Golden handcuffs: enforceability of non-competition clauses in professional partnership agreements of accountants, physicians, and attorneys

INTRODUCTION

The justification for their special position rests on their expertise and on training that purportedly inculcates values leading appropriately to regulation by their peers rather than by outside watchdogs.(1) Whether courts sought therefore treat professionals differently from those engaged in other occupations is an issue in the enforcement of non-competition clauses.

This question has become more troublesome in the last ten or fifteen years, particularly concerning legal partnerships. As Chief Justice Rehnquist remarked a few years ago, “Partners in law firms have become increasingly |mobile,’ feeling much freer than they formerly did and having much greater opportunity than they formerly did, to shift from one firm to another and take revenue-producing clients with them.”(2) Recently the Wall Street Journal noted, “Rainmakers–partners who bring in hefty clients– used to stay put for life. But the prosperity of the 1980’s triggered an unprecedented free-agent market for heavy hitters.”(3) Recognizing this, law firms have faced a dilemma in trying to draft partnership agreements that discourage the departure of “heavy hitters” and their clients without restricting their right to practice law. Consequently, courts have had more frequent opportunities to decide whether to enforce restrictive covenants on withdrawing partners in professional legal partnerships.

Even forty years ago, as one court described it, the case law on covenants not to compete in employment contracts alone was “a sea–vast and vacillating, overlapping and bewildering.”(4) Enforcement of such clauses has been the subject of innumerable law review articles and annotations.(5) This article examines how courts have viewed non-competition clauses in a different, increasingly more important, context that has received little attention: the enforceability of such clauses as they appear in professional partnership-agreements of accountants, doctors and dentists, and attorneys, especially when they are formulated as indirect restrictions or financial forfeitures, rather than as absolute restrictions on the departing partner’s professional practice.(6) The article discusses the different standards courts have applied in deciding whether or not to enforce non-competition agreements involving accountants, physicians, and attorneys. It analyzes the interests involved in such agreements and concludes that many of those interests deserve protection. Therefore, lawyers and other professionals merit special treatment by courts considering whether to enforce such clauses. These interests can be safeguarded by upholding carefully crafted financial forfeiture provisions rather than by striking down such indirect restrictions on competition. Absolute restrictions on these professionals, however, should not be permitted.

Historical Background

Agreements not to compete have a long history. These clauses have appeared in employment contracts, contracts for the sale of businesses, and in partnership agreements. Until the sixteenth century, English courts generally found them to be illegal restrictions on economic freedom.(7) By the eighteenth century, however, judges looked on such agreements more favorably and developed an analysis leading to a “reasonableness” test for determining their validity.(8) Whether such a clause is reasonable has come to depend on three considerations: the geographical area covered, the time period it is to be in effect, and the interests to be protected,(9) including the interest of the public in general as well as those of the parties to the contract.(10)

Courts have been more willing to find such clauses reasonable when the contract is for the sale of a business rather than for employment.(11) Since the value of the business’s good will figures in the purchase price, the buyer deserves protection from the former owner’s possible competition.(12) When the contract is for employment, however, courts view such restrictive clauses more skeptically and they are less likely to limit the employee’s chances to obtain future employment, unless the restraint is minimal or the employer has a strong interest to protect, such as lists of clients or other confidential information.(13) The considerations to be taken into account by a court when professionals dealing on an equal level have agreed to such clauses, and where the restriction is mutual, differ from those in employment agreements, where the parties lack equal bargaining power and the restriction is one-sided. In addition, several states have passed statutes that prohibit all agreements not to compete except in limited circumstances

The enforceability of such restrictions, especially indirect ones such as financial forfeitures, in the context of professional partnership agreements when a partner withdraws, is an emerging area of the law. Courts have applied different standards when viewing these restrictions in partnership agreements of accountants, physicians, and attorneys.

Accountants As Business Persons: A Reasonableness Standard

The treatment accorded accounting professionals by the courts most closely resembles that given to business people. Non-competition clauses in agreements of accounting partnerships have thus been judged by the same standard as non-professionals — that of reasonableness — and both direct and indirect restrictions are generally enforced by the courts.(15)

Direct Restrictions: A Reasonableness Test

A Colorado court enforced a covenant not to compete restricting the withdrawing partner from practicing accounting in or/within forty-five miles of Greeley, Colorado for a period of five years.(16) The restriction was found to be both reasonable and mutual among all the partners. The court noted furthermore that in this case, unlike previous non-competition clauses which had also been upheld, the withdrawing partner would receive ten percent of the cash receipts of the partnership.(17)

In Peat, Marwick, Mitchell & Co. v. Sharp, one of the first cases in which a court held a restrictive covenant agreed to by an accountant invalid, the court based its decision on the failure of the clause to specify a reasonable geographic area.(18) Concerning a withdrawing partner, the agreement provided:

Except at the request of the Firm, a Partner or Principal not vested
under the Retirement Allowance Plan shall not engage directly or
indirectly in the practice of Public Accounting in any of its phases
within the Territory of the Partnership for a period of two (2) years
after the date he ceases to be a Partner or Principal, except with
the written permission of the Executive Committee and then only
with the understanding that such Partner or Principal shall not
solicit or perform services for any client of the Firm or any organizations
with which the Firm was negotiating for the provision of
its services on that date.(19) Noting that Peat, Marwick, Mitchell & Co. has offices throughout the United States, and applying the traditional test of reasonableness, the court refused to enforce the clause.(20)

