Red Flags – Non-Competes are Not Enforceable

March 16, 2022

In this episode, Michael and Brad break down the common perception that “non-competes are not enforceable.” Tune in as we share the story of a physician who spent close to $100k litigating his non-compete agreement. We discuss risk tolerance, state courts vs. appellate courts, and the enforceability of non-competes.

Listen to the full episode using the player below, or by visiting one of the links below. Below is the episode’s transcript which has been edited for readability. If you have any questions or would like to learn more, email us at info@byrdadatto.com.

Transcript

Intro: [00:00:00] Welcome to Legal 123s with ByrdAdatto. Legal issues simplified through real client stories and real world experiences. Creating simplicity in 3, 2, 1.

Brad: Welcome back to another episode of Legal 123s with ByrdAdatto. I am your host Brad Adatto with my co-host Michael Byrd.

Michael: Hey, Brad! As a business and healthcare law firm, we are sometimes triggered by certain buzzwords our clients will say in conversation. We know there is potential disaster when we hear these words and we’re immediately on high alert. This season’s theme is red flags.

Brad: Do you think our audience has picked up on the fact that we’re a little competitive?

Michael: I think we gave it away when we started keeping score on the number of times that we said “ding” during the episodes of the season.

Brad: Ding! I’m one up.

Michael: Well, actually it’s one-to-one Brad, because I said ding right before you and I just said it again so now I’m up. [00:01:00] Two to one. So let’s move on and let’s tell a few of our favorite compete stories to really paint the picture on our competitive fire.

Brad: All right. So those in the audience probably have heard that one of our core values is compete. And I don’t think we can go much further in this pod until we say, we have got to tell the chicken Parmesan story in New York.

Michael: Ding! Brad that may reveal a little too much about us.

Brad: You’re probably right. But audience this is just between us. So do not repeat this. It’s bad…

Michael: It’s a secret.

Brad: Yeah. So we were in New York, we there for a huge medical conference. It was you and I up there and we were going to this Italian restaurant. We were meeting a bunch of our clients and some friends, it was probably a table of at least 10 or 12 of us.

Michael: Yeah. I remember my dad was there.

Brad: Yes. And so we had one of my family friends from New Orleans, Ravi was there. [00:02:00] Ravi has a hedge fund and he had just sold so he had a house in New Orleans, had a house in New York, and so he’s like, oh, come visit us, I’ll meet you up there. So he comes along and he brought his date and neither of us have ever met her before. And you actually never had met Ravi before. And we just started asking her about her life, you know, in shocking news, I started quizzing people about who they were. It turns out that she was a former professional ballerina. And so she went on to explain about all the different productions in New York and London she was a part of, in New York, the Metropolitan Ballet. Basically, she was a big deal, but had no idea who we were.

Michael: Yeah. Nor should she have. And probably perhaps most embarrassingly, we had some of our largest clients at that dinner.

Brad: Yeah. And even though we happened to be sitting next to each other, unknowingly we both had ordered the chicken parmesan.

Michael: Yeah and audience, I do not know how to adequately describe the size of the [00:03:00] chicken parmesan that came. It was so big that the edges were hanging off the plate on both ends.

Brad: Yes and this was not a small plate either. Not a small plate kind of place.

Michael: The best I can do is just, if you take like the shape of a college football and you deflated that college football and set it on a plate. I think that’s what we both received.

Brad: Yeah. It might even be a jumbo size college football. So we started eating and I was eating and I felt like I was making no progress. And I remember debating internally whether it was just time to stop and I noticed that you had quit. You were just visiting with the ballerina and I silently kept plugging away. And then all of a sudden I stopped and asked the ballerina, hey, have I eaten more than, than Michael? And she kind of looked at me like, you know, like a dog when they kind of turn their heads sideways like, what did you just say? Like, could not believe what I just asked her. So I had to ask it again and she looked at both of our plates and she confirmed that [00:04:00] I had eaten more.

