Restrictive covenants preventing competition by former employers are enforceable only to the extent that they are reasonable under New Jersey law.
Lawyers and psychologists are exceptions to the general rule, however, because both are subject to disciplinary rules that prohibit restrictions against competition.
Courts have recognized that the personal relationship and confidentiality that exist between a lawyer or psychologist and their clients are such that a restriction on competition is appropriate.
Physicians continue to be subject to restrictions on competition that protect a legitimate interest and that do not impose unreasonable restrictions on the party subject to the agreement.
In the world of business divorce, one of the key issues is the existence or absence of restrictive covenants that prohibit competition from former shareholders, partners, members or employees. It affects the value of a business – particularly professional and sales-driven businesses – because restrictive covenants generally protect the good will of the enterprise.
There are only two classes of professionals for whom restrictions on competition are always unenforceable. These are lawyers and psychologists, not because of any specific distinction between them and other deeply personal relationships, but because the professions are subject to unique restrictions. Attorneys are prohibited from restricting competition by the Rules of Professional Conduct that govern lawyers. Psychologists are subject to an administrative regulation that have the same effect.
Restrictions on Competition Barred by Regulation
In a 2005 decision, the New Jersey Appellate Division distinguished between physicians, who are subject to “reasonable” restrictions on competition, from those imposed on psychologists.
There are also two classes of restrictive covenants to consider. The are those restrictive covenants in which there has been some purchase of good will, which courts will distinguish from a traditional employment business. Enforcing a restrictive covenant against a party that has sold a business, for example, is going to be quite different from enforcing a restrictive covenant against
When there is no contractual limation to restrict the key players from competing, or when restrictive covenants are unenforceable, the value of the good will in the business is typically diminished. Consider the rainmaker who leaves a law firm with his or her large book of business. All of the good will tied up in those relationships is portable, and any valuation of the firm has to consider the loss of those clients and so much of the reputation of the firm that was tied to the departing attorney.
The rules that limit the ability of lawyers and psychologists to participate in or be subject to a restrictive covenant are the exception, one that arises not from general legal principles, but from regulatory oversight.
Appellate Division Bars Enforcement of Restrictive Covenant against Psychologist
In Comprehensive Psychology Systems, PC v. Prince (see opinion here) , a 2005 opinion of the the New Jersey Appellate Division, the court refused to enforce the non-compete clause in the employment agreement of a licensed psychologist. The agreement at issue in the case prohibited the departing defendant psychologist from practicing for two years within 10 miles of any of plaintiff’s locations or any hospital used by plaintiff and also probibited the defendant from soliciting any patient or referral source or hiring any of its employees.
The court declined to consider whether the restrictions were reasonable, relying on a regulation adopted by the Board of Psychological Examiners the prior year:
A licensee shall not participate in offering or making a partnership or employment agreement that restricts the right of a licensed health care professional to practice the licensed profession after termination of the relationship, except an agreement concerning benefits upon retirement.
The court held that the regulation (similar to the rule governing attorneys), including an amendment after the trial court’s decision, prohibited enforcement of the restriction, and distinguished psychologists from physicians. The court noted, first, that physicians are not subject to any similar regulation. In addition, the court noted that the psychologist-patient relationship was unique.
[A]part from the existence of the regulations, the nature of the practice of psychology and the uniquely personal patient-psychologist relationship forbid any restrictions which might interfere with an ongoing course of treatment. We do not believe it is sufficient to say that the psychologist can continue to treat patients who seek out the doctor. We perceive that a psychologist who changes his office location, voluntarily or involuntarily, has a duty to inform patients of the change and the new location and phone number.
Restrictions Against Competition May Be Enforceable Against Doctors
Later that same year, the Supreme Court in The Community Hospital Group v. More (full opinion here) declined to reverse its existing precedent and extend the per se prohibition on restrictive covenants to physicians. The court affirmed its existing reasonableness standard, articulated in Karline v. Weinberg in 1978 (opinion here).
Restrictions on competition are unethical of the lawyers’ Rules of Professional Conduct 5.6 and unenforceable under New Jersey for many years, and definitively since the Supreme Court’s decision in Jacob v. Norris, McLaughlin & Marcus (opinion here). The court held that although restrictions on competition are discouraged by the American Medical Association, they are not prohibited by any applicable regulation and that the reasonableness standard would continue to be applied.
In considering the reasonableness of the restriction courts must determine whether the restrictive covenant is necessary to protect the employer’s legitimate interests in enforcement, (2) whether it would cause undue hardship to the employee, and (3) whether it would be injurious to the public
Feel free to contact me if you have any questions on this topic.