Managed Health Care Associates, Inc. v. Kethan

RECOMMENDED FOR FULL-TEXT PUBLICATION Pursuant to Sixth Circuit Rule 206 ELECTRONIC CITATION: 2000 FED App. 0143P (6th Cir.) File Name: 00a0143p.06

UNITED STATES COURT OF APPEALS FOR THE SIXTH CIRCUIT _________________

;  MANAGED HEALTH CARE  ASSOCIATES, INC., MHCA  ACQUISITION INC., d/b/a  No. 99-5444 MHA/MedEcon,  Plaintiffs-Appellants, >    v.

  RONALD KETHAN, EAST  TEXAS REGIONAL COOPERATIVE, d/b/a First   Defendants-Appellees.  Choice Cooperative,

 1 Appeal from the United States District Court for the Western District of Kentucky at Louisville. No. 99-00066—Jennifer B. Coffman, District Judge. Argued: March 10, 2000 Decided and Filed: April 21, 2000 Before: WELLFORD, SILER, and GILMAN, Circuit Judges.

2 Managed Health Care No. 99-5444 No. 99-5444 Managed Health Care 15 Associates, et al. v. Kethan, et al. Associates, et al. v. Kethan, et al.

_________________ issue (and certainly not to the issue I would certify to that Court). Pertinent to the issue was the unpublished decisions COUNSEL of the Kentucky trial court and the Court of Appeals which noted no controlling Kentucky authority on the question of ARGUED: William J. Hunter, Jr., MIDDLETON & necessity of consent to a purported assignment by the REUTLINGER, Louisville, Kentucky, for Appellants. James employee. D. Cockrum, BROWN, TODD & HEYBURN, Louisville, Kentucky, for Appellees. ON BRIEF: William J. Hunter, I dissent, accordingly, in favor of certification under the Jr., Thomas P. O’Brien, III, Dennis D. Murrell, circumstances. MIDDLETON & REUTLINGER, Louisville, Kentucky, Daniel L. Abrams, Louis M. Solomon, SWIDLER, BERLIN, SHEREFF & FRIEDMAN, New York, New York, for Appellants. James D. Cockrum, Charles M. Pritchett, Jr., BROWN, TODD & HEYBURN, Louisville, Kentucky, R. Gregg Hovious, TACHAU, MADDOX, HOVIOUS & DICKENS, Louisville, Kentucky, for Appellees. GILMAN, J., delivered the opinion of the court, in which SILER, J., joined. WELLFORD, J. (pp.14-15), delivered a separate dissenting opinion. _________________ OPINION _________________ RONALD LEE GILMAN, Circuit Judge. Managed Health Care Associates, Inc. and MHCA Acquisition, Inc., d/b/a MHA/MedEcon (collectively MHA), commenced an action in state court against Ronald Kethan (Kethan) and East Texas Regional Cooperative, d/b/a First Choice Cooperative (First Choice). MHA sought a preliminary injunction to prevent Kethan from violating the noncompetition clause that he had signed when employed by MedEcon Services, Inc. (MedEcon), MHA’s predecessor. After Kethan and First Choice removed the case to federal court based on diversity of citizenship, the district court held that the noncompetition agreement was enforceable only by MedEcon, and that it was not assignable by MedEcon to MHA without Kethan’s consent. It therefore denied MHA’s request for a preliminary

14 Managed Health Care No. 99-5444 No. 99-5444 Managed Health Care 3 Associates, et al. v. Kethan, et al. Associates, et al. v. Kethan, et al.