Michael: And let me just pause and acknowledge that Brad started this whole thing. He just admitted to it. So I’ll confess what happened next now, but Brad started it. I in turn, started eating again after it was revealed that I was losing and I kept plugging away until I perceived that I’d eaten more than Brad. And then I brought our judge, the ballerina back in to get her to weigh in on who had eaten more chicken parm. And she very begrudgingly checked our plates again and confirmed that I had.

Brad: So it, unfortunately, audience, it went back and forth for some time. The rest of the table was living their lives, laughing and drinking and having wine. And we were acting like two contestants at a state fair eating contest, and we just kept pushing our limits. I think to the point where we were both starting to feel sick.

Michael: [00:05:00] At one point finally, and mind you my wife was on a plane flying to come meet us.

Brad: Yeah our wives weren’t there quite yet to scold us.

Michael: And so I knew that we were going to have to be functional and meet them and go out later and so we’ve eventually decided just to call it even. Okay, I feel like I’ve got that weight off my shoulders now that we got the story out. It’s a secret, but Brad, I’ll just give you a little bit of a platform right now. Tell the audience your favorite ridiculous story about you winning against me, not a tie.

Brad: How many episodes Riley do we have dedicated to my victories over Michael?

Michael: Ding!

Brad: Okay. One example, just one off the top of my head. At our firm we like to celebrate things and so every year we celebrate our anniversary. We typically close the firm for about a half [00:06:00] day, we go grab some tex-mex, we might have a libation or two, and it’s always followed by some type of fun activity that we decide to do. One year the firm had elected to go play put putt golf that was not far from where our offices were. We broke up into different teams. It happened to be a warm day and so I determined that my team needed a bucket of ice cold brews to keep hydrated because it was hot, Michael so hydration was important. And when I approached the first hole, the ground just seemed too warm to me so I didn’t want to put the beer down. So I played the entire course one handed, never placing a beer on the ground. I had probably more than one during that 18 holes. Well the hydration was going so well and the flow of the one handed golfer worked really well that I basically just dominated it. I had several holes in one and dominated you and all the other teams. And so that was a day in which I just destroyed everyone. And of course I [00:07:00] could tell the whirly ball wins that my team has accumulated too, but I think we’ll save that for another day. Michael since I got to tell my story, you can just now make up some story about winning against me.

Michael: First of all, that little whirly ball plug at the end kind of goes back to that, I’m not going to tell another story, but I’m going to tell you real quick that I won something else. So, yeah, since we have Brad accusing me of making up, and I’m not competitive at all, but I do want the truth to be out there. Riley, please post for our YouTube viewers the picture of me with a metal from just not too long ago, this past Christmas season me winning the ugly sweater contest at Christmas. And for those who can’t see the picture, I of course won and have a metal to prove it.

Brad: You know audience, I think y’all probably heard him, [00:08:00] but yes, he did win for being ugly.

Michael: Touché. Okay well Brad, this is all fun and good and definitely revealing. Probably a little bit of an overshare, but imagine if when we started this place, if we had signed an agreement with each other that says we can’t compete with each other.

Brad: That would be so horrible. But Michael, nice transition to today’s topic.

Michael: Thank you. I did a little bow. Our red flag buzzword we’re talking about today deals with covenants not to compete and the buzzword or the phrase we hear is “non-competes are not enforceable”.

Brad: Oh my gosh. The classic locker room talk. So let’s just jump in today’s story, Michael.

Michael: So our story today is about an employed physician in private practice in Houston, Texas. We will call him Dr. Regret. [00:09:00]

Brad: Ding! I thought we agreed to move on from the chicken parmigiana incident.

Michael: We did. However, Dr. Regret signed his first employment agreement without having an attorney.

Brad: Ding!

Michael: Or even a friend review it with him.

Brad: Ding again! All right. We actually covered this scenario at the end of season four, Signing Blindly – Physician Employment Agreements with Gary Tuma.

