Business Is Business: Recognizing Referral Relationships as Legitimate Business Interests Protectable by Restrictive Covenants in Florida
Your client has built a medical equipment business from scratch into a successful enterprise, based mainly upon his ability to secure the trust and confidence of a select group of physicians who refer their patients to his company for goods and related services. He secures those continuing referrals by being reliable, dependable, and responsive to those physicians and their patients, and also by carefully cultivating and developing personal relationships with each of those referral sources.
The referring doctors are pleased with your client’s services, as well as his wit and charm. They endorse the company to other referring doctors. His business grows to such an extent that he needs to elevate a trusted employee to help him deal directly with the referral sources. He shares with her the particular wants, needs, and pet peeves of the individual referring doctors. The trusted employee gets a raise, more responsibility, and more autonomy as the business grows.
One day, your client comes to work to find that his trusted employee has resigned from the company. A few days later, he discovers that the former employee has started a competing company. Over the next few weeks, he learns that she has treated each and every referral source (and their respective staffs) to lunch, has left behind brochures and magnetic business cards, and has promised a few perks specifically calculated to address particular wants, needs, and pet peeves of the referral doctors. His revenues dip dramatically and soon he discovers that his carefully cultivated referring physicians are now dividing their referrals between his firm and the new company started by the former employee.
Fortunately, he had the foresight to hire you, his Florida lawyer, and had all of his employees sign covenants not to compete. The former employee has breached her contract with the company, and her breach is slowly but surely destroying his business. He regrets having to resort to litigation for relief, but at least he’s protected, right?
Currently, the answer is no: Neither that client nor any of the other business owners in Florida who rely upon referral sources for their business are necessarily protected. Whether referral relationships are legitimate business interests protectable by covenants not to compete is entirely unclear in Florida. The Florida Supreme Court recently had a chance to clarify this situation by resolving an apparent conflict between the district courts on this issue in the case of Florida Hematology & Oncology v. Tummala, 969 So. 2d 316 (Fla. 2007). However, following oral argument, the Supreme Court dismissed the case, leaving the matter unresolved.1
The Legitimate Business Interest Analysis
Contracts in restraint of trade are unlawful and unenforceable.2 This basic principle has been established for more than a century.3 However, this firmly entrenched legal doctrine is in direct conflict with the freedom of contract.4 Every covenant not to compete is a contract in restraint of trade. Thus, courts have always had to strike a balance between these two competing principles when dealing with restrictive covenants.5 Traditionally, enforcement of contracts in restraint of trade has been governed by the rule of reason.6 At common law, determining whether a covenant not to compete is reasonable involved an analysis of whether the proponent of the noncompete had a legitimate business interest in its enforcement sufficient to justify the restraint at issue.7
In Florida, the modern analysis of the enforcement of restrictive covenants begins with Hapney v. Central Garage, Inc., 579 So. 2d 127 (Fla. 2d DCA 1991).8 Hapney holds that the common law’s prerequisite of a legitimate business interest for enforcement of restrictive covenants was implied in F.S. §542.33.9 Hapney concludes that a covenant not to compete which prohibits competition per se is void as against public policy, but if the proponent proves that enforcement of the covenant is reasonably necessary to protect a legitimate business interest, then the covenant will be enforced.10
Hapney specifically recognizes the following legitimate business interests: 1) trade secrets or confidential information; 2) customer lists and the right to prevent direct solicitation of existing customers and customer goodwill; and, 3) other business interests, including but not limited to, extraordinary or specialized training.11 In 1996, the Florida Legislature codified the common law notion of legitimate business interest as refined in Hapney by enacting F.S. §542.335. Thus, today, a covenant not to compete must pass muster under F.S. §542.335 to be enforceable.