_________________ injunction and dissolved the temporary restraining order that MHA had obtained in state court. For the reasons set forth DISSENT below, we REVERSE the decision of the district court and _________________ REMAND the case for further proceedings consistent with this opinion. HARRY W. WELLFORD, Circuit Judge, dissenting. This is a difficult case and my brothers would reverse and remand I. BACKGROUND to the district court for further proceedings. I respectfully differ. I am persuaded that the best course, in light of the A. Procedural history uncertainties that exist in this area of the law in Kentucky, is to certify this legal question to the Kentucky Supreme Court: On January 5, 1999, MHA commenced an action against Kethan and First Choice in the Circuit Court of Jefferson Is the non-competition agreement in this case between County, Kentucky. MHA sought and obtained a restraining MedEcon and its employee, Kethan, assignable to the order, enjoining Kethan from violating the noncompetition plaintiff company (a third party), in the absence of clause that was part of his employment agreement with Kethan’s consent? MedEcon. I do not agree with the majority opinion that the district On February 2, 1999, Kethan and First Choice removed the court “held that non-competition clauses are not assignable in action to the United States District Court for the Western Kentucky.” Rather, the essence of the district judge’s holding District of Kentucky. Kethan and First Choice then moved to was this: dissolve the restraining order that MHA had obtained in state court and opposed MHA’s motion for a preliminary [T]he non-compete agreement and the confidentiality injunction. On March 4, 1999, the district court dissolved the clause applied only to MedEcon and . . ., under W. R. restraining order and denied MHA’s request for a preliminary Grace, they were not assignable to MedEcon to MHA injunction. In late March of 1999, MHA filed this timely without the employee’s consent. Reinforcing this notion appeal. is the Kethan/MedEcon agreement’s inclusion of a requirement that all contract modifications must be B. Factual background written. No such writing occurred here; thus, MedEcon did not assign the covenant to compete or confidentiality On December 27, 1991, Kethan signed an employment clause to MHA. agreement with MedEcon, a group purchasing organization (GPO) for hospitals with its principal place of business in (emphasis added.) Kentucky. GPOs contract for the purchase of a vast array of products for use by member healthcare facilities. They also The majority holds that “a non-competition clause is enter into agreements directly with suppliers to allow member assignable in Kentucky.” It adds that “[t]here is only one case facilities to purchase the products at reduced prices, thereby in Kentucky that addresses this issue,” Choate v. Koorsen providing a substantial savings of both time and money for Protective Servs., Inc., 929 S.W.2d 184 (Ky. 1996). We are their members. GPOs also engage in bulk purchasing in order in agreement that this particular Kentucky Supreme Court to provide their members even greater discounts. decision did not determine the answer to the assignability

4 Managed Health Care No. 99-5444 No. 99-5444 Managed Health Care 13 Associates, et al. v. Kethan, et al. Associates, et al. v. Kethan, et al.