Michael: And today we’ll specifically drill down and deal with how non-competes are not enforceable as a phrase can be a problem that will come back to haunt you.

Brad: Yeah. I probably should have dinged you while you were saying that again. We’ve heard that red flag statement way too many times.

Michael: Yes and so a little backstory, Dr. Regret was a highly recruited dermatologist, had all the top training. His grand plan was to move his family home to Houston and start his own practice. For financial reasons he decided to take a job with a large private equity backed dermatology group [00:10:00] to generate cash flow and to get settled before going out on his own.

Brad: Yeah. And we’ve touched on this before. We’ve heard the term derm roll-ups, basically when a private equity comes along, they’ve been acquiring medical practices for many years all across the country and they basically integrate it into a much larger practice.

Michael: Yeah. The model is built around the idea of having a ton of employed physicians. Some of the models have a pathway for the physician to become an owner, but it’s a little different than your traditional practice in that they become an owner in an MSO.

Brad: Oh Ding! Sorry, ding! You of all people, Michael. You just casually dropped this term and you love context. So we’ve discussed this many times in the past, but the vocabulary word of the day so far is MSO. And for those who don’t know, our loyal listeners probably do, management service organization, is what MSO stands for. And that’s how non-physicians [00:11:00] often can become involved in medical practice enterprise.

Michael: Yeah so obviously in a derm roll up, we have private equity involved that’s going to be the model. The MSO is addressed and season one, The Painful Discovery of the basics of Med Spa Compliance. And we talk about ownership and the MSO in part two of that two part episode.

Brad: That’s right we did cover it at length. So Dr. Regret, he decides, as you said, to join this private equity derm group. So let’s call them Dermatology Worldwide.

Michael: Nice. You know I love the movie Stepbrothers and I cannot hear the term worldwide without thinking about Prestige Worldwide, the company that they founded. So let’s roll with it. Dermatology Worldwide presented Dr. Regret his employment agreement and informed him that this is the contract that all the doctors signed.

Brad: Oh, ding! This is [00:12:00] straight out of, “don’t even try to negotiate, this is how it works.” And this is the playbook a lot of these larger organizations try. I’m hoping, just hoping that maybe Dr. Regret had listened to the podcast episode we did with Gary Tuma when he was told he couldn’t negotiate?

Michael: Well, Brad, his name is Dr. Regret so we all know this does not end well. And I don’t think that episode was out back when this happened, but that’s a side note.

Brad: Oh he can’t go back in time?

Michael: Because Dr. Regret was going to be a short timer, he did not see the need to pay someone to review his contract.

Brad: Ding!

Michael: Or run it past anyone.

Brad: Ding!

Michael: The only provision that mattered to him was the super strict non-compete.

Brad: Ding! Lots of dings there. Non-competes Michael, in their pure nature are supposed to be strict. So what does super strict mean?

Michael: Well, Brad, it means extra or more. But this non-compete, [00:13:00] if you want to really know what it was, would prohibit him from practicing medicine within 60 miles of any Dermatology Worldwide location for three years after he left the practice.

Brad: Ding! You got to be kidding, you’re not kidding right? That is super strict. Okay, I’ll go with you on this one. And this is in Texas and physician non-competes in Texas they can be allowed, but they have to have a buyout clause. So did Dr. Regret have one of those?

Michael: Yes, it did have a buyout. He could buy out of the non-compete for $600,000. And this was two times his base salary.

Brad: Okay. Well, that’s somewhat normal in some capacity. So he recognized the non-compete was important to him. Why didn’t hire an attorney to help him?

Michael: His best friend in California had told him non-competes are not enforceable.

Brad: Ding, ding!

Michael: Why the double ding?

Brad: Okay. Well, we already started this. [00:14:00] There’s this staff room, locker room talk that always seems to get people in trouble. And it’s about as reliable as probably going to Wikipedia and trying to find out your information for your term paper. Whatever the subject matter is, you have no idea if it’s actually real information.