This statute, like the common law, balances the two competing principles of law inherent in every covenant not to compete — the prohibition on restraint of trade versus the freedom of contract. The proponent of the noncompete must prove that enforcement of the covenant is reasonably necessary to protect one or more of the proponent’s legitimate business interests.12 The 1996 statute made enforcement of covenants not to compete somewhat easier by more clearly setting out the requirements necessary to enforce them and by eliminating some traditional defenses, including consideration of employee hardship and construction of the covenant language against the drafter.13 The statute further simplified enforcement by providing for the presumption of irreparable harm upon the showing of a valid, enforceable covenant not to compete.14 However, the statute retained the overriding principle of reasonableness by providing that a covenant not to compete cannot be overlong or overbroad, and requiring that relief be narrowly tailored to protect the legitimate business interests proven by its proponent.15
F.S. §542.335 lists certain legitimate business interests that have historically been accepted by the courts, including trade secrets, confidential information, substantial relationships with existing or prospective customers, customer goodwill associated with a specific geographic area or trade area, and specialized training.16 However, the legitimate business interests itemized in the statute are not exclusive.17 This is consistent with Hapney, which recognizes a universe of “other business interests” which may be worthy of protection in restrictive covenants.18
Prospective Relationships Must Be With an Identifiable Individual or Entity
The statute expressly states that “substantial relationships with specific prospective or existing customers, patients or clients” are legitimate business interests.19 In University of Florida Bd. of Truteees v. Sanal, 837 So. 2d 512, 516 (Fla. 1st DCA 2003),this language was interpreted to require that such prospective relationships be with particular, identifiable individuals. The court explained that to require otherwise would render meaningless the words “substantial relationship.”20 The Sanal court reasoned further that the purpose of the statute was to protect identifiable assets of a business from being misappropriated.21
Sanal is consistent with case law requiring a plaintiff to show an actual business relationship with a specific identifiable person or entity to state a claim for tortious interference with a business relationship.22 The requirement that prospective customers be identifiable to qualify for protection is also consistent with the basic notion that relief for speculative injuries will not be granted.23 Thus, there seems little doubt that the mere possibility of future revenues generated through potential sales to unidentified members of the public is not a business asset that would, or should, be entitled to protection under F.S. §542.335.
The question, of course, is where do referral sources fall? On the one hand, referral sources represent potential future business of unidentified prospective customers. On the other hand, the established referral source itself is a specifically identifiable person or entity. Considering the stream of revenue generated from customers gained through referral sources, such referral sources are, without question, important assets to certain business operations. However, there is authority that referral sources are per senot legitimate interests protectable by noncompete agreements,24 and the state of the law on this question in Florida is, at best, unclear.25
Referral relationships are enormously important to certain businesses, and these businesses expend a lot of time and money to cultivate and maintain their referral sources. Until recently, the legitimacy of referral sources as a protectable business asset was not debated. In Southernmost Foot and Ankle Specialists, P.A. v. Torregrosa, 891 So. 2d 591, 594 (Fla. 3d DCA 2005),the court identified “referral doctors” among the legitimate business interests justifying enforcement of a noncompete. However, the Torregrosa court did not discuss the matter of referral sources any further.26
Recently the idea that protection of referral sources could justify enforcement of a covenant not to compete was successfully challenged in Florida Hematology & Oncology v. Tummala, 927 So. 2d 135 (Fla. 5th DCA 2006). Dr. Tummala’s employment agreement prohibited him from practicing medicine within a 15-mile radius of any of Florida Hematology’s offices.27 After Dr. Tummala was terminated, he opened his own medical practice within the 15-mile radius. The facts of the Tummala case are notable for the extreme precautions taken by Dr. Tummala to avoid any claims by Florida Hematology that Dr. Tummala was encroaching upon any of Florida Hematology’s traditionally recognized legitimate business interests.
Dr. Tummala did not solicit any former patients and refused to accept requests for treatment from several Florida Hematology patients.28 Further, Dr. Tummala notified referring physicians and advertised in the local newspaper that he would not accept patients of his former employer at his new practice.29Dr. Tummala’s new patient information form asked patients to state whether they had ever been treated by Florida Hematology, and Dr. Tummala accepted only those patients who replied in the negative.30 Florida Hematology claimed that, although Dr. Tummala was not diverting existing patients, Florida Hematology had suffered a significant drop in new patients referred by area physicians that were traditionally referral sources for Florida Hematology.31
The trial court found that Florida Hematology had a legitimate business interest in its existing patients, but that the restrictive covenant was not necessary to protect that interest so long as Dr. Tummala did not accept former Florida Hematology patients at his new practice. Dr. Tummala agreed to the entry of a permanent injunction prohibiting him from treating any of Florida Hematology’s existing or former patients.32 Nonetheless, Florida Hematology argued that it had a legitimate business interest in its referral sources, which justified enforcement of the covenant against Dr. Tummala.
