Valley Medical Specialists v. Farber
| Decision Date | 30 September 1997 |
| Docket Number | CA-CV,Nos. 1,s. 1 |
| Citation | 950 P.2d 1184,190 Ariz. 563 |
| Parties | , 13 IER Cases 623, 253 Ariz. Adv. Rep. 18 VALLEY MEDICAL SPECIALISTS, an Arizona professional corporation, Plaintiff-Appellant, v. Steven S. FARBER, D.O. and Susan H. Farber, husband and wife, Defendants-Appellees. 95-0520, 1 96-0533. |
| Court | Arizona Court of Appeals |
This case concerns an agreement between a group of doctors restricting where a doctor who leaves the group may continue to practice medicine. The trial court found that the agreement was unenforceable. We disagree, and we reverse.
In 1984, the Appellant, Valley Medical Specialists, hired Steven S. Farber, D.O., to work as an internist and pulmonologist. At that time, three other doctors were the shareholders, officers, and directors of the corporation. Three years later, when Farber became a shareholder, he and the other shareholders executed stock redemption and employment agreements. Several years after that, the departure of one of the doctors resulted in litigation, and, in an effort to avoid a similar problem in the future, the remaining shareholders adopted new stock and employment agreements. (See Appendix).
In September 1994, Farber, discontent for a number of reasons, withdrew from the corporation. Under the terms of the agreement as it had evolved by the time Farber left, a departing doctor could not practice medicine within five miles of any corporation office for a period of three years. Liquidated damages for a breach were set at forty percent of the departing doctor's gross receipts.
Farber began practicing from an office in Mesa that was within the restricted area, and he saw patients at hospitals within the restricted area. At least sixty people he treated at his new office were patients he had seen while he was with the corporation. He also began competing with the corporation for patients from health care plans within the restricted area.
The corporation filed its complaint and application for an order to show cause regarding preliminary and permanent injunctions. It sought (1) a preliminary injunction and then a permanent injunction enjoining Farber from violating the restrictive covenant, (2) damages for breach of the employment agreement in the form of liquidated damages in the amount of forty percent of Farber's gross receipts after his resignation, and (3) damages for breach of fiduciary duty, conversion of patient files and confidential information, and intentional interference with contractual and/or business relations.
Following testimony and argument, the trial court denied the corporation's request for a preliminary injunction because it believed that the restrictive covenant violated public policy. Alternatively, the trial court concluded that if the covenant did not violate public policy, it was unenforceable because it was too broad, finding that no restrictive covenant over six months would be reasonable. The court also found that a five-mile radius from any corporation office was unreasonable because there were three offices and the restricted area encompassed about 235 square miles; the restriction was unreasonable because it did not provide an exception for provision of emergency medical aid and the restriction was overbroad because it was not limited to the practice of pulmonology.
Initially the court permitted the corporation to proceed with the case on the issue of liquidated damages or any other damages to which it might be entitled. The corporation appealed from the judgment denying its request for a preliminary and permanent injunction. Farber then moved to dismiss the corporation's claims for breach of contract, breach of fiduciary duty, conversion, and intentional interference with contractual and/or business relations. The trial court granted the motion as to claims for damages based on violations of the restrictive agreement. Because it had previously ruled that the restrictive agreement was invalid, the court reasoned that no damages could be awarded based on its breach. The court declined to dismiss claims for breach of fiduciary duty and interference with contractual and business relations, and amended claims for breach of a car insurance contract, abuse of process, and for a declaration concerning stock buy-out provisions.
In a judgment containing finality language pursuant to Rule 54(b), Arizona Rules of Civil Procedure, the court dismissed the claims for permanent injunction, breach of contract/liquidated damages/actual damages, conversion, and unjust enrichment. The corporation appealed from the judgment. Upon a joint motion of the parties, the two appeals were consolidated.