An important consideration for at least one court in deciding not to enforce a non-competition clause was that the partner withdrew involuntarily. In that case the other partners had forced the withdrawal of the accountant against whom they then wished to enforce the covenant not to compete.(21) The restriction at issue applied to a radius of sixty miles from the State House in Columbia, South Carolina for a period of three years. The court held that because the only reference to the non-competition clause appeared in the section of the partnership agreement on voluntary withdrawals, it did not apply to involuntary withdrawals.(22)

Indirect Restrictions

As the following cases indicate, courts have been especially willing to uphold non-competition clauses when the restriction on the accountant’s right to practice is not absolute and involves simply a forfeiture of money. Such restrictions have been regarded as a valid protection of the business interests of the firm. For example, a Texas court upheld a non-competition clause against an accountant, even though no geographical area at all was stated.(23) The relevant clauses in the partnership agreement provided:

6. This agreement may be cancelled by any party hereto upon thirty
days written notice to the other parties, in which event the earnings
of Mattison and Riquelmy will be determined on the accrual basis
as of the end of the month in which the notice is given in order to
determine the earnings subject to this agreement. This amount due
the withdrawing partner plus his capital account will be paid by
Mattison and Riquelmy … at a rate to be determined but in not
less than three years.

7. Any partner withdrawing from the partnership of Mattison and
Riquelmy agrees not to enter into competition for a period of three
years with Mattison and Riquelmy and agrees not to solicit any of
its clients or accept work from any of its clients without first
notifying Henry C. Riquelmy.(24) The court held that because the restriction did not prevent the accountant from working but only imposed a forfeiture of previous profits, it was “reasonably necessary to protect the good will and the going business asset of an existing partnership engaged in the accounting profession.”(25)

The Supreme Court of Virginia balanced interests and upheld a non-competition clause which provided that a partner who withdrew voluntarily from the firm and performed accounting services for clients of the partnership during the twenty-four month period immediately following such withdrawal must pay the partnership one-third of the fees earned from such clients for three years.(26) The court found the restriction necessary “to protect the legitimate business interests of the firm and to prevent the use by a withdrawing partner of confidential information to the disadvantage of the partnership.”(27)

Summary

Courts have decided the validity of non-competition clauses in accounting partnership agreements according to the traditional standard applied to any business or occupation — whether it is reasonable in the circumstances.(28) When the restrictions concern only a forfeiture of money, courts have been especially inclined to uphold them and find them not to be a restraint on the accountant’s freedom to practice a profession.(29) Accounting partners have not argued that their professional status requires any different standard, and the Code of Professional Conduct of the American Institute of Certified Public Accountants does not address this issue.

Physicians and Dentists: The Public Interest

Courts have taken a step beyond reasonableness in judging whether to enforce restrictive covenants against physicians and dentists. Courts consider the need of the public for medical services, a concern not mentioned when applying restrictions on partnerships of accountants.(30) Nevertheless, even when other interests are considered, these clauses have generally been enforced.

Direct Restrictions and the Public Interest

One New York court stressed the reasonableness of a covenant restricting a physician’s right to practice within thirty miles of the partnership for five years.(31) In this case, the partner’s withdrawal was involuntary, but be was paid his share of the profits. The court reasoned that he had freely entered into the agreement and had no strong roots in the area other than his brief stint as a partner.(32) The court found no harm to the public by enforcement of the covenant not to compete, because there were other physicians serving the small village.(33) Despite the fact that he was the only surgeon in the village, the court upheld the restriction since there were other surgeons available in nearby cities.(34)

The public interest argument actually strengthened the decision to enforce a non-competition clause when a Georgia court upheld a covenant restricting a physician’s practice within a radius of twenty-five miles of the city of Toccoa for three years.(35) First, the court stressed the difference between such clauses in employment agreements and partnerships.(36) In the latter, the partner “has not only restricted himself, but he has also exacted from each of

the other contracting parties a like restriction.”(37) Also, professionals entering partnership agreements have no disadvantages in the bargaining relationship.(38) Going on to consider the public interest argument that the restriction limits the right of potential patients in that county to call on the doctor’s services, the court held that the public interest would also be served by upholding the agreement.(39) This “would afford countless other people in other areas, both in and outside the state, the opportunity to have a physician in their areas.”(40) The court ignored the major interest individual patients within the restricted area have in retaining the services of the physician of their choice.