The Fifth District analyzed whether referral sources were legitimate business interests under F.S. §542.335. Acknowledging that Florida Hematology, like most physician specialty practices, obtains a substantial share of its patients from referring physicians, and that they expend money, time, and effort to cultivate those referral relationships, the court stated that relationships with referral sources were, “perhaps [a]ppellants’ most crucial business interest.”33 Nevertheless, the court concluded that referral relationships are not legitimate business interests sufficient to justify enforcement of a covenant not to compete.34
The Tummala court reasoned that referring physicians “supply a stream of unidentified prospective patients with whom [a]ppellant [Florida Hematology] has no prior relationship.” Therefore, the court found that accepting referral relationships as a legitimate business interest would circumvent the language in the statute and the holding in Sanal, which requires relationships with prospective customers to be with specific and identifiable individuals.35 The court concluded, “We see no way to recognize referring physicians as a legitimate business interest and still give effect to the plain language of the statute.”36 The Fifth District acknowledged conflict with the Third District’s opinion in Torregrosa.37
Florida Hematology appealed the Fifth District’s decision to the Florida Supreme Court which initially accepted conflict jurisdiction of the matter.38 However, the Supreme Court dismissed the case after hearing oral argument, holding that conflict jurisdiction was improvidently granted.39 Chief Justice Lewis dissented, arguing that the majority was wrong to dismiss the case, and that the court should resolve the conflict between the Third and Fifth districts on this issue.40
Referral Sources Should Be Considered Legitimate Business Interests
Referral sources should be legitimate business interests entitled to protection under F.S. §542.335. The basic premise of the Tummala decision, that the express language of the statute precluded a finding that referral sources may be legitimate business interests, is flawed. Relationships with specific referral sources are not the equivalent of relationships with unidentified prospective customers.
F.S. §542.335 is clear that the legitimate business interests enumerated in the statute are not exclusive.41 Other legitimate business interests have been recognized by courts, including a legitimate business interest in unique on-air talent42 and in disintermediation.43 Referral relationships have also been recognized as legitimate business interests by the courts of a number of sister states.44 Neither the express language of F.S. §542.335, nor the analysis in Sanal, prevents a finding that referral relationships are legitimate business interests. A legitimate business interest is an asset of the business that, if misappropriated, would cause harm to the business.45 Referral sources plainly qualify as legitimate business interests under this test.
Clearly, there can be no substantial relationship with prospective customers if those prospective customers are merely unidentified members of the general public or a nonspecific segment of a market. However, the situation is significantly different where a company has spent time, money, and substantial efforts to cultivate and maintain relationships with specific, identifiable referral sources that historically provide a quantifiable amount of business to the company. Recognizing referral sources as a legitimate business interest does not run afoul of the basic principal that speculative relief should not be granted. When a complaining party can show evidence of a specific referral relationship that has been misappropriated, resulting in harm, the requested relief is not based on speculation.
Furthermore, acknowledging that referral relationships can be legitimate business interests does not upset the balance achieved by Florida’s statute. Protection of referral relationships can form the basis for enforcing a covenant only when the proponent of the covenant can plead and prove substantial relationships with identifiable referral sources and that the proposed restraint is reasonably necessary to protect those referral relationships. All the defenses available under the statute and the case law would still be available to the defendant, including an opportunity to show that the restraint is over broad or over long, and/or that no irreparable injury will result from a violation of the covenant.46 The statutory scheme is sufficient to ensure that referral sources will justify the enforcement of a noncompete agreement only when they are shown to be an asset of the business that has been misappropriated in violation of the parties’ agreement.