From 1992 through 1996, Kethan worked as a salesman and Kethan’s reliance on the statement was unreasonable in light an agreement administrator for MedEcon. Kethan’s job of the contractual requirement that all modifications have to responsibilities included meeting with various representatives be in writing. Aside from the fact that there appears to be no from hospitals and encouraging them to use the products consideration for Irene’s alleged promise, this is exactly the covered by MedEcon’s agreements. He contacted numerous type of claim that the non-modification clause was designed representatives in Texas and Oklahoma on MedEcon’s behalf. to prevent. Accordingly, Kethan’s reliance argument is During this period, Kethan had the opportunity to develop unavailing. strong business relationships with MedEcon’s customers, including First Choice. Kethan eventually became the E. The district court must balance the equities agreement administrator for the First Choice account. Although we have concluded that the district court erred in In June of 1998, MHA, which is also a GPO, began dismissing MHA’s motion for a preliminary injunction based negotiations with MedEcon for the acquisition of MedEcon’s on the legal issues regarding assignability, this leaves assets. On September 9, 1998, most of MedEcon’s assets unresolved the factual issues that must be considered. These were purchased by MHA. Included in those assets was issues include (1) the likelihood of success on the merits, (2) Kethan’s employment agreement. Neither MedEcon nor the irreparable harm that could result if the injunction is not MHA obtained Kethan’s written consent to the assignment. issued, (3) the impact on the public interest, and (4) the Following the transaction, Kethan continued to be an at-will possibility of substantial harm to others. See In re Eagle- employee, performing the same job, receiving the same salary Picher Industries, Inc., 963 F.2d 855, 859-60 (6th Cir. 1992). and benefits, and reporting to the same supervisor. Kethan and First Choice strenuously argue that the district court did not abuse its discretion in refusing to grant the Twenty days after the sale of MedEcon’s assets to MHA, preliminary injunction because MHA cannot show any Kethan gave thirty-days’ notice of his resignation. Two days damages and, in any event, could be adequately compensated after Kethan tendered his resignation notice, First Choice by a monetary award. These issues will need to be resolved ceased using MHA/MedEcon for group purchasing services. by the district court on remand. When the thirty days had passed from Kethan’s resignation notice, he commenced employment with First Choice. III. CONCLUSION Shortly thereafter, MHA brought suit seeking to enforce Kethan’s noncompetition agreement with MedEcon. For all of the reasons set forth above, we REVERSE the decision of the district court and REMAND the case for The noncompetition clause provides as follows: further proceedings consistent with this opinion. Employee, during the term of this agreement and for a period of two (2) years after the termination thereof, will not do, directly or indirectly, for himself or herself or as an agent of, or on behalf of, or in conjunction with, any person, trust, firm, partnership, corporation, or business organization other than the Company (“Other Firm”), nor will he or she, directly or indirectly, cause or permit any

12 Managed Health Care No. 99-5444 No. 99-5444 Managed Health Care 5 Associates, et al. v. Kethan, et al. Associates, et al. v. Kethan, et al.

Kethan’s and First Choice’s final argument is based on this Other Firm in which he or she has a proprietary or circuit’s decision in W.R. Grace & Co. v. Hargadine, 392 financial interest, or of which he or she is a director, F.2d 9 (6th Cir. 1968), which arguably held that officer, employee, shareholder, partner, or representative, noncompetition clauses are not assignable under Ohio law. to do any of the following[:] In the first place, Grace is distinguishable from the facts of the present case because the court was interpreting Ohio law a. solicit or cause any past, present or future (up to the as opposed to Kentucky law. Second, the holding in Grace time of the termination of employment) customers (or with respect to assignability is ambiguous at best. The district members) of the Company or of any of the existing or court’s decision in Grace actually supports MHA’s position, future subsidiaries or affiliates of the Company because it held that the new employer had the right to enforce (“Subsidiaries or Affiliates”) to transfer all or part of the covenant against the employee for the specified term of their business from the Company or the Subsidiaries or two years. Id. at 19. But because the two-year covenant had Affiliates or render competitive services to any such ended in April of 1962 due to a prior corporate change, customers (or members). however, and because Grace did not acquire ownership until May of 1964, the district court held that the two-year ban had b. induce or attempt to influence any existing or future already lapsed. Id. This court affirmed the district court’s employee of the Company or any of the Subsidiaries or decision but, in dicta, stated that noncompetition clauses were Affiliates to leave such employment; and not assignable under Ohio law. Id at 20. Because Grace was interpreting Ohio law and because the basis for the court’s c. engage in any of the kinds of business activities in decision is unclear, we find that the case is not determinative which the Company or any of the Subsidiaries or in resolving the present action. Affiliates have been or is now engaged within the States of Texas, Kansas, Nebraska, Oklahoma, Colorado, Idaho, Based on the opinions of the lower Kentucky courts in Arizona, Wyoming, and Missouri. Choate, the majority rule from the other states that have addressed the issue, and the additional reasons set forth In addition to the noncompetition clause, the agreement above, we believe that the Kentucky Supreme Court would contained a provision requiring that any modifications be in conclude that noncompetition clauses are assignable. writing and signed by both parties. The agreement also Consequently, we reverse the district court on this point. provided that any disputes were to be governed by Kentucky law. No clause in the contract, however, directly addressed D. Kethan could not reasonably rely on Larry Irene’s the issue of whether Kethan’s contract could be assigned. statements The district court concluded that the assignment of Kethan and First Choice next argue that even if the Kethan’s contract was a modification. Because any noncompetition clause was properly assigned to MHA, MHA modification had to be in writing, and there was no such waived its contractual rights or is now estopped from writing, the district court held that Kethan was no longer asserting its contractual rights because its president Larry bound by the noncompetition clause. The district court also Irene allegedly told Kethan that MHA would not enforce the held that noncompetition clauses are not assignable under clause against him. MHA argues that Irene never made such Kentucky law. a statement to Kethan. Even if Irene did so state, however,