This same questionable reasoning persuaded an Illinois court to uphold a covenant restricting the right of a physician withdrawing from a partnership to practice within a five-mile radius of the city of Blue Island for five years.(41) The court regarded these terms as reasonable and not harmful to the public interest.(42) The doctor “can be equally useful … by practicing his medical specialty in some location other than the prohibited area since the health of individuals living elsewhere in this state is just as important.”(43)

On the other hand, a severe shortage of doctors in a medical specialty persuaded an Alabama court to accept a more sensible public policy argument in a case concerning a restraint on an otolaryngologist (ENT), preventing him from practicing within a radius of fifty miles of Birmingham with no specific time limit stated.(44) After hearing testimony from doctors about the difficulty of filling openings for ENT specialists at the clinic, the court recognized the dire need for more ENT specialists within that area and found that “it would be adverse to the public interest” to stop the physician from practicing there.(45) In this case the court emphasized the difference between a profession and a trade or business, characterizing the relationship between doctor and patient as similar to that between lawyer and client — “one of personal confidence. The patient or client is not a |customer.'”(46) Moreover, the court examined the provision of the Alabama Code on restraint of trade, which states that contracts restraining the lawful exercise of a profession, other than the sale of a business or partnership arrangements, are void.(47) The court found that the doctors in the case before it were in an “association” rather than a partnership, because an individual doctor was not liable. for any losses resulting from the acts of the “association.”(48) Thus the exception to the statute granted for partnerships did not apply to this arrangement, and the clause was not enforced.(49) The court did not mention the absence of any time limit in the non-competition clause as important in its decision to hold the clause unenforceable.

The demands of public policy again weighed heavily in the reasoning of an Arkansas court which invalidated a clause restricting an orthopedic surgeon, who was a partner in a medical practice, from practicing within a radius of thirty miles from the offices of the partnership for one year.(50) According to this court, “all other considerations must give way where matters of public policy are involved,”(51) and the restriction “constitutes an undue interference with the interests of the public right of availability of the orthopedic surgeon it prefers to use.”(52) Thus the clause constituted an “unreasonable restraint of trade.”(53) The court might well have phrased this using considerably stronger language. One’s choice of a physician to perform major surgery or treat a life-threatening illness should be characterized not as a mere “preference,” but as a major interest of the patient. Many people will consult more than one physician before making the important decision to use the services of the one they finally choose. That choice is based on trust and confidence rather than on a simple “preference.”

Indirect Restrictions

The need to protect the public interest convinced the Supreme Court of Indiana to uphold a non-competition clause that was formulated as liquidated damages.(54) This court’s interpretation of the “public interest,” ever, departed substantially from that of the courts previously discussed. The restriction at issue covered a twenty-five-mile radius from Hammond for a period of two years and provided for liquidated damages in case of a breach of the covenant.(55) The court looked to the Indiana Anti-Restraint of Trade Statute(56) in deciding this case and held that doctors should not be treated differently from other business or professional people.(57) The physician had argued that the public interest raises two concerns: First, that physicians should be permitted to determine their code of conduct and ethical standards

The use of liquidated damages coupled with a non-competition clause in partnership agreements has become common in recent Years.(64) Such a clause in a dental partnership did not appear unduly restrictive to an Iowa court.(65) The partners had agreed not to compete within a radius of twenty miles of the partnership or its branches for two years.(66) If any withdrawing partner violated the agreement, he had to pay forty percent of whatever work was done for a patient of record at the partnership for one year.(67) The court found that since this did not prevent a withdrawing partner from practicing dentistry or penalize him for performing dental services on those who had not been patients of the partnership, the covenant was enforceable.(68)

Summary

Courts considering whether to apply restrictive covenants to medical professionals have recognized the public interest in having physicians available to provide essential services. Many courts, however, determine that that interest can be served by enforcing the noncompetition clause, thus making the medical service available to the public elsewhere than in the restricted area.(69) This view disregards the significant interest of individual patients within that restricted area in having their choice of physician. If the restriction is coupled with a forfeiture of money, rather than being an absolute restraint on practice in an area, courts generally uphold the clause.(70) Finally, a few courts have balanced the interest of the public in having a choice of medical personnel with that of the freedom to enter voluntarily into non-competition agreements, and have favored the interest in freedom of contract.(71)

ATTORNEYS: A PER SE RULE

Of all professionals, attorneys have been singled out by the courts for special treatment when deciding whether to uphold covenants not to compete.(72) In large part, the special treatment accorded lawyers stems from a set of ethical restrictions on lawyers that do not exist for accountants and physicians.(73) Both the Model Rules of Professional Conduct adopted by the American Bar Association in 1983 and the earlier Model Code of Professional Responsibility impose ethical restraints on agreements not to compete. Model Rule 5.6(a), which is substantially the same as the earlier Disciplinary Rule 2-108(a)(74) referred to in some cases provides: “A lawyer shall not participate in offering or making: (a) a partnership or employment agreement that restricts the right of a lawyer to practice after termination of the relationship, except an agreement concerning benefits upon retirement ….”(75) The commentary to this Rule notes that “restricting the rights of partners to practice after leaving a firm not only limits their professional autonomy but also limits the freedom of clients to choose a lawyer.”(76)

Because of the many changes in the size and nature of firms in recent years and in the loss of the sense of loyalty partners once felt to one another, legal partnerships have structured elaborate arrangements including attempts to prevent departing lawyers from taking along the firm’s clients and competing with the firm for new business.(77) These clauses have been problematic because of the ethical standards of Model Rule 5.6. Every court that has refused to enforce a non-competition agreement has referred to this Rule or its earlier embodiment in the ABA Model Code.(78)

