Nuts and Bolts of the Final Rule
The FTC’s rulemaking authority stems from the Federal Trade Commission Act (FTC Act or the Act), 15 U.S.C. §§ 41-58, through which Congress empowered the FTC to, among other things, promulgate rules and bring enforcement actions to prevent unfair methods of competition. Pursuant to its rulemaking authority under sections 5 and 6(g) of the Act and after a Notice of Proposed Rulemaking and the submission of over 26,000 public comments, on April 23, 2024, the FTC voted 3-2 to issue the Final Rule (published May 7, 2024) banning the vast majority of all noncompete agreements in the United States. Although some states previously restricted noncompete agreements, including some that banned them in the healthcare context, the reach of the Final Rule represents a sea change.
Broadly speaking and subject to exceptions, the Final Rule provides that as of the effective date, it is an “unfair method of competition” and “a violation of section 5” of the FTC Act for an employer (1) to enter into a new noncompete agreement with a worker, including a “senior executive” (i.e., a worker in a “policy-making position” earning more than $151,164 per year); or (2) with respect to existing noncompete agreements with workers other than “senior executives,” to enforce a noncompete agreement or represent that the worker is subject to one. The Final Rule does not ban existing noncompete agreements with “senior executives” as defined in the rule. For existing noncompete agreements with all other workers, employers must provide “clear and conspicuous notice” that the existing noncompete clauses are “no longer in effect and will not be, and cannot legally be, enforced against the worker.”
One key exception is that the Final Rule does not apply to noncompete clauses “entered into by a person pursuant to a bona fide sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.” This is crucial, particularly in the healthcare context, as acquirers often want a reasonable noncompete clause to ensure the value of their purchase is not diminished. Although the Final Rule exempts these noncompete clauses, they will continue to be governed by state laws and federal antitrust law, which generally focus on the reasonableness or necessity of the restriction.
With those nuts and bolts of the Final Rule in mind, the following sections focus on a few nuances that are particularly pertinent to healthcare practices.
Does the Final Rule (or the FTC) Cover the Many Nonprofit Healthcare Organizations that Exist?
It depends. In the Final Rule, the FTC expressly rejected some commentors’ contentions that healthcare organizations that claim tax-exempt status as nonprofits pursuant to section 501(c) of the Internal Revenue Code are categorically outside of the FTC’s authority. Rather, the FTC pointed to both FTC and judicial precedent to explain that “not all entities claiming tax-exempt status as nonprofits fall outside the [FTC]’s jurisdiction.”
Notably, the FTC Act defines a “corporation” as an entity “which is organized to carry on business for its own profit or that of its members.” And the Eighth Circuit has explained that “Congress took pains in drafting § 4 [of the Act] to authorize the [FTC] to regulate so-called nonprofit corporations, associations and all other entities if they are in fact profit-making enterprises.”
To determine whether an organization is in fact a nonprofit, the FTC applies a two-part test: “The not-for profit jurisdictional exemption under Section 4 requires both that there be an adequate nexus between an organization’s activities and its alleged public purposes and that its net proceeds be properly devoted to recognized public, rather than private, interests.” In other words, whether an employer qualifies as a nonprofit outside the scope of the FTC’s jurisdiction depends on (1) “whether the corporation is organized for and actually engaged in business for only charitable purposes,” and (2) “whether either the corporation or its members derive a profit.” The FTC may exercise jurisdiction, including with respect to its Final Rule, over “any entity satisfying the two-prong test.” This includes nonprofit healthcare corporations.
To further illustrate the fact that the FTC may, depending on the situation, exercise jurisdiction over nonprofit healthcare entities, the Final Rule provides the following examples:
- The FTC has previously exercised jurisdiction in a Section 5 enforcement action over a physician-hospital organization, which claimed tax-exempt status as a nonprofit, because the organization engaged in business on behalf of for-profit physician members.
- The FTC has exercised jurisdiction over an independent physician association, which consisted of private, independent physicians and private, small group practices, claiming tax-exempt status as a nonprofit. However, the “association was organized for the pecuniary benefit of its for-profit members because it ‘contract[ed] with payers, on behalf of its [for-profit] physician members, for the provision of physician services for a fee.’”
- Under IRS precedent, purportedly tax-exempt nonprofit hospitals and other related entities that partner with for-profit entities and cede effective control to such for profits, “conferring impermissible private benefit,” lose tax-exempt status.
- “The IRS has also rejected claims of nonprofit tax-exempt status for entities that pay unreasonable compensation, including percentage-based compensation, to founders, board members, their families, or other insiders.”
As these examples highlight, the fact that a healthcare organization claims nonprofit tax-exempt status under the Internal Revenue Code will not, in itself, prevent it from being subject to the FTC’s Final Rule. Rather, the FTC will conduct a fact-specific inquiry under its two-prong test to determine whether the organization is subject to the FTC’s jurisdiction. Nonprofit healthcare organizations should perform the same exercise.
Who is a "Senior Executive" in the Healthcare Context?
The FTC’s Final Rule defines a “senior executive” as “a worker who: (1) Was in a policy-making position; and (2) Received from a person for the employment: (i) Total annual compensation of at least $151,164 in the preceding year; or (ii) Total compensation of at least $151,164 when annualized if the worker was employed during only part of the preceding year; or (iii) Total compensation of at least $151,164 when annualized in the preceding year prior to the worker’s departure if the worker departed from employment prior to the preceding year and the worker is subject to a non-compete clause.”