6 Managed Health Care No. 99-5444 No. 99-5444 Managed Health Care 11 Associates, et al. v. Kethan, et al. Associates, et al. v. Kethan, et al.

II. ANALYSIS type of employee for whom noncompetition clauses were designed. See Central, 622 S.W.2d at 685-86. A. Standard of review Kethan and First Choice respond by arguing that a personal Although this court reviews a challenge to a district court’s services contract cannot be assigned. A personal services decision regarding preliminary injunctions for abuse of contract, however, requires that one of the parties be bound to discretion, see Sandison v. Michigan High School Athletic render personal services. See generally Kenneth D. Corwin, Ass’n, 64 F.3d 1026, 1030 (6th Cir. 1995), the two key issues Ltd. v. Missouri Medical Service, 684 S.W.2d 598, 600 (Mo. in this case are questions of law dealing with assignments Ct. App. 1985) (“[T]he duty to perform is not assignable under Kentucky law. Neither issue has been directly without the consent of both parties.”). In contrast, a addressed by the Supreme Court of Kentucky. “When the noncompetition clause only requires that one of the parties district court construes a contract, such interpretation is a abstain from certain activities. See generally Equifax Servs., question of law and reviewable de novo by the appellate Inc. v. Hitz, 905 F.2d 1355, 1361 (10th Cir. 1990) court.” F.D.I.C. v. Aetna Cas. and Sur. Co., 903 F.2d 1073, (“Although an employee’s duty to perform under an 1077 (6th Cir. 1990). Our role in this diversity of citizenship employment contract generally is not delegable, . . . the right case “is to make [the] best prediction, even in the absence of to enforce a covenant not to compete generally is assignable direct state court precedent, of what the Kentucky Supreme in connection with the sale of a business.”) (citation omitted); Court would do if it were confronted with this question.” In re Andrews, 80 F.3d 906, 912 (4th Cir. 1996) (“Although Welsh v. United States, 844 F.2d 1239, 1245 (6th Cir. 1988). the Thirteenth Amendment prohibits a court from specifically enforcing a personal service contract, an agreement not to B. An assignment does not modify the underlying terms compete is specifically enforceable if it is reasonable.”). of an employment contract Here, Kethan was an at-will employee who was free to resign at any time. Consequently, the noncompetition clause does Provision fourteen of Kethan’s employment agreement with not require any affirmative action on the part of Kethan, and MedEcon provides that “[n]o waiver, alteration, or is thus assignable. modification of any of the provisions of this Agreement shall be valid unless in writing and signed by both of the parties Kethan and First Choice further argue that the management hereto.” The first key issue thus becomes whether style and “character” changed when MHA purchased the MedEcon’s assignment of Kethan’s employment agreement assets of MedEcon. This, however, is irrelevant to the issue was a modification of the terms of his contract. of whether the noncompetition clause is assignable because the clause was not tied to the management style or “character” Kentucky courts have not yet addressed the issue of of MedEcon. In fact, MedEcon could have changed its whether the assignment of an employment contract modifies management at any time, and Kethan would have still been the underlying terms of the contract. The Second Circuit, bound by the noncompetition clause. Similarly, management however, has rejected the notion that an assignment modifies would have changed exactly as it did if MHA had purchased the underlying terms of a contract: the stock of MedEcon rather than its assets and, as previously noted, Kethan would have had no basis to complain. The fact that the Agreement also provided that its terms could not be waived or altered without the written consent of the bank did not justify a departure from the

10 Managed Health Care No. 99-5444 No. 99-5444 Managed Health Care 7 Associates, et al. v. Kethan, et al. Associates, et al. v. Kethan, et al.

