Litigation related to the lateral movement of sales representatives among competitors, or “poaching”, is pretty common. The medical device industry is one that has enormous strength in the relationships between sales representatives and the surgeons they service. Surgeons don’t view sales reps as interchangeable, particularly for the more complex medical devices that they use in surgeries. Often, sales reps are viewed as a critical part of the physician team to deliver healthcare. Reps take on the responsibility to train surgical staff, arrange for necessary equipment to be in the OR, and might be physically present in the room to answer questions while procedures are taking place. Such responsibility means that if a high quality sales rep were to leave and go to a competitor, there’s a good chance that the rep’s surgeons would follow. Considering that a single busy surgeon at a metropolitan hospital can account for more than $1 million in annual device sales depending on the practice, that’s a big concern for employers.
To combat this risk, device manufacturers often use restrictive covenant provisions like noncompete or nonsolicit agreements. Depending on the amount of business that’s at stake when a sales rep changes jobs, employers will not hesitate to sue if they think those agreements are not being honored.
The financial industry is a lot like the medical device industry in at least one sense: it is built on customer relationships. Securities brokers handle their client’s money, and so their relationships with customers are inherently based on trust. When brokers move from one brokerage firm to another, their clients are inclined to move with them because they view the brokers, rather than the firm, as the persons who have earned their business.
Like the medical device industry, the financial industry has also used restrictive covenants for quite some time. But litigation over these agreements has lessened over the last decade or so, and it’s largely because of something that the industry developed known as the “Protocol for Broker Recruiting.”
The Broker Protocol is a voluntary agreement created by securities industry firms in 2004 that its members could accept. Generally, the protocol provides that, if a broker moves laterally between two firms that have both signed on to it, there will not be litigation over noncompete or nonsolicit agreements if the steps outlined in the protocol are followed.
Essentially, the protocol establishes a set of rules for what type and how much information a departing broker can take to a new firm. It also limits the solicitation of old clients to the departing broker only (as opposed to solicitations by others in the new firm). Provided that these limitations are followed, protocol firms agree not to enforce existing restrictive covenants, and so the protocol acts as something like a “cease-fire” among its signatories.
The Broker Protocol has been extremely successful. Today, there are more than 900 signees among companies in the securities industry, and while it hasn’t eliminated all litigation, it has dramatically reduced the incidence of restrictive covenant disputes.
One of the reasons that the broker protocol makes sense has to do with economics. The average book of business for a departing broker in the financial industry is approximately $500K. Since this figure is just an average, there are many departing brokers whose annual production is far less. In these cases, the cost of litigation simply isn’t worth it because it can rapidly approach or exceed the book of business in issue.
The medical device industry is a little different. To begin with, it’s very diverse, and some segments of the industry are much more lucrative than others. In the spinal device market, for example, a busy surgeon group operating out of one metropolitan hospital will often make several million dollars in annual purchases. That makes litigation against a departing employee who services the group a lot more viable from an economic perspective.
The other difference is that the book of business for medical device sales reps is generally much more concentrated. Securities brokers might have 50 clients or more, and even a highly successful broker might have trouble converting more than 75% of them to a new brokerage firm. But in the medical device industry, it wouldn’t be uncommon for a sales rep to have his or book of business concentrated in sales to only 2-4 key surgeons. The significance of this difference is obvious: the fewer clients involved, the easier it is to convert large chunks of business. Thus, the risk associated with departing medical device sales reps is a lot higher than the risk associated with departing securities brokers.
One other point is worth noting. There are a lot of start-ups in the medical device industry. There seems to be something unfair about allowing a new orthopedic device company to sign a hypothetical Medical Device Sales Rep Protocol that works like the Broker Protocol, to recruit the top sales reps with $2 million-plus books from industry leaders like Medtronic, Stryker, and others by offering them distributorships with 20% commissions (as opposed to the 12% or so they are probably earning), and then relying on the truce in this hypothetical Sales Rep Protocol to create tens of millions of dollars in sales virtually overnight without the fear of litigation.
It is unrealistic that the medical device industry would establish a protocol exactly like the financial industry’s Broker Protocol for the reasons outlined above. A lot of companies would be very reluctant to let a sales rep take any client with them to a competitor. But that doesn’t mean that a different type of protocol can’t be useful.. Instead, companies can harness internal procedures that they are probably already using to communicate better about competitive hires, and in so doing, reduce the need for litigation to resolve problems.
Every company should have an internal procedure for evaluating restrictive covenants when making a competitive hire. Very generally, the procedure should include doing three things at a minimum:
These internal procedures can form the basis of an industry-wide protocol. After following them and having an employment offer accepted, the new employer could provide the former employer with a writing that identifies the restrictions determined to be valid and enforceable and that describes how the new employment will be structured to ensure compliance. For example, it could be something as simple as a writing that says, “we understand that John Jones is restricted under his agreement with you from soliciting customers located in Detroit for one year. We intend to assign him to a sales territory in Lansing.”
The former employer could then be given a period of time to review the proposed new employment and to state, in writing, any objections or concerns that it has. Finally, the new employer could then likewise be given some time to determine whether and how, if it all, it might choose to remedy a stated objection. Neither the hiring employer, nor the employee, nor the former employer would be permitted to initiate litigation relating to restrictive covenants until this process is completed and determined to be unsatisfactory to any of them.
I actually developed this type of protocol with one of my clients as part of a settlement agreement following a restrictive covenant dispute. The two employers agreed to a hiring protocol that governed how they would handle future situations where one of them hired from the other. It was highly successful. While the protocol was in place, there was not a single lawsuit between them over restrictive covenant issues.
Now there are all kinds of issues that would have to be fleshed out for this kind of idea to become an industry-wide protocol for hiring practices. For example, there could very well be different ideas about things like how long each company would be given to consider the proposals and responses and about whether the employee in question could begin working for the new company while the discussions were taking place. However, I also think that if an influential industry association like AdvaMed were to outline some potential suggestions for formulating an industry protocol in these situations, it could gain some traction. AdvaMed did something similar when it assisted the medical device industry in creating a uniform code of ethics.
The bottom line is pretty much this: litigation also forces competitors to outline their positions and to consider possible solutions, and very often, that process can lead to a settlement, too. Litigation just costs more than utilizing a protocol which is designed to identify the very same issues and possible solutions that are often apparent right at the time of hire. Why not start the discussion about potential problems and solutions before filing lawsuits that raise the stakes and the costs for everyone involved?
Paul Greco is a shareholder at AmLaw 250 firm Buchanan Ingersoll & Rooney. He focuses his practice on restrictive covenants in the medical device industry.