Direct Restrictions on the Practice of Law

One of the earliest cases to deal with a restrictive covenant in a legal partnership agreement, Dwyer v. Jung,(79) set the tone for future cases. In Dwyer, the partnership agreement provided that on dissolution the clients would be divided up among the partners and all would be restricted from doing business with a client designated as that of another partner for five years.(80) Here clients were clearly parceled out among the lawyers without regard for their freedom to choose their counsel. The court characterized the attorney-client relationship as one that is both fiduciary and also regulated by the ethical principles expressed in DR 2-108(a).(81) The court held this agreement void as against public policy, stating that “commercial standards may not be used to evaluate the reasonableness of lawyer restrictive covenants.”(82)

When that same New Jersey court had to decide whether to enforce a restrictive covenant in a partnership agreement between two physicians, it refused to apply the per se rule it had adopted in Dwyer.(83) The standard to be used for such agreements by physicians did not differ from that applied to any restrictive covenant — that of reasonableness.(84) The court rejected the defendant physician’s argument, based on Dwyer, that such agreements among physicians are unreasonable per se, because they harm the public.(85) The court held the relationship between attorneys and clients to be unique, and thus ordinary standards could not be applied.(86) Moreover, the exclusive role of the New Jersey Supreme Court in enforcing the ethical rules of the legal profession required it to hold any restrictive covenants among attorneys as per se detrimental to the public interest.(87) Because the court plays no similar role in regulating physicians, no such rule need be applied to them.(88)

Financial Forfeiture Clauses

After Dwyer, most legal partnership agreements were carefully drafted to avoid direct restrictions on a client’s right to choose counsel. Instead, the agreements were modeled on those that courts had upheld against accountants and physicians, which provided for a financial forfeiture when a withdrawing partner provided services to clients of his former firm or competed with it for new clients.(89) In Gray v. Martin,(90) for example, the agreement stated that if a partner withdrew, he would be entitled to his unpaid draw, his capital account, and his partnership interest

Courts in other states, following Gray, have struck down financial forfeiture provisions coupled with non-competition clauses.(98) In a well-publicized case, Cohen v. Lord, Day & Lord,(99) New York’s highest court refused to enforce a clause in the partnership agreement that conditioned receipt of earned but uncollected partnership profits upon the withdrawing partner’s agreement not “to practice law in any state or other jurisdiction in which the Partnership maintains an office or any contiguous jurisdiction.”(100) The court conceded that the provision did not completely prohibit the withdrawing partner from practicing law, but held that the “significant monetary penalty it exacts . . . would functionally and realistically discourage and foreclose a withdrawing partner from serving clients who might wish to continue to be represented by the withdrawing lawyer and would thus interfere with the client’s choice of counsel.”(101) Citing Gray, the court stated that the loss of benefits, which the withdrawing partner would otherwise get, acts as a restriction on the lawyer’s right to practice and that the Disciplinary Rule’s exemption for retirement benefits does not apply to withdrawals.(102) Cohen thus firmly rejects the argument that because financial forfeitures are not absolute restrictions on lawyers’ and clients’ freedom of choice, they do not violate the disciplinary rule.(103)

The Cohen decision strongly influenced the most recent decisions by the Supreme Courts of Tennessee and Iowa. In the Tennessee case,(104) a lawyer, who was a former stockholder of a disbanded professional corporation operating as a law firm, sued because he did not receive payments of deferred compensation allegedly payable to shareholders who left the employment of the legal corporation. The original stockholders, including the plaintiff, had signed an employment and deferred compensation agreement providing that an employee who withdrew from the firm would receive deferred compensation unless he continued to practice law.(105) Because he went on to practice as in-house counsel to a business, the firm refused to pay him the deferred compensation. The court held the agreement unenforceable as a matter of public policy.(106) Citing Cohen, the court rejected the argument that the forfeiture provision did not restrict the lawyer’s right to practice and serve clients.(107) The court saw no reason to distinguish Cohen because that case concerned a partnership rather than a legal corporation or because New York and Tennessee partnership law differed.(108) At issue was the financial disincentive clause, which the court said was an impermissible restriction based on DR 2-108 incorporated into Rule 8 of the Tennessee Supreme Court rules.(109)

The Iowa court(110) also adopted the Cohen court’s rationale. In Anderson v. Aspelmeier, Fisch, Power, Warner & Engberg,(111) the lawyer had withdrawn from a legal partnership whose agreement provided for monthly payments over two years of the net purchase price paid, less any debt to previously withdrawn partners, and for monthly payments over an additional eight years of the value of the withdrawing partner’s interest above the net purchase price.(112)

This latter obligation, however, could be eliminated should the withdrawing partner commit an act “detrimental to the partnership which affects the value of the remaining partners’ interest in the partnership.”(113) The firm made the two-year payments but refused to make the additional ones, because the lawyer continued to practice law in competition with the firm and in fact took with him 325 of the 329 clients who were notified of his departure.(114) The court rejected the partnership’s argument that the agreement merely permitted them to protect the financial integrity of the firm without restricting the lawyer’s right to practice or the client’s right to his service.(115) It held that the partnership tried to penalize the lawyer for his clients’ decisions to follow him, and that “[h]is freedom to withdraw cannot be abrogated by the monetary penalty the firm has attempted to exact in this case.”(116)