In addition to opinions from the lower courts of Kentucky, general New York rule . . . that a parol assignment of a this court may use the rule adopted by most of the debt, claim, or chose in action is valid. An assignment jurisdictions that have addressed the assignability issue as does not modify the terms of the underlying contract. It persuasive authority in determining how the Kentucky is a separate agreement between the assignor and Supreme Court would likely decide the question. See Kurczi, assignee which merely transfers the assignor’s contract 113 F.3d at 1429. With respect to the assignability of rights, leaving them in full force and effect as to the party noncompetition clauses, “[a] majority of courts permit the charged. Insofar as an assignment touches on the successor to enforce the employee’s restrictive covenant as an obligations of the other party to the underlying contract, assignee of the original covenantee (the original employer) .” the assignee simply moves into the shoes of the assignor. 6 RICHARD A. LORD, WILLISTON ON CONTRACTS § 13:13 (4th ed. 1995). Citibank, N.A. v. Tele/Resources, Inc., 724 F.2d 266, 268-69 (2d Cir. 1983) (citations omitted); accord, Ametex Fabrics, MHA also correctly points out that if it had purchased the Inc. v. Just In Materials, Inc., 140 F.3d 101, 107 (2d Cir. stock of MedEcon rather than its assets, MedEcon would have 1998) (noting that it is “elementary” that assignments do not remained in existence and continued to be Kethan’s employer. modify the underlying terms of a contract). Those cases Because no assignment would have been necessary under correctly recognize that assignments and modifications are such circumstances, Kethan would have had no basis to even completely different concepts, and that assignability is not question the enforceability of the noncompetition clause. impacted by “boilerplate” modification provisions. Allowing Kethan to avoid his obligations under the circumstances of this case simply because MHA decided to Based on the reasoning of Citibank and Ametex, we structure the transaction as a purchase of assets rather than conclude that the terms of Kethan’s employment were not stock would exalt form over substance. modified by the assignment of his contract and the substitution of MHA for MedEcon. Following the The policy behind enforcing noncompetition clauses is to assignment, Kethan’s contractual rights and duties as an protect businesses against employees resigning and taking employee did not change. The only thing that changed was valued clients with them. See Central Adjustment Bureau, the entity now entitled to enforce the terms and conditions Inc. v. Ingram Associates, 622 S.W.2d 681, 685-86 (Ky. Ct. that Kethan had previously agreed to when he entered into his App. 1981). In this case, while working for MedEcon, employment agreement. Accordingly, we hold that the Kethan had access to MedEcon’s customer lists. He district court erred when it concluded that the assignment of eventually became First Choice’s primary advisor. Because Kethan’s employment contract modified the terms of his of that, Kethan developed a special business relationship with agreement. First Choice. Shortly after First Choice decided to end its business relationship with MHA/MedEcon, Kethan ceased C. A noncompetition clause is assignable in Kentucky working for MHA and commenced working for First Choice. The reason that Kethan was able to develop his unique Under Kentucky law, it has long been recognized “that a business relationship with First Choice, and later go to work contract is generally assignable, unless forbidden by public for it, was because MedEcon employed him and placed him policy or the contract itself, or its provisions are such as to in charge of the First Choice account. He is thus precisely the show that one of the parties reposes a personal confidence in the other, which he would have been unwilling to repose in