Michael: Well, and this particular statement is common and we hear it from the young physicians and sometimes even the older ones.

Brad: Yeah. And the reason why I did a second ding is for our audience to understand it is a state law issue. Non-competes are in fact, as his friend said, unenforceable in California, but they are allowed in Texas if the non-compete meets certain criteria that is written out, but I won’t get into that.

Michael: So Dr. Regret signed his contract with a super strict non-compete and in his mind it was [00:15:00] unenforceable.

Brad: Oh ding!

Michael: So we came into the picture when Dr. Regret was wanting help to start his new practice, and he kind of threw in at the end, “hey, do you mind checking out my contract where I’m currently at as part of this, just to make sure? You know, it’s got a non-compete in it”. He didn’t use the word super strict, he was like, “yeah it has a non-compete in it, but I’ve heard those are not enforceable”.

Brad: Well, hopefully Dermatology Worldwide was laid back about their non-competes.

Michael: Well, Brad, it turns out that the private equity group that had invested $100 million plus into the Texas roll-up and was in fact not that laid back about it. And in fact, they were quite the opposite of laid back.

Brad: Yeah unfortunately, that’s not really a surprise to us. So what happened?

Michael: So of course we’re in the midst of trying to get Dr. Regret’s entities [00:16:00] set up and we review this and we said, okay, well, let’s talk we got some risks here. And we did talk about the fact that, hey, this is probably outside the bounds of normal for a non-compete, but there’s non-competes that are enforceable in Texas and there’s some serious risks here. And so after weighing all that, I think Dr. Regret continued to live up to his name and decided to go with the head in the sand strategy.

Brad: Ding!

Michael: And decided that he wasn’t going to approach or negotiate with Dermatology Worldwide.

Brad: Ding!

Michael: He was just going to leave, put in proper notice, and go forward with opening his practice inside of the super strict non-compete.

Brad: Oh, that’s a double ding! Do we have a gong ding I can hit so loud? But maybe that would hurt our audience’s ears.

Michael: I’ll ding your ding. I’ll raise you a ding. It did [00:17:00] not go well for Dr. Regret. He was sued.

Brad: What?

Michael: Yes, yes. And then he had to hire litigation counsel to defend him. Here’s the good news, Brad, the court agreed that the restraint on trade, it’s kind of a legal buzzword, but what they’re saying looking at the 60 miles, they agreed that that was unreasonable.

Brad: Well for our audience, this probably sounds like a great result. Meaning that the non-compete was unenforceable?

Michael: Um, not so much. The court lessened the non-compete to 20 miles and two years through the reformation clause in the contract.

Brad: Ding for using legal jargon, Michael! All right. So we’ve got our next vocabulary word, which is reformation clause. This is a clause in a contract that actually allows the judges to modify certain pieces, in this case, the non- competes. And so if they say it’s too restrictive, then they can just kind of make it [00:18:00] so that it’s not as restrictive, so it could still be enforceable. So in a lot of states, you might hear the term called the blue pencil law, but basically it allows the judge to update the document to make it legal.

Michael: Yes. And just to have a little frame of reference on what that journey looked like, Dr. Regret spent close to a $100,000 litigating his non-compete.

Brad: Man, did the reduction in the mileage help him with his new practice?

Michael: Again Brad, his name is Dr. Regret. So no. Dr. Regret had signed a long-term lease. When I say long term, I mean a 10 year lease for his new practice about 10 miles from the office where he had worked.

Brad: I don’t know if I am supposed to say double ouch or double ding. So what did he do?

Michael: Well he borrowed money from the bank to stroke a check for the $600,000 buyout of the non-compete, because remember it had that provision in there. And so [00:19:00] all told he spent about $700,000 to leave that practice instead of the few thousand if he had just hired someone to help him on the front end.

Brad: That is unbelievable. Michael, let’s go to commercial and on the other side let’s talk about the enforceability issues that we’ve somewhat raised with the dings on the non-competes.