Balancing Interests

Until recently, courts found no reason to look beyond the Rules of Professional Conduct when deciding challenges to non-competition clauses in legal partnership agreements, even when the restriction was indirect and limited to a financial forfeiture. In two cases that raised these challenges, however, courts recognized a need to balance the requirements of the ethical rules with the need to protect a law firm’s financial position.(117)

It is ironic that, despite the strong precedent of Dwyer, a New Jersey appellate court in Jacob v. Norris, McLaughlin, & Marcus(118) was the first to question the Cohen view that forfeiture provisions constitute restrictions on a lawyer’s right to practice.(119) Although the decision of this appellate court was eventually reversed by the New Jersey Supreme Court,(120) the appellate court’s reasoning merits attention. The legal professional corporation in the case had a service termination agreement that provided that shareholders who terminated their employment would receive compensation over and above their equity interest unless theirs was a competitive voluntary departure.(121) This type of termination occurs “if within one (1) year of the date of termination of employment the Member … engages in the practice of law involving providing professional services to clients of the Law Firm, who are clients of the Law Firm at the date of termination….”(122)

The court adopted the argument rejected by the Iowa court in Anderson,(123) that the remaining lawyers have a, right to protect the financial base of the firm, given the potential loss of clients that occurs when a lawyer terminates his role in a partnership.(124) The court stressed that the firm had not interfered with the lawyer’s right to represent any clients or restricted the right to practice law in any respect other than ending any obligation of the firm to pay termination compensation.(125) The court looked on the provision as a “careful attempt to foresee and provide for the financial requirements of departing members.”(126) Because the firm’s revenues decline in proportion to the number of clients lost to the departing member, the court refused to enforce a clause that obliges payment to the departing lawyers, which would increase the firm’s debt obligation “just when its ability to pay is being substantially eroded.”(127) The court explained that “the purpose of termination compensation was to provide financial assistance to a departing member only under circumstances not inconsistent with defendant’s economic interest.”(128) The New Jersey appellate court thus recognized as a legitimate interest the financial situation of the remaining members of the firm.

The New Jersey court distinguished earlier cases which had struck down non-competition clauses. Dwyer concerned an absolute restriction, a provision allocating clients among partners, and thus clearly limiting clients’ choice of counsel.(129) The court distinguished the Iowa case by saying that there the provision restricted the departing member’s practice of law “by working a forfeiture of money he had already earned by reason of his membership in the firm …. “(130) The Iowa plaintiffs monies did not arise from a contract under which “the obligation comes into existence only upon the performance of certain conditions.”(131) The court dismissed Cohen and Gray by the same reasoning. In those cases, too, the monies withheld had already been earned when the plaintiff was a member of the firm.(132) The New Jersey plaintiff’s claim did not represent a partnership interest “nor money otherwise earned by plaintiffs, but a claim that is merely inchoate and conditional within the context of the Service Termination Agreement.”(133) Moreover, in Cohen and Gray, the New Jersey court stated, the restrictions aimed at stopping “all professional activity by the departing member that could be competitive in any way to the interests of the firm.”(134) Here the restriction concerned representing the firm’s clientele at the time of the lawyer’s departure and only for a period of a year. This limitation was “plausibly related to preventing a double impact on the economic base from which the departing member’s termination benefits are to be drawn….”(135)

When this case was appealed to the New Jersey Supreme Court, however, that court rejected the balancing approach of the appellate court.(136) Instead, the court reaffirmed Dwyer and returned to a rigid interpretation of Rule 5.6 of the New Jersey Rules of Professional Conduct, holding that any restriction, however indirect, on a lawyer’s practice after termination of employment with a firm is per se detrimental to the public interest and a violation of the ethical rule.(137) The client’s freedom of choice emerged as the “paramount” interest to be protected, and no other interests should interfere with that one.(138) No type of payment to a departing partner, whether of earned income or future profits of the firm, may be conditioned on the lawyer’s acceptance of any restraint on practice.(139) Any such forfeiture provision “operates as a penalty designed to protect the former law firm’s turf.”(140) The court did suggest some ways to alleviate the detrimental effect a partner’s withdrawal could have on a firm, such as taking account of this decrease in the firm’s good will when computing the partner’s interest beyond the value of his or her capital account.(141) Such a realistic calculation would not, according to the court, operate as a restriction on the practice of law.(142)

Another challenge to Dwyer and its progeny came from the Second Appellate District in California in Haight, Brown & Bonesteel v. Superior Court.(143) In that case the partnership agreement provided that a withdrawing partner who engaged in “any area of the practice of law regularly practiced by the law firm” and in so doing represented any client of the firm for twelve months after leaving the firm would forfeit “any and all rights and interests, financial and otherwise, to which he would otherwise be thereafter entitled as a departing Partner under the terms of this Agreement.”(144)

The departing partners claimed an interest in the firm’s capital accounts and assets in accounts receivable.(145) The agreement also stated that the paragraph quoted above was designed “to comply with and take advantage of the provisions of the California Business and Professions Code Section 16602.”(146) This section states that “Any partner may, upon or in anticipation of a dissolution of the partnership, agree that he will not carry on a similar business within a specified county or counties, city or cities … where the partnership business has been transacted so long as any other member of the partnership … carries on a like business therein.”(147)