8 Managed Health Care No. 99-5444 No. 99-5444 Managed Health Care 9 Associates, et al. v. Kethan, et al. Associates, et al. v. Kethan, et al.

any other person.” Pulaski Stave Co. v. Miller’s Creek Supreme Court declined to address it. Consequently, the only Lumber Co., 128 S.W. 96, 101 (Ky. 1910) (citation omitted). Kentucky authority on point, as enunciated by both the trial Kentucky courts have also acknowledged that noncompetition and the appellate courts in Choate, recognizes that clauses play a critical role in business and are favored as long noncompetition clauses may be assigned as part of the sale of as they are reasonable in geographic scope and duration. See a business’s assets. “Where a state appellate court has Central Adjustment Bureau, Inc. v. Ingram Associates, 622 resolved an issue to which the high court has not spoken, we S.W.2d 681, 685-86 (Ky. Ct. App. 1981) (noting that the only will normally treat [those] decisions . . . as authoritative protection for highly specialized businesses against absent a strong showing that the state’s highest court would employees resigning and taking their clients away are decide the issue differently.” Kurczi v. Eli Lilly & Co., 113 noncompetition clauses); Lareau v. O’Nan, 355 S.W.2d 679, F.3d 1426, 1429 (6th Cir. 1997) (citation and internal 681 (Ky. 1962) (“[T]he policy of this state is to enforce quotation marks omitted). We find no such strong showing, [noncompetition clauses] unless very serious inequities would or indeed any showing at all, in the case before us. result.”); Borg-Warner Protective Services, Corp. v. Guardsmark, Inc., 946 F.Supp. 495, 501 (E.D. Ky. 1996) But Kethan and First Choice argue that Choate is (distinguishing Calhoun v. Everman, 242 S.W.2d 100 (Ky. distinguishable because the trial court did not enforce the 1951), by noting that “the more modern cases, including those noncompetition clause until the original employer had been in Kentucky, place more emphasis on the employer’s joined as a plaintiff. We find this argument unpersuasive, investment in the employee and have evolved an approach however, because the circuit court in Choate found that all balancing the importance of that factor against the hardship to contractual rights to Choate’s noncompetition clause were the employee and the public interest”). transferred from Sexton, Choate’s original employer, to Koorsen, and held that “Koorsen [has] the right to enforce the The second key issue in the present case, however, is not covenant not to compete against Choate” without any the general enforceability of a noncompetition clause, but reference to Sexton. Consequently, the fact that Sexton was whether such a clause is assignable under Kentucky law. joined as a party plaintiff had no effect on the circuit court’s There is only one case in Kentucky that addresses this issue. analysis or holding. In Choate v. Koorsen Protective Servs., Inc., 929 S.W.2d 184 (Ky. 1996), an employee was subject to a noncompetition Kethan and First Choice also argue that the unpublished clause that was silent as to whether it could be assigned. The decisions of the Jefferson County Circuit Court and the assets of the company were later sold, and the seller assigned Kentucky Court of Appeals cannot be considered because the noncompetition clause to the purchaser. Choate, the Rule 76.28(4)(c) of the Kentucky Rules of Civil Procedure employee, argued that the clause was unenforceable because provides that unpublished decisions cannot be cited as he did not expressly consent to the assignment. The Jefferson authority. This Kentucky procedural rule, however, is not County Circuit Court rejected this argument and issued an controlling in the case before us. See Miller v. Davis, 507 injunction enforcing the noncompetition clause. This F.2d 308, 313 (6th Cir. 1974) (noting that federal courts may decision was affirmed by the Kentucky Court of Appeals. use their own procedural rules in diversity cases). Instead, Sixth Circuit Rule 28(g) is the relevant authority, and it does By the time the case reached the Kentucky Supreme Court, not preclude this court from considering the persuasive the one-year noncompetition clause had expired by its own reasoning of unpublished cases. terms. Because the issue was then moot, the Kentucky