For some businesses in Florida, referral sources are the primary source of new business. Referral relationships are assets of a business that can be misappropriated by a former employee resulting in harm to the employer. Therefore, referral relationships fit the definition of a legitimate business interest and the express language of the statute does not prohibit such a finding. While the business generated through referral sources is typically undefined future business, relationships existing with such referral sources are real, present, identifiable and definite, and should be entitled to protection. Unfortunately, until the issue is resolved by the Supreme Court or the Florida legislature, the economic futures of businesses that rely on covenants not to compete to protect their valuable referral relationships are in peril.
1 Florida Hematology & Oncology v. Tummala, 969 So. 2d 316 (Fla. 2007).
2 15 U.S.C. §1; Fla. Stat. §542.18; Ariz. Rev. Stat. §34-252; Wis. Stat. §133.03; Miss. Code Ann. §75-21-3; Mich. Comp. Laws §445.772; Mo. Rev. Stat. §416.031; Va. Code Ann. §59.1-9.5.
3 United States v. Addyston Pipe & Steel, Co., 85 F. 271 (6th Cir. 1898), affirmed as modified by, 175 U.S. 211 (1898) (contracts that unreasonably restrain trade were always void under the common law, but were made unlawful and punishable as a criminal offense under 15 U.S.C. §1).
4 See Addyston Pipe & Steel Co. v. United States, 175 U.S. 211, 228-229 (1899) (“It has been held that the word ‘liberty,’ as used in the Constitution, was not to be confined to the mere liberty of the person, but included, among others, a right to enter into certain classes of contracts for the purpose of enabling the citizen to carry on his business.”).
5 See Massari v. Salciccia, 136 So. 522, 524 (Fla. 1931) (There is no good reason for restricting the freedom of contract when the restraint imposed is reasonable.).
6 Standard Oil Company v. United States, 221 U.S. 1, 58-64 (1911); United States v. Topco Associates, Inc., 405 U.S. 596, 606 (1972); Adams Dairy Co. v. St. Louis Dairy Company, 260 F.2d 46, 53 (8th Cir. 1958); Levine v. Central Florida Affiliates, Inc., 72 F.3d 1538, 1545-1546 (11th Cir. 1996).
7 Id. In Addyston Pipe & Steel, Co., 85 F. at 282, Judge Taft uses notions of legitimate business interests in setting out an early framework for evaluating contracts in partial restraint of trade as follows “no conventional restraint of trade can be enforced unless the covenant embodying it is merely ancillary to the main purpose of a lawful contract, and necessary to protect the covenantee in the full enjoyment of the legitimate fruits of the contract, or to protect him from the dangers of an unjust use of those fruits by the other party.”
8 Hapney v. Central Garage, Inc., 579 So. 2d 127 (Fla. 2d D.C.A. 1991), rev. den., 591 So. 2d 180 (Fla.1991), disapproved on other grounds, Gupton v. Village Key & Saw Shop, Inc., 656 So. 2d 475 (Fla.1995).
9 Id. at 130-131. Fla. Stat. §542.33, applies to actions to determine the enforceability of restrictive covenants entered into after May 27, 1953, and before July 1, 1996. Fla. Stat. §§542.33(4) and 542.335(3).
10 Hapney, 579 So. 2dat 139.
11 Id. at 134.
12 Fla. Stat. §542.335 (1)(b)(c) (2007).
13 Fla. Stat. §542.335 (1)(g)(h) (2007); see also, Henao v. Professional Shoe Repair, Inc., 929 So. 2d 723, 726-727 (Fla. 5th D.C.A. 2006) (recognizing that Fla. Stat. §542.335 was intended by its drafters to make enforcement of legitimate restrictive covenants easier and more certain.).
14 Fla. Stat. §542.335 (1)(j)(2007); Variable Annuity Life Insurance Co. v. Hausinger, 927 So. 2d 243, 245 (Fla. 2d D.C.A. 2006); JonJuan Salon, Inc. v. Acosta, 922 So. 2d 1081, 1084 (Fla. 4th D.C.A. 2006); Am. II Elecs., Inc. v. Smith, 830 So. 2d 906 (Fla. 2d D.C.A. 2002).