In deciding whether to enforce the financial forfeiture provision and restrictive covenant in the partnership agreement, the court noted that the California Code Section 16602 had never been amended to prohibit attorneys from exercising the contractual rights stated.(148) On the other hand, the court recognized that the California Rules of Professional Conduct of the State Bar include a version of Rule 5.6 of the Model Code, Rule 1-500, stating that no California attorney may “be a party to … an agreement . . . if the agreement restricts the right of a member to practice law.”(149) The court interpreted this ethical rule broadly, holding that “it does not … prohibit a withdrawing partner from agreeing to compensate his former partners in the event he chooses to represent clients previously represented by the firm from which he has withdrawn.”(150) This interpretation allows the departing partner to practice law any place within the state but also allows the remaining partners “to preserve the stability of the law firm by making available the withdrawing partner’s share of capital and accounts receivable to replace the loss of the stream of income from the clients taken by the withdrawing partner to support the partnership’s debts.”(151)

The California court relied on a previous decision concerning a similar financial forfeiture and non-competition provision in a partnership of physicians.(152) Recognizing the personal and confidential relationship that exists between lawyers and their clients, the court nevertheless noted that such a relationship does not put lawyers in a class apart from other business and professional partnerships.(153) The court could find no reason to treat attorneys differently from other professionals and thus held that lawyers may enter into non-competition agreements under Section 16602.(154)

The California decision in Haight, Brown & Bonesteel departed significantly from case precedents in other jurisdictions. First, the court refused to characterize the financial forfeiture provisions as a restriction on a lawyer’s right to practice and client’s right to choose counsel,(155) as the court in the influential Cohen case did. Thus the court had no problem upholding the clause despite the provision of the professional code of ethics – an obstacle previous courts found insuperable in enforcing non-competition clauses, even when only forfeiting money was at issue.(156) This same reasoning could be applied by other courts, even in states where no statute comparable to Section 16602 exists, as the dissenting opinion by Judge Hancock in Cohen suggested.(157) More surprising was the court’s willingness to equate partnerships of attorneys with those of other professionals and even businesspeople in upholding the restrictive covenant.(158) Once the legal code of ethics presents no absolute barrier to enforcement of non-competition clauses tied to financial forfeitures, then lawyers can be treated like other professionals by the courts.

This appellate court decision has been challenged by another California appellate court in Howard v. Babcock.(159) The partnership agreement at issue in that case provided:

Should more than one partner, associate or individual withdraw
from the firm prior to age sixty-five (65) and thereafter within a
period of one year practice law … in a practice engaged in the
handling of liability insurance defense work as aforesaid within the
Los Angeles or Orange County Court system, said partner or partners
shall be subject, at the sole discretion of the remaining nonwithdrawing
partners to forfeiture of all their rights to withdrawal
benefits other than capital as provided for in Article V herein.(160)

The trial court upheld the clause, and the departing partners withdrew their share of the firm’s capital but forfeited their share of the profits on accounts receivable and on work completed but not yet billed.(161) They also had to pay the firm any net profits on money they received for services to the firm’s former clients.(162)

The Fourth Appellate District Court, however, refused to apply Section 16602 of the California Business and Professional Code to attorneys,(163) unlike the Second District Appellate Court in Haight. Quoting Abraham Lincoln’s remark that a lawyer’s clients are not chattels or merchandise, the California court explicitly rejected the reasoning of Haight and refused to equate attorneys and doctors.(164) The court relied heavily on the Cohen court’s interpretation of the disciplinary rule as barring any restriction on a withdrawing partner’s right to practice law and concluded that the clause at issue was void on its face” as a violation of California public policy.(165)

Summary

Until recently, courts had uniformly declined to enforce restrictive covenants in legal partnership agreements, even when the restriction consisted of only a financial forfeiture. These courts adopted a more stringent standard than that of mere reasonableness, amounting to a per se rule, largely because they interpreted the Model Rules of Professional Conduct as barring any restrictions on competition.(166) Only recently has any court viewed the Rules as permitting enforcement of an indirect restriction such as a financial forfeiture clause, so long as there is no absolute restraint on the lawyer’s right to practice and the client’s right to choose counsel.(167) This view is based on a balancing of the interests to be weighed, including the firm’s need to protect its financial base.(168) One California appellate court went even further in stating that lawyers should be treated no differently from other professionals and that professionals should be judged by the same standards as commercial partnerships.(169)

ANALYSIS

Courts have singled out attorneys for special treatment when deciding whether to enforce non-competition clauses in partnership agreements largely because of Disciplinary Rule 5.6.(170) This Rule purportedly protects the freedom of clients to choose counsel and the professional autonomy of the attorney.(171) The first issue this discussion addresses is whether the Rule should continue to be interpreted as an absolute bar to enforcement of non-competition clauses or whether the interests deserving protection can be served equally as well or better by an alternative approach as suggested in some recent cases.(172)

Secondly, if guarding the clients’ and the departing lawyer’s autonomy are the predominant concerns of the courts in refusing to enforce these agreements, then physicians and their patients and accountants and their clients are equally worthy of protection. This discussion suggests that courts should adopt an approach that rejects absolute restrictions on the practice of all of these professionals but would enforce carefully crafted financial forfeiture clauses against them.

