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Health Care Competition: Beware The Middleman

Health Law360 - August 5, 2011

Patrick Sorek authored an article, "Health Care Competition: Beware The Middleman" which appeared in Health Law360

As one of the most vibrant areas of economic activity today, health care receives regular attention. One form of attention the health care industry attracts is business partners who seek to provide services for, or with, hospitals. One hospital recently had an experience with a service provider that led to expensive litigation in which the hospital was successful, but which teaches an important lesson to hospitals and doctors when teaming up with any such business partner.

The hospital hired a third party to help it administer a treatment facility. The facility was operated on property owned by the hospital. The doctors who performed the treatment were either affiliated with, or employed by, the hospital; they had no formal relationship with the third party. The doctors received training from the third party, but the decision about exactly how to treat any particular patient, and what techniques to use, was the doctors’ alone. The third party employed no professionals on-site at the center other than a nurse who performed administration. In essence, the third party lent its name to the facility; administered the facility; provided equipment; entered charges for services; and conducted training for the doctors in its proprietary processes. The doctors had complete discretion, however, in how they provided treatment; they were free to use, or not use, the third party’s processes.

Various disagreements caused the hospital to end its contract with the third party. This decision led to the surprising threat from the third party that the hospital and the doctors were prohibited from continuing to provide treatment at the facility maintained on the hospital’s property. The basis for this statement was the related contract, which contained restrictive covenants prohibiting the hospital from “competing” with the third party.

Restrictive covenants have been a frequent subject of lawsuits in recent years, especially as economic pressures cause people to change jobs. Restrictive covenants most commonly apply to two types of business relationships, and cover two subjects. By far the most common business relationship to which restrictive covenants apply is between employer and employee. Less common are the covenants which accompany the sale of a business. The subjects covered by restrictive covenants usually consist of prohibitions against use of confidential information, and prohibitions against competition. In either case, it is easy to understand why the party with the trade secrets, or which just paid for a business’s assets, does not want to face competition based on the same information and goodwill showing up across the street.

The situation here fits neither the employer–employee, nor the buyer–seller model of restrictive covenants. Instead, here was the “middleman” seeking to prohibit the hospital that hired it, and the independent doctors who treated patients, from “competing” – in other words, from doing what the hospital and doctors did before the third party arrived on the scene, and expected to do afterward.

It must be emphasized that there was never any question about the third party’s right to protect its trade secrets. Information can be owned, and there was no dispute that the third party could stop anyone, including the hospital and the doctors, from using its proprietary information, products, and processes. The hospital and the doctors had agreed in writing early on not to use the third party’s trade secrets, however, and there was no evidence that they were doing so. Many of the participating doctors had learned other forms of treatment elsewhere, and testified that they could provide care in the future using techniques other than the proprietary ones developed by the third party.

The third party nonetheless went ahead and sued the hospital and the doctors based on the restrictive covenants, seeking a preliminary injunction against “competition” by the hospital and doctors. After a hearing, testimony, and briefs, the court ruled against the third party.

There really was no evidence that the hospital or doctors were using the third party’s trade secrets after the third party had left, so that angle was covered.

With regard to competition, the court found in part that once the third party was gone, the “center,” or treatment facility, which the hospital, the third party, and the doctors were joined in operating, no longer existed. Thus, the covenant failed because one of the conditions essential to enforcement of the covenant – the hospital operating a service competing with the third party’s service – no longer was possible, because the third party was no longer present. Despite that decision, the case is still pending, and seems likely to result in an appeal of the preliminary injunction ruling, or a full trial on a permanent injunction.

A much larger issue was left unaddressed by the court (which it is free to do, by the way, if it uses a different issue to decide the case). This larger issue is based on the status of the party seeking to enforce a restrictive covenant. The court did not examine in-depth the third party’s status in relation to the hospital and the doctors. Nonetheless, hospitals and doctors should be vigilant for this potentially thorny and expensive problem.

Sports analogies are overused in discourse of every type today, but one seems particularly appropriate here. The third party telling the hospital and the doctors they are barred from “competing” is like a baseball manager telling the team owner and the players they can’t play after the manager leaves. Yes, the manager may have some “trade secrets,” that is, some strategies and training methods unique to him. Yes, he may have imparted these secrets to the players. But the manager does not own the stadium; he does not own the team; he does not own the players; he does not own the fans; and he does not own all baseball knowledge a player might use, or an owner might seek.

The third party made some of its own arguments based on analogies. It compared itself to a franchisor and a franchisee. But this comparison does not fit. If the third party is a franchisor, then a more accurate comparison is that the hospital is like the mall. If the mall gets rid of a store, even a franchised store, and wants to replace it with a similar store, usually it is free to do so. The third party does not own the mall; the store itself; or the customers. Some customers may want to follow the third party even after it leaves the mall, which is fine. But even McDonalds cannot tell the mall it is prohibited from bringing in Wendy’s after McDonald’s leaves.

There are two important lessons to be drawn from this experience, which distinguish it from the typical employer-employee restrictive covenant. The first relates to the relationship of the parties when a third party joins with a hospital, and then tries to control “competition” by the hospital. Hospitals and doctors should be aware of this tactic by third parties who seek to stop them from delivering the services they have always delivered, both before and after the third party appears on the scene. The issue is not protection of trade secrets. Anyone in business gets to do that, and the third party is entitled to do that as vigorously as its budget will allow. Rather, the issue is whether the third party can restrict “competition.” The law of restrictive covenants was not designed to address this situation.

Second, it is extremely important always to keep in mind that these are medical services being provided to citizens who may not have a choice of where and when to receive them. Restrictive covenants apply to the world of medicine, and have for decades. Hospitals and doctors owe it to their patients, however, to maintain the relationships they have built, and not to allow them to be easily bargained away.

In short, when you bring third parties into the hospital, do not let them keep you from doing what you have always done, and will probably want to do after they leave.

Patrick Sorek is a Partner with Cohen Seglias Pallas Greenhall & Furman PC and focuses his practice in commercial litigation, and has considerable experience in civil rights and employment cases. He can be reached at psorek@cohenseglias.com or 412.434.5530.