15 Fla. Stat. §542.335 (1)(c) (2007).
16 Fla. Stat. §542.335 (1)(b) 2007).
17 Id. (“Legitimate business interests, include, but are not limited to….” Thus, making it clear that the legitimate business interests identified in the statute are nonexclusive.).
18 Hapney, 579 So. 2d at 134.
19 Fla. Stat. §542.335(1)(b) (2007).
20 University of Florida Bd. of Truteees v. Sanal, 837 So. 2d at 516.
22 See Ethan Allen, Inc. v. Georgetown Manor, Inc., 647 So. 2d 812 (Fla. 1994) (In Florida, one can bring an action for tortious interference with a prospective customer, but not with the general public or community at large.); Southern Alliance Corp. v. Winter Haven, 505 So. 2d 489 (Fla. 2d D.C.A. 1987) (business relationship interfered with must be with an identifiable person and not with the public at large).
23 See Santa Rosa County v. Administration Commission, Division of Administrative Hearings, 661 So. 2d. 1190, 1193 (Fla. 1995) (courts will not entertain declaratory judgment where parties show mere possibility of legal injury on the basis of a hypothetical “state of facts which have not arisen” that are “contingent, uncertain, [and] rest in the future”); Condominiums on Intracoastal Ass’n, Inc. v. Barnett Bank of Palm Beach County, 502 So. 2d 84 (Fla. 4th D.C.A. 1987) (entry of an injunction was premature where the injury complained of was speculative and contingent); Florida Outdoor, Inc. v. Stewart, 318 So. 2d 414, 415 (Fla. 2d D.C.A. 1975) (lost profits will not be awarded where they are based on speculation or conjecture).
24 Florida Hematology & Oncology v. Tummala, 927 So. 2d 135 (Fla. 5th D.C.A. 2006).
25 Southernmost Foot and Ankle Specialists, P.A. v. Torregrosa, 891 So. 2d 591, 594 (Fla. 3d D.C.A. 2005) (affirming trial court’s holding that referral doctors, among other interests listed in the statute, were legitimate business interests); Florida Hematology & Oncology Specialists v. Tummala, 969 So. 2d 316 (Fla. 2007) (in dissent) (noting that because of the Supreme Court’s dismissal of the case, the law in Florida as to whether referral sources were legitimate business interests is unclear).
26 Torregrosa, 891 So. 2d 591, 594 (Fla. 3d D.C.A. 2005).
27 Tummala, 927 So. 2d 135, 137 (Fla. 5th D.C.A. 2006).
28 Id. at 137, n.1.
30 Id. at 137, n.1.
31 Id. at 137.
32 Id. at 138.
34 Id. at 139.
35 Id. See also Steamatic of Kansas City, Inc. v. Rhea, 763 S.W.2d 190, 192 (Mo. App. 1988) (using a similar analysis and finding that a cleaning company’s referral relationships with insurance adjusters was not a legitimate business interest because the adjusters were not “customers” and there was no ongoing relationship between Steamatic and any identifiable persons or companies).
36 Id. at 139.
37 Id. at 139, n.4.
38 Florida Hematology & Oncology Specialists v. Tummala, 937 So. 2d 122 (Fla. 2006) (granting review).
39 Tummala, 969 So. 2d 316 (Fla. 2007) (in dissent).
40 Id. Streaming video of oral arguments before the Florida Supreme Court are accessible at wfsu.org/gavel2gavel/archives. Little discussion of the jurisdictional issue occurred at oral argument and the Supreme Court apparently decided the jurisdictional issue based on arguments in respondent’s jurisdictional brief that because there was no discussion of the court’s grounds for its decision in Torregrosa, there was no express conflict. Respondent’s Brief on Jurisdiction, Case No. SC06-993, p. 4-5.
