Is a Contractual Covenant Not to Compete Enforceable?

Dr. Fink is professor of pharmacy law and policy at the University of Kentucky College of Pharmacy, Lexington.

Issue of the Case

When 2 pharmacists, the employer and the employee, enter into a contract bearing a noncompetition clause addressing the geographic area and activities to be covered but not specifying the duration of the restrictions, is such a contract provision enforceable?

Facts of the Case

An employee pharmacist in a western state was planning to leave his current position with an established community pharmacy to launch a compounding pharmacy. The departing employee formed a corporation to operate the compounding pharmacy and the 2 pharmacists agreed that the compounding operation would be part of the former employer’s pharmacy.

The compounding pharmacy agreed to pay the established community pharmacy a specified amount of money each month while actively serving patients in the area where the established pharmacy had been functioning. The contractual agreement also addressed the rental of space for the compounding pharmacy and an agreement to provide supplies for operation of the new enterprise. As part of that agreement, the established pharmacy agreed not to engage in compounding prescriptions anywhere in the state.

The situation escalated when the former employee pharmacist relocated to a southern state but continued to provide compounded prescriptions to patients back in his state of origin. Seeing that patients in the specified service area outlined in the noncompetition agreement were being served, the established pharmacy invoked the monthly payment clause and demanded payment of that agreed upon amount each month. This demand was met with a refusal to pay by the now-departed pharmacist living in another state.

The owner of the community pharmacy filed suit against his former employee pharmacist alleging breach of their contract and other legal claims. The former staff pharmacist countersued alleging fraud and breach of contract, among other arguments. A trial was held that resulted in a verdict from the jury that the former employee pharmacist had in fact breached the agreement. The jury established the amount of damages at approximately $69,000.

The owner of the community pharmacy felt the award of damages was inadequate. As a result, at the conclusion of the trial proceedings, the owner of the community pharmacy filed a motion for a new trial, alleging juror misconduct based on an allegation of errors in the method used for jury selection. He also alleged that the calculation of inadequate damages appeared to have been given under the influence of passion or prejudice with the amount awarded not being supported by the evidence. The trial court judge disagreed with the last 2 arguments but did rule that an error had indeed occurred in the form of juror misconduct. A new trial was granted.

Facing the prospect of a new trial and the potential for a higher assessment of damages, the defendant former employee pharmacist appealed, raising 3 issues for consideration by the appellate court. The first, and pivotal, argument advanced on appeal was that the original provisions addressing the noncompetition agreements were too broad. For example, there was no duration established for the restrictions on competition. The agreement addressed the activities covered and the geographic territory in question but was open-ended with regard to duration.

The Court’s Ruling

The court concluded that the original contractual agreement bore mutual covenants not to compete, but they were unenforceable because they were not for a specified limited duration of time.

The Court’s Reasoning

The court concluded that the noncompetition agreements continued in force as long as the compounding pharmacy continued to serve patients in the area, an open-ended commitment. The general rule governing noncompetition agreements is that they must be limited in 3 ways: geographical territory covered, activities covered, and a specified, limited time period. If such agreements are so focused or limited, they will not be viewed as being anticompetitive by unlawfully restraining trade. Noncompetition agreements do in fact restrain competition by their very nature by limiting or eliminating competition in a specified area, on a specified activity, and for a specified period of time. As long as all 3 elements are clearly described and limited in scope, they will be reasonable and, therefore, enforceable. This was not the situation here, and the element of a specified duration was omitted from the agreement. The mutual covenants not to compete were ruled unenforceable