Enforceability of Liquidated Damage Clauses in Physician Non-Compete Agreements
While physicians may not be enjoined from practicing medicine in Colorado under the Colorado non-compete statute, the statute does allows non-compete provisions with physicians that “require the payment of damages in an amount that is reasonably related to the injury suffered by reason of termination of the agreement.” C.R.S. § 8-2-113(3).
As a result, it has been increasingly common for medical practices to include “liquidated damage” clauses in non-compete provisions in physician employment agreements. A liquidated damages clause specifies a predetermined amount of money that must be paid as damages for failure to perform under a contract (such as by competing in violation of a non-compete provision). Liquidated damage clauses are agreed upon in advance of any breach (usually at the outset of the employment relationship) to provide a remedy in the event of a breach of contract.
While the statutory provision allowing damage awards against physicians has been in effect for over 35 years, it has been interpreted in only two published decisions by the Colorado Court of Appeals. These decisions have both addressed the critical question of whether the amount of a liquidated damages clause is “reasonably related to the injury suffered,” as required by the non-compete statute, for the provision to be enforceable.
In Wojtowicz v. Greely Anesthesia Servs., P.C., 961 P.2d 520 (Colo. App. 1997), the Colorado Court of Appeals held that a liquidated damages provision requiring a physician to pay 50 percent of his fees from practicing medicine in competition with his former practice to be unenforceable. In evaluating the liquidated damages clause, the court recognized that liquidated damage clauses in physician contracts may not be: (1) “based on speculation or conjecture” or (2) “sustained by evidence that is speculative, remote, imaginary, or impossible of ascertainment.” Id. at 522. The Court found the liquidated damages clause unenforceable, relying primarily on evidence that the net profits of the physician’s former practice remained essentially unchanged after the physician left the practice. As the net profits had not changed, the court held that the practice failed to show that the liquidated damages amount was “reasonably related to the injury suffered,” as required by C.R.S. § 8-2-113(3). As a result, the liquidated damages clause was found to be unenforceable.
More recently, in Crocker v. Greater Colorado Anesthesia, P.C., 2018 COA 33 (Colo. App. 2018), the Court of Appeals provided additional – and much needed – guidance on how to evaluate whether a liquidated damages clause in enforceable under C.R.S. § 8-2-113(3). In that case, a physician signed a shareholder employment agreement with his employer, old GCA, with a provision for liquidated damages to be paid if the physician engaged in competitive activity within two years of his termination from employment. The liquidated damages clause provided that a physician who violated the non-compete provision had to pay: (1) the three-year annual average of the gross revenues produced by the doctor’s practice; (2) minus the three-year annual average of the “direct cost of [old GCA] employing Employee,” which included “direct compensation paid to Employee and expenses paid directly on behalf of Doctor by [old GCA]”; (3) multiplied by two, to reflect two years of competition; and (4) plus $30,000 to cover the estimated internal and external administrative costs to terminate and replace the competing doctor.
The trial court determined that the liquidated damages clause was unenforceable because old GCA failed to prove any damages in the case – such as evidence that work had been diverted or that revenue had been reduced. The Court of Appeals affirmed, holding that the “statute directs that a damages term in a noncompete provision such as here is enforceable only if the amount (whether a fixed sum or calculated pursuant to a formula) is reasonably related to ‘the injury suffered,’” in the past tense.” Id. at 3. Thus, under this analysis, the court found that “the reasonableness of the relationship between the two amounts must be demonstrated, and it cannot be analyzed prospectively; by definition, it can only be determined upon termination of employment.” Id.
Under Crawford, courts must now determine that a liquidated damages provision is reasonably related to the injury actually suffered at the time of a physician’s termination from employment, as opposed to the injury anticipated at some earlier point in time. If no reasonable relationship to actual damages at the time of termination is demonstrated, then the provision will be held unenforceable under the Crawford analysis. All non-compete provisions in physician contracts should be drafted with this analysis in mind to increase the likelihood that the non-compete provision will be enforced by the courts in the event of a breach.