenant between physicians forbidding competition within a five-mile radius of any medical office owned by the former employer for three years); Lassen, 86 Ariz. at 328, 346 P.2d at 140 (finding reasonable a provision prohibiting competition for five years within a twelve-mile radius of a veterinarian's former employer). We have, however, employed the same fact-based reasonableness analysis to determine the enforceability of agreements under which a departing employee is not entirely forbidden to compete. See Olliver/Pilcher Ins., Inc. v. Daniels, 148 Ariz. 530, 715 P.2d 1218 (1986). Olliver/Pilcher involved an "anti-piracy" agreement forbidding solicitation of the former employer's customers. Id. at 531, 715 P.2d at 1219. While recognizing that such a provision is "less restrictive than a covenant not to compete," id. at 531, 715 P.2d at 1218, we reiterated that "`the test of validity of restrictive covenants is one of reasonableness,'" id. at 532, 715 P.2d at 1219 (quoting Lessner Dental Labs. v. Kidney, 16 Ariz.App. 159, 160, 492 P.2d 39, 40 (1971)).²

B.

¶ 11 Were Fearnow not an attorney, the voluntary withdrawal provisions would be subject to a fact-based reasonableness analysis. This Court, however, has adopted a rule governing the ability of lawyers to enter into certain types of agreements. That rule, ER 5.6, provides:

A lawyer shall not participate in offering or making:

(a) a partnership or employment agreement that restricts the rights of a lawyer to practice after termination of the relationship, except an agreement concerning benefits upon retirement; or

(b) an agreement in which a restriction on the lawyer's right to practice is part of the settlement of a controversy between private parties.

Such restrictions are prohibited because they limit a lawyer's "professional autonomy" and interfere with "the freedom of clients to choose a lawyer." ER 5.6 cmt.

¶ 12 The Arizona Rules of Professional Conduct, of which ER 5.6 is part, are based on the 1983 Model Rules of Professional Conduct promulgated by the American Bar Association ("ABA"). See Ariz. R. Sup.Ct. 42 (providing that the professional conduct of State Bar members shall be governed by the ABA Model Rules, as amended by this Court). But even before the ABA adopted Model Rule 5.6(a), its Committee on Professional Ethics had issued several opinions condemning non-compete agreements among lawyers under previous Canons of Professional Ethics. Those opinions stressed the same themes as the current commentary to ER 5.6 — lawyer autonomy and client choice. See, e.g., ABA Comm. on Prof'l Ethics, Formal Op. 300 (1961) (finding a non-compete agreement improper under Canon 7 (forbidding encroachment on the business of another lawyer), Canon 27 (prohibiting solicitation), and Canon 35 (protecting client confidences)); ABA Comm. on Prof'l Ethics, Informal Op. 1072 (1968) (stating that covenants not to compete "interfere with and obstruct the freedom of the client in choosing and dealing with his lawyer" and that an "attorney must remain free to practice when and where he will and to be available to prospective clients who might desire to engage his services"). These opinions led to the adoption in 1969 of Disciplinary Rule ("DR") 2-108 of the Model Code of Professional Responsibility,³ which in turn was incorporated into Rule 5.6 of the 1983 Model Rules without substantive change.

¶ 13 ER 5.6 categorically forbids lawyers from making an "agreement that restricts the right of a lawyer to practice after the termination of [a law firm] relationship," ER 5.6(a), or a settlement agreement containing "a restriction on a lawyer's right to practice," ER 5.6(b). Neither ER 5.6 nor prior ABA opinions, however, expressly deals with agreements that do not restrict a lawyer's right to practice or compete, but rather impose only some financial disincentive for doing so. Such provisions are before us today.

C.

¶ 14 In analyzing the voluntary withdrawal provisions, we write on a clean slate. No prior opinion of this Court has applied ER 5.6(a). We did, however, discuss ER 5.6 in Farber, which involved a covenant not to compete among physicians. In that case, we analogized the importance of a patient's right to choose a doctor to the need for a client to be free to...