Recent challenges to the application of Rule 5.6 as a per se bar to agreements not to compete in legal partnerships so far have not succeeded,(173) except in one appellate jurisdiction in California.(174) The

Supreme Court of New Jersey(175) reversed a carefully reasoned appellate court’s(176) attempt to uphold such a clause simply by invoking the magic words of Rule 5.6.(177) Nevertheless, these challenges plus a well-reasoned dissent in Cohen,(178) a recent New York Court of Appeals case, weaken the interpretation of Rule 5.6 as an absolute barrier to enforcement of non-competition clauses. As Judge Hancock asserted in that dissenting opinion, the majority’s conclusion that the financial forfeiture clause violated the disciplinary rule is based on a mistaken interpretation of the language of that rule.(179) In his view, the language of the rule forbids only a total prohibition on the practice of law in a given geographical area.(180) He found “no legal justification and no basis in fairness or logic” to permit a lawyer who accepted and benefited from the clause for twenty years to then repudiate it.(181)

If the prime concern of the courts is the protection of certain essential interests, what are the interests that must be considered when deciding to enforce such a clause and how can they best be safeguarded? First and foremost, the client has an interest in the free choice of counsel that must be protected.(182) The client has placed trust in an attorney who is familiar with his or her problems. When a lawyer has won a client’s confidence, that professional relationship should not be disturbed. Moreover, the privacy of the client warrants protection. Questions often arise as to who owns the client’s files when a partner leaves. The client’s privacy interest and freedom of choice are paramount concerns.

A second important interest is the autonomy of the departing lawyer.(183) The right to use his or her expertise to earn a livelihood should be protected. If a lawyer specializing in banking work cannot continue to serve major bank clients because of a non-competition clause, the lawyer’s ability to make a living would be seriously compromised. It would also appear to be unfair to enforce a noncompetition clause on a partner who withdraws involuntarily because of the actions of other partners (for example, cutting his or her draw or stinting on such perquisites as a nice office and a private secretary). This has not been a significant issue in cases involving lawyers, as it has for physicians, perhaps because a legal partner who leaves involuntarily is unlikely to be taking a large number of important clients away from the firm. Any partner with a substantial clientele is likely to be too valuable to be forced out by colleagues.

A significant interest emphasized in two recent cases in New Jersey(184) and California(185) is that of the firm. The remaining partners have to be concerned with the financial stability of the firm when departing lawyers take important clients with them. This is particularly true for smaller law firms as, for example, in one Iowa case, when the withdrawing lawyer took with him 325 of the 329 clients whom the firm notified of his departure.(186) The court nevertheless refused to enforce a financial forfeiture clause because the clients’ interests had to be protected.(187) In circumstances like this a law firm faces a considerable, perhaps devastating, loss. Thorny issues are raised when a departing partner “inherits” clients from a retired or deceased partner or when a client is brought in by one partner but subsequently requires the services of another partner. Whose client is it anyway, and how should the court properly resolve the conflict between the departing lawyer and the firm?

Not to be ignored is the public interest in enforcement of contractual promises. An attorney who has received the benefit of a noncompetition clause mutually agreed to and imposed on all the other partners should not be permitted to repudiate that promise. Attorneys, more so than other professionals, should know the ethical reasons for keeping promises and the public policy reasons for enforcing them.

Interpreting Rule 5.6 as an insuperable barrier to enforcement of non-competition clauses does not serve these varied interests in the best possible way. Direct or absolute restrictions on a lawyer’s right to serve clients cannot be enforced without harming the dominant interest of the client and that of the attorney. Nevertheless, Rule 5.6 can be interpreted to permit indirect restrictions in the form of reasonable financial forfeitures. Such an interpretation would protect a greater number of interests, while still safeguarding the dominant interest of the client in free choice of counsel. The forfeiture clause would have to be crafted carefully to satisfy as many of the interests as possible. The imposition of a financial disincentive on departing partners would allow the client to retain freedom of choice, so long as there is a provision that the cost of such forfeitures will not be passed along to the client of the departing attorney. The attorney retains autonomy and can use specialized skills to earn a livelihood, but she cannot have the cake and eat it too. Breaking the contractual promise will entail some loss, and thus the public interest in enforcing agreements can be served. The firm would avoid severe losses of expected profits from clients who choose to follow the departing attorney, if the forfeiture covers a reasonable portion of future profits from the client for a limited period of time. The clause might even be drafted to cover a portion of already earned profits, a reimbursement for the firm’s lost good will, as suggested by the Supreme Court of New Jersey in Jacob.(188) Such a forfeiture clause would allow reallocation of profits between the firm and the withdrawing partner without imposing any penalty on the client.(189)

