United States: Due Diligence Strategies: How Buyers Can Preserve Human Capital In Healthcare M&A

Originally published in Healthcare Michigan, Volume 40, No. 1

Merging with or acquiring healthcare entities can often be complex, with many competing considerations. As purchase price is contemplated, acquiring entities are not only evaluating the profits of the entity being acquired but also considering key employees and the value they provide post-closing. Key employees and service providers undoubtedly bring significant value to healthcare practices and companies through their industry-specific expertise and experience. An acquiring entity must conduct due diligence to assess what measures can or are being implemented to incentivize key employees to remain with the new entity post-closing. Incentives such as retention bonuses and stock options tend to work well when utilized alone, but can also be implemented with restrictive covenants. Restrictive covenants may include confidentiality/non-disclosure, non-solicitation, and non-competition ("non-compete") agreements. Non-competes can be implemented post-closing and post-employment.

Sellers of healthcare entities typically agree to a post-closing restrictive covenant that prevents the seller from engaging in competition or soliciting the target company's patients or employees for a certain time. The main objectives are to preserve the value of the purchase for the buyer and prevent the loss of key employees. Sellers and key employees may also be required to sign post-employment restrictive covenants. In Michigan, post-employment restrictive covenants are permissible so long as the agreement is narrowly drawn, protects a reasonable business interest, and is reasonable in duration, geographical area, and type of business.¹ The Michigan Court of Appeals has held that restrictive covenants "can protect against unfair competition by preventing the loss of patients to departing physicians, protecting an employer's investment in specialized training of a physician, or protecting an employer's confidential business information or patient lists."²

Buyers are motivated to protect the goodwill of the business being purchased, which includes keeping the assembled workforce in place without the risk of competition after the acquisition. The acquiring entity should first assess restrictive covenants and similar agreements already in place and consider whether the transaction is a purchase of equity or assets

In an equity puchase, the acquiring entity essentially assumes the role of the target entity. There is no need for formal assignments of restrictive covenants unless the agreements contain "change of control" clauses, in which case consents to the change of control will be required from the service providers bound by restrictive covenants to avoid the service provider having the right to terminate the agreement. Obtaining required consent mitigates the legal risk that such contracts will be terminated due to the transaction.

Next, the acquiring entity must determine if the existing restrictive covenants comply with current law. Attorneys should ensure that all employees and service providers with access to confidential information or trade secrets are subject to confidentiality or non-disclosure agreements, evaluate the enforceability of non-compete and non-solicitation covenants, and assess the scope and reasonableness of the restrictions (geographic area protected, types of activities covered, and period). It is also critical that the acquiring entity assess if the agreements with employees or service providers staying on post-transaction are legally sufficient to secure these workers via incentives and/or protections. Finally, attorneys should review the agreements to discern if the equity purchase will trigger any financial payments to the service providers or adversely impact the scope and duration of the agreements after the equity purchase.

In an asset purchase, the acquiring entity must determine if there is an assignment provision. Under Michigan law, restrictive covenant agreements are assignable.³ In addition to being assignable via specific assignment provisions, assignment clauses can be present in restrictive covenant agreements, equity grants, stock option plans, employee agreements, and more. As such, thorough due diligence must be conducted to ensure that the assignability provision, if present, is noted by the acquiring entity. The buyer must obtain notice from those requiring it under the enforceable agreements in place. If consent is required, the buyer must obtain such consent under the enforceable agreements.

In Michigan, contractual rights can be freely assigned unless assignment is restricted.⁴ If assignability is not addressed, assignability depends on whether the court views the agreement as a personal services contract.⁵ According to the Michigan courts, personal contracts are those "involving a personal trust in a party or the special skills and knowledge of a particular individual or group of individuals."⁶ If viewed as a personal services contract, the agreement is not assignable without consent. If it is not viewed as a personal services contract, then the agreement is freely assignable. Even if the agreements are assignable, acquiring entities must determine if the asset purchase will trigger a financial payment by the assignee to the service provider or will adversely impact the scope, duration, and other terms.

In January 2023, the Federal Trade Commission (FTC) proposed a new rule to ban employers from imposing non-competes on workers.⁷ The proposed rule is based on a preliminary finding that non-competes constitute an unfair method of competition. The FTC purports that "unfair methods of competition" encompass business activity such as non-competes, precluding or limiting employee mobility in the workplace. Included is an exception for sale-related non-competes, which would allow non-competes to be imposed on a seller who is selling his/her business interest in both equity and asset transactions.⁸ The exception would apply to post-closing restrictive covenants but not post-employment restrictive covenants unless the seller will also provide services to the buyer post-closing.

Footntoes

1 MCL 445.774a(1).

2 St. Clair Medical, PC v Borgiel, 270 Mich App 260, 715 NW2d 914 (Mich Ct App 2006).

3 Virchow Krause & Co v Schmidt, 266271, 2006 WL 1751835 (Mich App 2006).

4 Burkhardt v Bailey, 260 Mich. App. 636 N.W.2d 453 (2004).

5 Virchow Krause & Co v Schmidt at *2.

6 Northwestern Cooperage & Lumber Co v Byers, 133 Mich. 534, 538; 95 NW 529 (1903); see also Board of Trustees of Michigan State Univ v Research Corp, 898 F. Supp. 519, 521-522 (WD Mich, 1995).

7 See proposed CFR 910.

8 Proposed 16 CFR 910.3.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.