A “policy-making position” means that the worker, such as a president or chief executive officer, has “policy-making authority.” A worker has “policy-making authority” if the worker is able to make policy decisions that control a significant aspect of the business “as a whole, not a particular office, department, or other sublevel.” A worker who makes policy decisions with respect to a single office, department, or sublevel would not qualify as a senior executive. The FTC offered an example in the healthcare context: “neither the head of a hospital’s surgery practice nor a physician who runs an internal medical practice that is part of a hospital system would be senior executives, assuming they are decision-makers only for their particular division.”
The FTC elevated substance over form regarding what a policy-making position is. The FTC broadly defines who may be in such a policy-making position—whether a president, chief executive office or the equivalent, or other officer or employee—to account for the fact that job titles and duties vary between companies. “This ensures that the term ‘senior executive’ is broad enough to cover more than just a president or chief executive officer … as others may have final policy-making authority over significant aspects of a business entity.” To illustrate, a physician who is a partner in an independent physician practice would likely qualify as a senior executive, regardless of their title, if the physician both met the compensation threshold and had authority to make policy decisions about the practice. In contrast, a physician who works for a hospital system and does not have policy-making authority over the organization would not qualify as a “senior executive” under the Final Rule, despite any officer title they might be given, since they lack policy-making authority.
In sum, whether a healthcare worker is a senior executive for whom an existing noncompete can remain in force will require a fact-specific analysis that takes into account both the worker’s compensation and whether the worker is in a policy-making position that allows them to make policy decisions controlling significant aspects of the healthcare organization as a whole.
Do Healthcare Employees Have a Private Right of Action to Sue Their Employers Under the Final Rule?
One question employers may be sweating over is whether the Final Rule grants their employees the right to sue their employers for failing to comply with the Rule. In short, not exactly, but there continue to be other avenues by which an employee may bring an action against an employer regarding noncompete agreements.
With the FTC Act, Congress empowered the FTC to bring lawsuits to enforce the Act. The FTC Act does not grant private rights of action to persons who may be harmed by conduct that otherwise violates the Act. Accordingly, an employee who may be harmed by an illegal noncompete agreement if the Final Rule goes into effect does not have a private right of action under the FTC Act or the Final Rule to sue their employer for violating the Final Rule; that is the FTC’s job.
On the other hand, the Final Rule leaves open the possibility that an employee may take private action under state law. Specifically, the Final Rule “does not limit or affect enforcement of State laws that restrict non-competes where the State laws do not conflict with the final rule, but it preempts State laws that conflict with the final rule.” This effectively creates a “floor”: the Final Rule would supersede state laws that conflict with the Final Rule (for example, a state law purporting to deem all noncompete agreements legal), but it would not preempt state laws that restrict noncompete agreements in other ways or provide additional protections (for example, a state law banning noncompete agreements for nonprofits or providing a private right of action for employees harmed by illegal noncompete agreements).
In fact, the FTC has already weighed in on state legislative efforts to “fill gaps with respect to noncompetes that are beyond the FTC’s jurisdiction.” For instance, in the context of Pennsylvania’s consideration of a law that would “restrict the use of noncompetes for certain health care practitioners,” an FTC letter noted that “state-based enforcement against noncompetes can be a potent force that supplements the federal rule,” and specifically mentioned that “states’ noncompete laws, unlike the FTC Act, may provide for a private right of action and/or monetary penalties.” In that same vein, California recently passed a law providing a private right of action for employees harmed by illegal noncompete agreements and allowing them to seek damages, injunctive relief, attorneys’ fees, and costs.
While neither the FTC Act nor the Final Rule grants employees a private right of action to sue under the Act or the Final Rule itself, employees in certain states may have a private right of action under state law to sue their employer over illegal noncompete agreements. And employees, even employees in states that do not grant such private rights of action, can blow the whistle and alert the FTC to violations of the Final Rule—the FTC encourages it.
How Can Employers Protect Their Legitimate Business Interests Without Noncompete Agreements?
Some employers have historically used noncompete agreements to try to protect their investments or confidential business information. The justification goes something like this: If Practice A developed a trade-secret technique and taught it to a physician-employee, and the physician-employee later went to work for Practice B, a competitor across town, and the physician-employee taught Practice A’s trade-secret technique to Practice B’s employees, then not only would Practice A be worse off, it would also disincentivize Practice A (and others) from developing efficiency-enhancing trade secrets, to the detriment of the company and consumers. Although the Final Rule would prohibit most noncompete agreements, employers still have some legal ways to protect their investments and confidential business information.
Most notably, the Final Rule does not prohibit the use of confidentiality agreements, non-disclosure agreements (NDAs), or other restrictive covenants such as non-solicitation agreements, to protect a company’s confidential information, trade secrets, and intellectual property, so long as those agreements do not function as a noncompete agreement and prevent a worker from seeking or accepting other employment. Indeed, the FTC recognized that NDAs can serve a procompetitive business justification by preventing the improper disclosure of commercially sensitive information while not unduly restricting employees from moving to different employers or going out on their own. If necessary, employers can also sue to obtain injunctive relief to protect their trade secrets or intellectual property, to enforce a valid NDA, or to claim damages for such violations. Accordingly, while some employers may lament the Final Rule’s restriction on its ability to rely on noncompete agreements to protect their investment and confidential information, alternative legal agreements and protections remain available to achieve their legitimate business objectives while complying with the Final Rule.
Conclusion
With the potential implementation of the Final Rule and the passage of new state laws, healthcare labor markets are undergoing a marked transformation. Employers—especially healthcare employers—must be vigilant and prepared to address the near complete elimination of noncompetes and increased protections for employees under state laws. Given the significant complexities in these areas, healthcare professionals should not hesitate to reach out to counsel for advice and guidance.