When seeking to enforce a restrictive covenant, the burden is on the employer to prove the extent of its protectable interest. Bryceland v. Northey, 160 Ariz. 213, 216, 772 P.2d 36, 39 (App.1989). We have enforced a restrictive covenant similar to the one in issue here when it was no broader than necessary to protect the employer's legitimate business interest. Phoenix Orthopaedic Surgeons, Ltd. v. Peairs, 164 Ariz. 54, 60, 790 P.2d 752, 758 (App.1989).
Restrictive covenants that tend to prevent an employee from pursuing a similar vocation after termination of employment are disfavored and are strictly construed against the employer. Courts are more lenient in enforcing similar covenants given in relation to the sales of businesses because of the need to ensure that goodwill is effectively transferred. Bryceland, 160 Ariz. at 216, 772 P.2d at 39. 1
The corporation argues that Farber's departure triggered a buy-out provision that is analogous to the sale of a business, so the non-compete provision should not be strictly construed against it. A buy-out situation is not completely analogous to the sale of a business. The scrutiny afforded a restrictive covenant involved in a shareholder buy-out agreement falls somewhere between the scrutiny applied to a covenant affecting a terminated employee with no ownership interest in the business and that applied to a covenant involved in the sale of a business.
The Supreme Court of Georgia in Rash v. Toccoa Clinic Medical Associates, 253 Ga. 322, 320 S.E.2d 170 (1984), considered whether a covenant not to compete in a partnership agreement was enforceable against a physician who resigned from the partnership, stating:
We are dealing here not with an employment contract but with a partnership agreement. Although it does not appear that the appellate courts of this state have had occasion to clearly distinguish between the two types of agreements, there are obvious differences. In a partnership agreement such as the one here, as opposed to an employment agreement, the consideration flows equally among the contracting parties. For example, when an employee agrees to subject himself to possible future restrictions, he does so in exchange for the opportunity to have the job. He really gets nothing other than the opportunity to work in exchange for giving up this aspect of his freedom. On the other hand, here a partner has not only restricted himself, but he has also exacted from each of the other contracting parties a like restriction.
....
The next distinction between employment agreements and partnership agreements is that it is generally true in the employer/employee relationship that the employee goes into a transaction such as this at a great bargaining disadvantage. Such would not be expected to be the case in a professional partnership arrangement....
The evidence shows that Arizona medical professional corporations commonly have restrictive covenants in their employment agreements as part of their business plans. Because those plans include buy-out provisions, the restrictive covenants help maintain the value of the practice when a shareholder employee leaves so that the corporation does not suffer a loss in revenue that would, among other things, diminish its ability to pay for the departed physician's stock. In addition, the valuation of the business on which the buy-out price is based generally would include a goodwill value that would be compromised if the physician who leaves takes patients from the practice.
In light of these considerations, we conclude that the trial court erred in regarding Farber as solely an employee comparable in status to the employees of the mobile disc jockey business in Bryceland v. Northey, 160 Ariz. 213, 772 P.2d 36 (App.1989). Because Farber was a shareholder as well as an employee, the court should not have applied the strict standard of construction disfavoring enforcement of the restrictive covenant.
The corporation also argues that it is entitled to protect its patient pool and the referral sources it has developed. We agree. An employer has a protectable interest in preserving customer or patient relationships when an employee leaves. Bryceland, 160 Ariz. at 216, 772 P.2d at 39. See Karlin v. Weinberg, 77 N.J. 408, 390 A.2d 1161, 1166 (1978) (); Pollack v. Calimag, 157 Wis.2d 222, 458 N.W.2d 591, 599 (App.1990) (). In addition, the continued success of a medical practice that is dependent upon patient referrals is a legitimate protectable interest; a specialty practice that largely depends on patient referrals from other doctors has an interest in protecting its established source of...
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Valley Medical Specialists v. Farber
...to pulmonology. ¶ 6 The court of appeals reversed, concluding that a modified covenant was reasonable. Valley Med. Specialists v. Farber, 190 Ariz. 563, 950 P.2d 1184 (App.1997). The court noted that there were eight hospitals outside the restricted area where Dr. Farber could practice. Id.......