No Rule 5.6 equivalent has prevented courts from enforcing noncompetition clauses in partnership agreements of physicians and accountants. Courts have upheld even absolute restrictions on their practices.(190) One may well ask whether the interests involved in such agreements differ so significantly from those in legal partnerships. A California Appellate Court did not think so, and although it recognized the personal and confidential relationship lawyers have with clients, this was no reason to treat them any differently from physicians and certified public accountants.(191) In one of the few cases where a court declared such an absolute restriction void as to a physician, the court compared the relation of doctor and patient with that of lawyer and client. Both involved personal confidence and the professional was chosen based on training, skill, experience, and integrity.(192)

The special trust patients place in their physicians merits as much if not more protection than that of the lawyer’s client. A recent article in the New York Times noted that Americans put so much importance in having the doctor of their choice that many will not enter into health maintenance organizations, even though they are cheaper, and employers have had to offer more expensive options such as preferred provider organizations and point of service networks, which offer greater choice of physicians.(193) Anyone who has had to undergo a major surgical procedure or treatment for a life-threatening illness such as cancer knows that choosing the right personal physician is a major concern. It is difficult to fathom the reasoning of some courts that have held the public interest in choice of a doctor can be served by making the doctor’s services available only outside a specified area.(194) Surely all potential and past patients have an interest in freedom of choice, not just those who live beyond a stated radius.

Moreover, the argument that the public interest requires striking down non-competition clauses in partnership agreements of lawyers but not necessarily in those of physicians seems feeble given that the average number of lawyers to population for the whole United

States in 1988 was 1 to 473(195) and the average for physician

s was 1 to 476.(196) Surely the public has a greater interest in having access to the limited number of physicians, and they, more than any other group, should be singled out for special treatment by courts deciding whether to enforce non-competition clauses.

Although one’s confidence in a certified public accountant may not rise to the level of one’s trust in a physician, the relationship between accounting professionals and their clients also deserves protection.(197) When individuals confide personal financial information to an accounting professional or businesses seek the help of such a professional, they too place a major trust in that person. It would be a rude shock to lose that professional’s expertise and familiarity with one’s financial matters. For some people, the information they are willing to confide in their accountants they would not willingly share with anyone else, even their spouses. The Code of Professional Conduct of the American Institute of Certified Public Accountants does not have a provision equivalent to Rule 5.6, but that may reflect the lack of publicity and small number of cases involving accounting partnership non-competition agreements that have ended up in court rather than insensitivity to the ethical concerns of trust and confidentiality that accountants have for their clients.

The reasonableness standard is no more appropriate for accountants and physicians than for attorneys. The client or patient of an accountant or physician has an interest in freedom of choice as strong as that of a lawyer’s client, and this interest should be protected by courts in the same fashion. A refusal to uphold absolute restrictions on a physician’s or accountant’s right to practice and a recognition of the validity of reasonable financial forfeitures would safeguard that interest, as it would for clients of attorneys.

CONCLUSION

Only two decisions(198) have challenged the long-standing refusal of courts to enforce non-competition clauses against partners in law firms, and one of them was reversed by the New Jersey Supreme Court.(199) Nevertheless, the distinction these challenges have made between the effect of absolute restrictions on the right of attorneys to practice law and that of indirect or merely financial forfeitures is significant and takes into account the striking changes in the practice of law during the past twenty years.

The life tenure that partnership in a law firm at one time conferred can no longer be taken for granted. On one day alone in March, 1992, the noted Chicago law firm of Winston & Strawn fired twenty partners.(200) Other venerable firms, such as Milbank Tweed in New York, have notified partners that they must leave within the year.(201) The Wall Street Journal attributes this to the economic recession, increased competition, and “the large growth by law firms during the 1980’s – which … has transformed them into large businesses that are far removed from their collegial roots.”(202)

As the practice of law has become more and more a business, the justification for treating legal partnerships differently from other professions has become less compelling, notwithstanding the ethical code of the legal profession. A reasonable forfeiture clause would not impose an absolute restriction and would protect the dominant interest of the client as well as those of the departing partner and the firm. Such a clause would be more appropriate also in partnerships of physicians and accountants than the absolute restrictions now upheld by some courts. Attorneys, like accountants and physicians, should be prepared to keep the promises they have made and adhere to agreements from which they have benefited, even if it means a loss of money. An interpretation of the disciplinary rules that prohibits enforcement of financial forfeiture clauses against attorneys should be rejected in the future. Courts should also refuse to enforce absolute restrictions against these other professionals. Just as clients are not customers, so physicians and accountants, like lawyers, are not fungibles, easily substituted for one another. (1) Bernard Barber, Some Problems in the Sociology of the Professions, in The Professions in America 15 (K. Lynn ed. 1965). (2) Chief Justice William H. Rehnquist, The Legal Profession Today, 62 Ind. L.J. 151, 152 (1986). (3) Arthur S. Hayes, Law Firms Use Various Tactics To Prevent Exodus By Partners, Wall St. J., Jan. 20, 1992, at B6. (4) Arthur Murray Dance Studios v. Witter, 105 N.E.2d 685, 687 (Ohio C.P. 1952). (5) See, e.g., Harlan M. Blake, Employee Agreements Not To Compete, 73 Harv. L. Rev. 625, 631-32 (1960)

SERENA L. KAFKER, Adjunct Instructor of Business Law, College of Business Administration, University of Cincinnati