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North Carolina Court Upholds Liquidated Damages Clause as Alternative to Covenant not to Compete in Physician Contract

  • January 22, 2003

If your medical practice has an employment agreement that includes a noncompete clause, you may be interested in a recent opinion delivered by the North Carolina Supreme Court. The case involved a North Carolina physician who challenged a provision in her employment agreement requiring that she pay a “Cost Share” to her former employer in the event she practiced in competition with her employer after termination of her employment.

The employment contract at issue included an acknowledgment by the employer and employee that the employer would incur significant expenses in hiring and training the employee and that the employer would suffer financial loss in the event of a termination of employment (due to lost revenue and costs of recruiting a replacement physician). The contract provided that a reasonable estimate of damages to the employer in the event of termination of employment (referred to as the “Cost Share”) would be (i) the total operating expenses of employer’s medical practice, divided by (ii) the number of physician-employees in the practice, times (iii) 25%. This formula yielded a damages amount of $109,029.04. The contract provided that such damages would be payable by the employee to the employer only in the event the employee engaged in the practice of medicine in the employer’s three county service area within one year after termination.

The physician-employee argued to the court that the Cost Share provision constituted a noncompete clause and that it was not enforceable because it constituted an unreasonable restraint of trade. In prior cases, the North Carolina Court of Appeals has subjected noncompete clauses to heightened scrutiny and has been receptive to public policy arguments against their enforcement. For example, in one case the court denied enforcement of a noncompete clause because enforcement would deprive the community of a subspecialty in which few physicians were trained. In this case, the court determined that the “Cost Share” liquidated damages clause was not a noncompete provision, even though it applied only if the physician practiced medicine in the restricted territory in the one year following termination. The court reasoned that the requirement to pay the Cost Share did not prohibit the employee from competing; it merely required that she pay damages to the employer if she chose to compete.

The physician in the case also argued that even if the Cost Share clause was not a noncompete, it should be unenforceable as a penalty. Courts generally will only uphold a liquidated damages clause if it is a reasonable estimate of the probable damages the employer will suffer, or if it is reasonably proportionate to the actual damages caused by the breach. If these standards are not met, the court will strike down the damages clause as an unenforceable penalty. In this case, the court concluded that the damages formula constituted a reasonable estimate of the damages that the employer would suffer.

This case provides helpful insight into interpretation of noncompete agreements and liquidated damages provisions in North Carolina. If you would like to discuss the implications of the case, please contact any of the Parker Poe attorneys listed on the following page:

Jonathan M. Crotty    (704) 335-9041

John R. Erwin    (919) 890-4510

Joy M. Hord    (704) 335-9848

Renee J. Montgomery    (919) 890-4162

S. Rogers Warner, Jr.    (704) 335-9076

Keith M. Weddington    (704) 335-9035

Stacy K. Wood    (704) 335-9844

This Alert is intended to inform readers of recent events in health care law. It should not be considered as providing conclusive answers to specific legal problems.