41 See note 17.
42 See T.K. Communications, Inc. v. Herman, 505 So. 2d 484 (Fla. 1987) (holding without discussion that noncompete agreement was enforceable against radio personalities); Cox Broadcasting Corp. v. Beckman, 296 So. 2d 566, 569 (Ga. 1982) (television station had protectable interest in the image of its newscasters, sports announcers, meteorologist, or other television personalities); Cullman Broadcasting Co., Inc. v. Bosley, 373 So. 2d 830, 835 (Ala. 1979) (radio station could have legitimate business interest in “feature personality” or “special talent” sufficient to justify noncompete agreement); Pathfinders Communications Corp. v. Macy, 795 N.E.2d 1103, 1113 (Ind. App. Ct. 2003) (radio station had legitimate business interest in its former on-air personality).
43 Disintermediation is the elimination of the middleman by the person actually supplying the service or product to the ultimate customer. Disintermediation arises in the employee staffing or consultant placement business when the staffing or consulting company seeks to prevent its employees from being hired directly by its clients. See, e.g., Volt Services Group v. Adecco Employment Services, Inc., 35 P.3d 329, 334 (Or. App. 2001); Aerotek, Inc. v. Burton, 835 So. 2d 197, 202-203 (Ala. App. 2001); Consultants & Designers, Inc. v. Butler Service Group, Inc., 720 F.2d 1553, 1558 (11th Cir. 1983).
44 Idbeis v. Wichita Surgical Specialists, P.A., 112 P.3d 81, 90-91 (Kan. 2005); Intermountain Eye and Laser Centers, PLLC v. Miller, 127 P.3d 121, 128 (Idaho 2005); Valley Medical Specialists v. Farber, 982 P.2d 1277, 1284 (Arz. 1999); RHIS, Inc. v. Boyce, 2001 WL 1192203 (Del. Ch. 2001); Medical Specialists, Inc. v. Sleweon, 652 N.E.2d 517, 523 (Ind. App. 1995); Ruhl v. J.E. Hanger Company, Inc., 1992 WL 223738 (Ohio App. 1992); Fields Foundation, Ltd. v. Christensen, 309 N.W.2d 125, 130 (Wis. App. 1981); but see Cardiovascular Surgical Specialists, Corp. v. Mammana, 61 P.2d 210, 214 (Okla. 2002); Pratt v. Grunenwald et al., 1994 WL 313050*5 (Ohio App.).
45 A legitimate business interest has been defined by one of the authors of the statute as “an identifiable business asset that constitutes or represents an investment by the proponent of the restriction such that, if that asset were misappropriated by a competitor (i.e., taken without compensation), its use in competition against its former owner would be “unfair competition.” John A. Grant & Thomas Steele, Restrictive Covenants: Florida Returns to the Original “Unfair Competition” Approach for the 21st Century, 70 Fla. B.J. 53, 54 (Nov. 1996). This definition was cited to and adopted in Sanal, 837 So. 2d at 516.
46 In Tummala, the referring doctors testified that they refer patients to specialists based on their evaluation of the specialist doctor, and that they would not have continued to refer patients to Florida Hematology even had Dr. Tummala left the geographic area. Tummala, 927 So. 2d at 139. Based upon this evidence, the court could have found that enforcement of the covenant was not reasonably necessary to protect the referral relationships, or that no injury to referral relationships had been shown. Alternatively, the court could have found that the referral relationships at issue were not an asset of Florida Hematology, but instead belonged to Dr. Tummala alone. See, e.g., Cardiovascular Surgical Specialists, Corp. 61 P.2d 210, 214 (finding that doctors refer patients to cardiovascular surgeons based on their reputation and expertise, not to corporations, therefore, an employer has no legitimate business interest in any one surgeon’s referral base); Pratt, 1994 WL 313050*5 (holding that referrals are made to individual doctors based on reputation and corporation had no referral base).
Charles A. Carlson and Amy E. Stoll practice commercial litigation as partners in the law firm of Barnett, Bolt, Kirkwood, Long & McBride in Tampa, and frequently handle litigation relating to covenants not to compete. Mr. Carlson is a graduate of Florida State University, B.A. (1983), and the University of Florida College of Law, J.D. (1987), with honors. Ms. Stoll is a graduate of the Florida State University, B.A. (1995), and the University of Florida College of Law, J.D. (1998), with high honors.
This column is submitted on behalf of the Labor and Employment Law Section, Stephen Allen Meck, chair, and Frank E. Brown, editor.