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Brad: Welcome back to Legal 123s with ByrdAdatto. I’m your host Brad Adatto with my cohost Michael Byrd. Now, Michael, this season’s theme is red flags. Why is there this locker room talk out there about these non-competes being not enforced?

Michael: Like many things there are with this particular kind of reputation out there is that there are strands of truth that kind of have evolved through the years, kind of like the game of telephone. So non-competes are controversial and even in some states they are not enforceable. But somehow what’s evolved is just this common perception as a blanket statement that non-competes are not enforceable.

Brad: Yeah. I completely agree with you. Oh, wait, cut that out. Sorry. It is a game of telephone and like in this story they hear that non-competes are not enforceable and they just wrongly assume every state has to be the same, right. And you know, I’ve actually heard clients that just had a meeting state the same thing or they said, oh, well, I just heard that since president Biden went and signed that executive order [00:21:00] non-competes are therefore not enforceable anymore, which is again, audience is not correct. So let’s talk about the reality, which of course is more complicated. And so when we discuss these things with the clients, we often say, look, there’s a risk involved and everybody has different risks. And we’ve talked about this, but your risk tolerance really is are you afraid to step out of the shower in the morning or are you the kind of person that jumps out of an airplane, right? Those are two very different risk tolerances. And so when you’re looking at a non-compete, they need to understand the risk associated. And I think one of the things we’ve talked about before is just because it might not be unenforceable or maybe that we look at it doesn’t mean that they won’t try to enforce it.

Michael: Yeah. I mean, I try to explain the risk and I use the analogy of a non-compete with playing poker.  

Brad: And audience, Michael loves playing poker.

Michael: I do. I do love playing poker.

Brad: That’s where the compete comes out hardcore.

Michael: Yes. And so if you think about a poker [00:22:00] game, the validity of your position in whatever state you’re in are the cards that you’re dealt. So you sign a contract, it’s got a non-compete and if that state is like California, you may have a nicer hand than if you were in a different state. But those are your cards. The second element are the stack of chips you have to play the game. Now as Dr. Regret learned when he spent a hundred thousand dollars to stay in the poker hand that poker can be quite expensive and litigation’s expensive. And so this isn’t some random offshoot that he spent a hundred grand. That’s actually really common that kind of fight to stay in the game, it’s going to cost a lot. Now, if you’re the departing physician going up against a practice, guess who has the bigger stack most often. And so you have to [00:23:00] deal with that element of, are you going to stay in the fight or are you going to fold them to move on to live another day? And then the third element in the poker game are the players themselves. You talked about this just a moment ago with risk tolerance of everyone. If you are Dr. Regret and you’re dealing with private equity, I think they’ve probably played poker before and they weren’t going to back down. We have some other clients who we know that the employer physician is very conflict averse and, you know, by reputation, maybe even past experiences won’t fight the fight, and that’s relevant when you’re evaluating what to do. So that’s a way to big picture kind of think about the non-compete. And while we’re talking about poker, I am better than Brad.

Brad: Ding! I thought we said we weren’t [00:24:00] going to talk about how our competition was taking out on this, but okay. Using the poker analogy, you laid out literally the cards, and so how does someone know if you have a strong or a weak non-compete?

Michael: Yeah, this is difficult. So I mean, in some states it might be easy because California is clear that non-competes are not enforceable. And so if you’ve signed one, the employer has a weak hand, but they do have a hand. And so the way to think about what you have to look at, is you look at first of all, the contract itself. And how is the law written in that particular state? And so in Texas, for example, the Supreme Court has bolstered the enforceability of non-competes, the appellate courts have and so non-compete law is well and good. So the first thing you do [00:25:00] is you look at the actual contract, compare it to the law, and you kind of understand how your hand lays. Here he didn’t have a great hand. He had a decent hand because of the 60 miles and three years, but there’s a reformation clause in it. So you have to weigh that. And then here’s the outlier is that the state courts, the courts where you go before the judge often can’t stand non-competes. And so they’re the ones looking in the eyeballs of an employee who will be displaced from working. And a lot of times they’ll just say, hey, you know, I don’t care what the law says I’m not going to keep this person out of a job. And so it brings a new balance to that risk. You know, in this case, just talking about Texas, but looking at it from both perspectives and it’s kind of gotten to the point where I don’t care if I’m talking to an employer or an employee in [00:26:00] Texas, and I’ll just say, hey, you know, it’s a coin flip.

