April 18, 2018

Colorado Court of Appeals: Noncompetition Clause Unenforceable Against Dissenting Shareholder Doctor

The Colorado Court of Appeals issued its opinion in Crocker v. Greater Colorado Anesthesia, P.C. on Thursday, March 8, 2018.

Shareholder Employment Agreement—Merger—Dissenters’ Rights—Covenant Not to Compete—Judicial AppraisalLiquidated Damages.

Crocker, an anesthesiologist, was a shareholder in Metro Denver Anesthesia from 2001 until 2013, when that entity merged with Greater Colorado Anesthesia, P.C. (old GCA), now known as Greater Colorado Anesthesia, Inc. (new GCA). In conjunction with the merger, Crocker purchased one share of old GCA stock for $100. In April 2013 he signed a shareholder employment agreement (the Agreement), which contained a provision for liquidated damages to be paid to old GCA in the event that the former employee violated the “Damages Upon Competition” section within two years immediately following termination of the Agreement.

In 2014, old GCA began entertaining a merger with U.S. Anesthesia Partners (USAP) under which USAP would buy out GCA shares for a lump sum of cash plus USAP common stock. To receive that payment, shareholders of old GCA would be required to execute a new employment agreement reflecting a 21.3% reduction in pay and a five-year employment commitment. Old GCA would form an interim company (GCA Merger Sub, Inc.), file amended and restated articles of incorporation, and convert the company into a C-corporation, new GCA.

Crocker voted against the action and provided notice under C.R.S. § 7-113-202 that he would demand payment for his share of old GCA if the merger were approved, in exercise of his dissenter’s rights.

The merger was approved in 2015. Each approving shareholder would receive $626,000 in cash; $224,000 in USAP common stock, to fully vest in five years; and a signing/retention bonus. Old GCA sent Crocker $100 for his share. He refused it and later demanded $1,030,996.

Crocker communicated that he did not understand how the merger would affect his employment status and offered to work under a temporary contract, but GCA did not offer one. He did not return to work, but took a temporary position and then signed an employment agreement with Guardian Anesthesia Services and began providing services at a hospital within the noncompete area of the Agreement.

As relevant to this appeal, the district court held a trial to address (1) new CGA’s claim for damages resulting from Crocker’s alleged breach of the Agreement’s noncompete terms, and (2) new CGA’s request for a judicial appraisal of the fair value of Crocker’s 1.1% share of old GCA. The district court found that Crocker was no longer bound by the Agreement and the covenant not to compete could not be enforced against him. It also found that the fair value of Crocker’s share of old GCA was $56,044 plus interest.

On appeal, GCA argued that the district court erred in finding the noncompete provision unenforceable. The court of appeals stated, as a threshold matter, that generally a noncompete provision will survive a merger and the right to enforce the provision will vest in the surviving entity. But the court held that new GCA could not enforce the noncompete provision against Crocker because it is unreasonable to enforce the provision against a dissenting shareholder forced out of employment by the action of a merger. Here, it was undisputed that an anesthesiologist must reside within 30 minutes of where he works, and as a practical matter, enforcing the noncompete provision would have required Crocker to move or to pay GCA damages to continue to practice. Enforcement would thus further penalize Crocker’s exercise of his right to dissent rather than protect him from the conduct of the majority. Under these circumstances, the noncompete is unreasonable and imposes a hardship on Crocker. It is thus not enforceable against him as of the date the merger was finalized.

Further, C.R.S. § 8-2-113(3) directs that a damages term in a noncompete provision such as the one here is enforceable only if the amount is reasonably related to the injury suffered. Under the Agreement’s liquidated damages provision, Crocker would have to pay $207,755 in damages for the alleged violation of the noncompete provision. The district court determined, with record support, that the injury suffered by old GCA because of Crocker’s departure was zero. Here, there was no reasonable relationship between the actual injury suffered and the damages calculated per the formula, and the noncompete was not enforceable against Crocker.

Crocker cross-appealed the district court’s valuation of his share of old GCA, contending that the court erred in valuing his share by excluding evidence of the price USAP paid for old GCA. The district court did not refuse to consider the deal price, but properly rejected it because it found the price to be an unreliable starting point from which to determine fair value.

The judgment was affirmed.

Summary provided courtesy of Colorado Lawyer.