Tennessee Supreme Court Voids Most Physician Covenants Not to Compete

The Tennessee Supreme Court has effectively voided most covenants not to compete in Tennessee that prohibit physicians from practicing medicine for a specified period of time in a given geographic area.  Previously, physician covenants not to compete, though disfavored by Tennessee courts, had been enforceable.  However, enforcement typically required satisfaction of a multi-factor balancing test.  In Murfreesboro Medical Clinic, P.A. v. Udom, the Court held that, except for restrictions specifically provided for by Tennessee’s corporate practice of medicine statute, "covenants not to compete are unenforceable against physicians."  The corporate practice of medicine statute limits covenants not to compete or to solicit or treat former patients by physicians employed by hospitals (and their affiliates) and physician practice plans.  Covenants in favor of hospitals and physician practice plans that comply with those limits remain enforceable.  While the Court's holding in Udom provides additional clarity compared to the multi-factor balancing test, it also leaves open several issues:

Physician Practice Acquisitions
If the Court's holding in Udom makes unenforceable covenants not to compete imposed against a physician selling his practice, it will hamper physicians' ability to sell the goodwill associated with their practices.  Tennessee's Board of Medical Examiners defines goodwill in the sale of practice as "the opportunity to take over the patients of the seller by purchasing the physician's medical records."  The purpose of a covenant not to compete in a physician practice acquisition is to protect the value of goodwill by preventing the selling physician from interfering with those patients.  If covenants not to compete are unenforceable, goodwill becomes more difficult to value, potentially creating tension with state and federal prohibitions on self-referrals and kickbacks.  As a result, physicians may find it difficult to include goodwill in the purchase price for their practices unless the buyer is a hospital able to enter into a covenant not to compete permitted by the corporate practice of medicine statute. 

Relying on public policy arguments and its interpretation of Tennessee's corporate practice of medicine statute, the Court in Udom held that, subject to limited exceptions, covenants not to compete are unenforceable against physicians.  But the issue presented in Udom was narrower: whether a covenant not to compete in an employment agreement between a physician and his former employer is enforceable.  Accordingly, it is tempting to argue that the Court has not voided covenants not to compete imposed against physicians selling their practices.  First, Tennessee courts have typically been more sympathetic to covenants not to compete in the context of the sale of a business than in the context of an employment arrangement.  Second, in crafting its public policy arguments against physician covenants not to compete, the Court reasoned by analogy to the rules governing the legal profession.  Lawyers in Tennessee are required to abide by rules of conduct approved by the Tennessee Supreme Court.  The rules of conduct prohibit lawyers from entering into a partnership or employment agreement that restricts their right to practice after termination of the agreement.  However, the comments to the rules clarify that this prohibition does not apply to restrictions that may be included in the terms of the sale of a law practice.  Rather, lawyers may sell or purchase a law practice, including goodwill, only if the seller ceases to engage in the private practice of law in the geographic area in which the practice has been conducted.

Nevertheless, on its face, the Court's holding can be read to apply to practice acquisitions as well as employment agreements.   Further, many of the arguments used by the Court to justify a ban on physician non-competition agreements–patient freedom of choice, the right of patients to maintain an ongoing relationship with a physician, and the public benefit from having an increased number of physicians practicing in the community–apply equally to non-competition agreements in physician practice sales.  Accordingly, even if it does not void covenants imposed on physicians selling their practices, Udom certainly makes them more difficult to enforce, and thereby makes the sale of physician practices in Tennessee more problematic. 

Alternative Arrangements To Protect Investments In New Physicians
Employers and others often seek to enforce covenants not to compete not to stop a physician from leaving but to extract monetary damages.  Engaging a new physician requires a significant investment.  New physicians must be recruited and trained, and may require additional office space, equipment and administrative support.  Following the Tennessee Supreme Court's holding in Udom, employers may rely more heavily on arrangements other than outright restrictive covenants to protect that investment.  For example, an agreement with a physician might provide that if the physician severs the relationship in violation of the agreement, the physician is required to pay a predetermined amount.  However, a Tennessee court might not enforce such a liquidated damages clause if it seems to be merely a proxy for a covenant not to compete.  In Udom for example, the Tennessee Supreme Court cited a case in which it refused to enforce a deferred compensation agreement, "which was in essence a non-compete agreement."  Further, courts will not enforce liquidated damages clauses generally unless the non-breaching party's actual losses are uncertain or will be difficult to prove and the liquidated damages are a reasonable forecast of the actual losses.  Accordingly, employers and others wishing to impose liquidated damages clauses in place of covenants not to compete should carefully document their damages forecast based on factors other than losses suffered as a result of competition from the physician (e.g., hiring and training costs, additional retirement benefit planning costs and costs of additional office space, equipment and administrative support).

Non-Competition Provisions That Do Not Restrict The Practice Of Medicine
Some covenants not to compete do not restrict physicians' right to practice medicine.  For example, physician investors in ambulatory surgery centers are often prohibited from holding an ownership interest in competing surgery centers.  Such covenants were not addressed by the Tennessee Supreme Court in Udom and should still be enforceable.

Non-Solicitation Provisions
Contracts with physicians often include a prohibition against soliciting (but not necessarily treating) former patients upon the termination of the contract.  The Court did not directly address non-solicitation covenants in Udom.  One might argue that such covenants do not restrict the rights of physicians to practice or even to treat former patients and therefore should still be enforceable.  Whether the Tennessee Supreme Court would agree is unclear.

Non-Competition During The Term Of The Relationship
Presumably, covenants that prohibit competition only during the term of the relationship are still enforceable.  For example, the American Medical Association's ethical guidelines and the rules of conduct for lawyers in Tennessee, both relied on by the Court in Udom, only prohibit restrictions on practice that are triggered by the termination of an employment or partnership relationship.  Accordingly, restrictions that apply only during the term of the relationship should still be enforceable.

Physician Extenders
The Tennessee Supreme Court in Udom addressed only physician covenants not to compete.  It is not clear whether Udom will affect covenants not to compete with nurse practitioners, physician assistants and other non-physician health care professionals.

For more information on Udom and its affect on health care professionals' covenants not to compete, please feel free to contact Mark Lewis at 615-252-2347, or another member of the Boult Cummings Health Care Team.