Brad: Yeah. So this is messy, Michael, and this triggers a lot of other conversations, but when it comes to signing a contract and it has a non-compete, you’re basically saying they’re going to have to do a coin flip. So in cases like Dr. Regret, what happens when you have an aggressive non-compete?

Michael: Well, Dr. Regret is a classic example that there is no such thing as no risk, even though he thought, with his blanket statement, they’re not enforceable. Because even a non-compete written in a state that would consider it unenforceable, it has a cost to it, right?

Brad: Sure does.

Michael: So even if he didn’t have a reformation clause that ended up hurting him, he would have spent a hundred thousand dollars to get there, to get his justice. And unfortunately for him it did have a reformation clause. And so again, just [00:27:00] using the analogy you have to pay to play. And if you allow a non-compete in the contract with the thought that it’s unenforceable, you have signed on for a future poker game. And so you better build up your stack of chips.

Brad: So two follow-up questions. Number one, does Dr. Regret ever want to play poker with me? Um, and number two… don’t answer that one, let’s strike that from the record. How is Dr. Regret doing? This sounds like it’s been pretty hard so far.

Michael: Believe it or not, he has a great practice and learned a great life lesson. He actually hired his first physician recently and included a non-compete. I didn’t smirk too big when I was on that call. More importantly, he’s an Access+ member and calls us to help him regularly than trying to do things [00:28:00] on his own. So Brad, let’s wrap this episode up. What final thoughts do you have?

Brad: Well, you know, a lot of people, they forget Michael, why would you have a non-compete? So I’m glad that you’re summing up that, you know, as someone who lived through the non- compete fight. He didn’t realize the importance of a non-compete. Non-competes can be extremely useful tools for many business, including medical practices. It helps protect the value they build up in their enterprise. This can be their Goodwill, their trade secrets, helping retain employees so they don’t go off and go to this direct competitor, and obviously enables like the practice or the employer to benefit over long-term periods of time. And as we have said often in many cases, the states will allow it if they’re correctly drafted. So non-competes for the audience can be enforceable and sometimes there are necessary for the betterment of the business.

Michael: You raised some great points and that is [00:29:00] for the audience to walk away thinking non-competes are bad, they have their place. And so I think that my takeaway is just that, hey deal with this on the front end and identify, whichever side you’re on, is this something that’s important and valuable to you and what you’re trying to accomplish? And if there’s a disconnect, that’s what negotiations are for. And so you won’t inadvertently find yourself in a chicken parm eating contest to the point of getting sick and not really feeling like going out with the wives afterwards.

Brad: So yes, that’s a good point. Well, Michael, next week is our final show of season seven. It’s going to be awesome. So you have got to bring your A-game because we’re talking about Red Flags – One Page Contracts. Outro: Thanks again for joining us today. And remember, if you liked this episode, please subscribe. Make sure to give us a five- star rating and share with your [00:30:00] friends. You can also sign up for the ByrdAdatto newsletter by going to our website at byrdadatto.com. ByrdAdatto is providing this podcast as a public service. This podcast is for educational purposes only. This podcast does not constitute legal advice, nor does it establish an attorney-client relationship. Reference to any specific product or entity does not constitute an endorsement or recommendation by ByrdAdatto. The views expressed by guests are their own and their appearance on the program does not imply an endorsement of them or any entity they represent. Please consult with an attorney on your legal issues.

ByrdAdatto founding partner Michael Byrd

Michael S. Byrd

ByrdAdatto founding partner Brad Adatto

Bradford E. Adatto