Anatomy Of The Asset Purchase Agreement Part 4: Non-Compete And Non-Solicitation Agreements

Our previous posts in this series looked at different ways you can structure the exchange of assets in a practice purchase agreement.  This post will look at a different topic: how non-competes can be structured so that a buyer can preserve the value of his investment in the practice, while a seller can continue to pursue his career without overly burdensome restrictions.

Considerations Behind Non-Compete And Non-Solicitation Agreements

A non-compete agreement typically restricts a selling doctor from practicing within a defined geographical radius for a specified period of time.  A non-solicitation agreement prohibits a selling doctor from contacting current patients and enticing them to see him at his new practice, regardless of where the practice is located.  Depending on the circumstances, non-solicitation agreements can also include restrictions on the selling doctor’s ability to recruit staff members away from the practice as well.  Non-compete agreements and non-solicitation agreements are commonly referred to collectively as restrictive covenants.

If you are selling your practice because of retirement or disability, restrictive covenants will likely not be a concern.  However, if you intend to continue practicing, the buyer will almost certainly insist on including restrictions that will affect where and how you can practice.  From the buyer’s perspective, if you have spent hundreds of thousands of dollars to purchase a business, you do not want the seller to be able to open a new office down the street, poach all of the practice’s patients and hire away its staff.

Limitations on Restrictive Covenants

Given the competing interests between the buyer and seller, it is best for both sides to work together to arrive at a reasonable scope and duration for any restrictive covenants.  Non-solicitation agreements are generally enforceable, especially as they relate to staff, so the parties will have to use their judgment in negotiating the terms of a non-solicitation provision.  However, courts often limit or eliminate non-compete agreements, and parties to an asset purchase agreement should be aware of these limitations when negotiating the terms of the asset purchase agreement.

The leading Arizona case on this issue is Valley Medical Specialists v. Faber.[1]  In Faber, the Arizona Supreme Court identified the important considerations applicable to non-compete agreements involving medical practices, including the right of the patient to continue seeing the physician of his or her choice.  As a result, non-compete agreements for medical and dental practices will be very limited.

There is no bright-line rule for determining when a non-compete agreement will be enforced.  However, in Faber, the court found that a three year restriction on practicing any medicine within a five-mile radius of any Valley Medical Specialists’ three offices was unreasonably broad.

The Faber court also rejected the lower court’s attempt to modify the non-compete agreement to make it more limited, holding that Arizona courts can only strike out unenforceable provisions, they cannot re-write the parties’ contracts.  As a result, a common feature of non-compete agreements following Faber is to include “step-down” provisions.  These start out with a broader non-compete agreement, and progressively step down the limitation.  For example, a non-compete agreement may provide:

Seller hereby covenants and agrees that for a period of three (3) years after termination of this Agreement for any reason, Seller shall not practice medicine within a five (5) mile radius of the Office.

Notwithstanding the foregoing, (i) if a duration of three (3) years is deemed to be unreasonable, then the duration shall be reduced to two (2) years; if two (2) years is deemed to be unreasonable, then the duration shall be reduced to eighteen (18) months; if eighteen (18) months is determined to be unreasonable, then it shall be reduced to twelve (12) months; (ii) if the geographic scope is deemed to be unreasonable, then it shall be reduced to a three (3) mile radius; if a three (3) mile radius is determined to be unreasonable, then it shall be reduced to a one (1) mile radius.

Without this type of step-down provision, if a court determines the original three year and five mile radius restriction to be unenforceable, the entire non-compete provision is stricken.  This essentially gives a court options in determining the reasonableness of the restrictions without completely striking the non-compete agreement, as happened in Faber.

One additional and important factor in the Faber case was that it involved an employment agreement, rather than the sale of an existing practice.  Courts are much more likely to enforce a non-compete agreement when it involves the sale of an existing practice, rather than an employment agreement.  The rationale for this is that courts recognize that when a party buys an existing medical or dental practice, the parties are in more equal bargaining positions, and that a large portion of what that doctor is buying is the practice’s goodwill.  Courts will allow broader non-compete agreements in the practice sale context to allow the buyer to protect his interest.

Remedies For Violating Restrictive Covenants

There are two main avenues for enforcing restrictive covenants.  The first is through injunctive relief.  That is, the buyer can file a request with a Court to have an order issued prohibiting the seller from continuing to practice in violation of the covenant.  This creates a considerable risk for the seller in violating the non-compete provision.  If the seller opens up his own practice or accepts employment in violation of the restrictive covenant, he can be forced to sell or abandon his office or leave his employment.  Since this remedy can be harsh, courts are often reluctant to grant injunctive relief, absent a clear, intentional violation.

The other common method for enforcing restrictive covenants is through a liquidated damages provision.  When the asset purchase agreement is negotiated, the parties can agree on a set amount as a damage provision for violating the restrictive covenants.  These are frequently in the tens of thousands of dollars, and they are generally easier for a buyer to prevail on a claim for liquidated damages than it is to obtain injunctive relief.  Therefore, this can be an effective way for a buyer to protect his investment in a practice.

Every practice sale is unique, and these are just some of the issues that arise as you and the other party negotiate the best way to structure the asset purchase agreement and care for your patients.  Whether you are buying or selling a practice, you should consult with an experienced advisor to guide you through how best to structure the transaction.

[1] 194 Ariz. 363 (1999)