CAGEY COVENANTS
To compete or not compete, that is the question. I am often asked
whether covenants not to compete are valid, and whether they will
withstand legal challenge. In general, a covenant not to compete is
designed to assign a value to the ‘goodwill’ of a dental practice.
Goodwill represents the ‘intangible’ or ‘soft’ assets of a practice. This
can include the reputation of a practice, the doctor, the patients and a
number of other things. The covenant, or promise, usually consists of an
agreement by a doctor not to practice within a certain number of miles
from a dental office with which he had a previous relationship. The
covenant is usually for a certain length of time and is in exchange for
money.

South Bay Medical Association v. Dr. W. M. Asher, a Court of Appeals
case from the San Diego area, does an excellent job of explaining
when covenants not to compete are valid in partnership agreements.
Dr. Asher was a radiologist and a partner in a four physician radiology
group. Luckily, this group had a formal, written partnership agreement
that narrowed the legal issue and thus the costs of this lawsuit.   

Dr. Asher tragically broke his neck in a skiing accident. He recovered
from most of his injuries, but was left without the full use of his right
thumb and forefinger. Dr. Asher was unable to perform certain
radiographic services which the group required and was therefore
‘kicked out’ of his group. In his status as a ‘dissolving partner,’ Dr.
Asher was entitled to money for the value of his portion of the
partnership. However, Dr. Asher and his former partners locked horns
on the issue of goodwill. When the partnership agreement was drafted,
the partners specifically agreed that upon a forced sale as in the case
of a disability, goodwill would have no value. Since the contract had a
mandatory arbitration clause before litigation could be pursued, the
parties headed for an arbitrator to solve their dispute.  

Dr. Asher argued to the arbitrator and later to the Court of Appeals that
the contract provision, which stated that he could not compete in the
surrounding area for a certain length of time, was not valid. Specifically,
Dr. Asher argued that the clause constituted an illegal restraint of trade.
Dr. Asher acknowledged that he had signed the partnership
agreement, and had agreed to that contract provision. However, he
said that when he signed the agreement he did not know the provision
constituted an illegal restraint of trade, based on Section 16600 of the
Business and Professions Code. This section states that a “contract by
which anyone is restrained from engaging in a lawful profession, trade,
or business of any kind is to that extent void.” Therefore, even though
the clause was in the contract, it was illegal and could not be enforced.
Furthermore, the practice had built up quite a bit of ‘goodwill’ which was
very valuable.

Unfortunately for Dr. Asher, the Business and Profession’s Code
specifically deals with the partnership covenant not to compete issue in
a section known as the ‘dissolving partner exception.’  This statutory
exception clearly upholds the validity of a covenant not to compete
clause in a partnership agreement. Courts have consistently followed
this statute, finding in this case and in others that it was certainly
reasonable that partnerships would wish to “protect themselves from
the risk of diminishing a partnership’s on-going goodwill by a
withdrawing partner” with a covenant not to compete clause.

In addition to illustrating the validity of a covenant not to compete in a
partnership agreement, this case also shows the value of an alternative
dispute resolution provision. Mediation and arbitration clauses in
contracts are routinely found valid by courts, and even if the clause
allows court intervention, as this one did, courts are reluctant to disturb
an arbitrator’s opinion. These provisions can and should be effectively
used with patients, employees, in sales contracts and in many other
business transactions as well as partnership agreements.

© Bette Robin, DDS, JD 8/97
Bette Robin                                                                                      714-421-4407
Dentist, Attorney, Real Estate Broker                                                                                                                                    
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