Access the audio version of this article
While they are a fixture in many employment arrangements, lawmakers and enforcement authorities recently have begun taking a closer look at the legality of non-compete provisions and other similar restrictive covenants. The trend toward greater scrutiny of non-compete provisions could have significant ramifications for the healthcare sector, where these covenants are particularly prevalent.
During the Middle Ages, English judges declined to enforce covenants not to compete for fear that doing otherwise would keep workers from earning a livelihood and sharing their skills with society. However, the common law on both sides of the Atlantic eventually evolved to permit reasonable non-compete provisions in employment. In the years that followed, the use of non-compete provisions ballooned. The Federal Trade Commission (FTC) estimates that nearly one in every five American workers is subject to a non-compete clause. Perhaps unsurprisingly, physicians are even more likely to be bound to a non-compete provision. A recent Medscape poll of 558 physicians found that 90% of respondents were subject to a covenant not to compete at some time during their careers.
For years, regulation of non-compete provisions was largely left to the states. Courts in many jurisdictions developed some form of a “reasonableness” test when analyzing the enforceability of such restrictive covenants. For example, Kentucky courts will enforce a non-compete provision if its terms are “reasonable in the light of the surrounding circumstances...” based on the nature of the employment and the “character, duration and territorial extent” of the restrictions. Similarly, the Nebraska Supreme Court instructs that any review of the enforceability of non-compete provisions must include three inquiries: (1) whether the restriction is injurious to the public, (2) whether the restriction is greater than is reasonably necessary to protect a legitimate interest of the employer, and (3) whether the restriction is unduly harsh and oppressive on the employee.
Other states have deviated sharply from a reasonableness test and have banned most or all non-compete provisions. California has prohibited most non-compete agreements for 150 years. The codes of Oklahoma and North Dakota have similarly long-standing near-total bans on the provisions. A measure prohibiting most covenants not to compete is poised to go into effect this July in Minnesota.
Although permitting non-compete provisions generally, some state legislatures have recently focused their attention on limiting their enforceability against physicians and other healthcare professionals. In 2015, New Mexico banned any contractual provision that restricts a physician’s right to provide clinical healthcare services after employment. Connecticut adopted a statute in 2016 that, among other things, limits the duration of a non-competition provision with a physician to one year and its geographic scope to 15 miles of the physician’s primary practice site. Rhode Island also passed legislation in 2016 that declared void any portion of most physician agreements that would limit the physician from practicing medicine. In 2018, Colorado proscribed collecting damages for breach of a covenant not to compete for physicians when they are providing treatment of a rare disorder for a previously established patient. Even more recently, South Dakota’s near-total prohibition against non-compete provisions with physicians, nurses, and many other categories became effective in 2021.
In addition to the recent wave of bans on physician non-compete provisions, at least seven states have enacted legislation to block enforcement of restrictive covenants against low-wage or low-skilled workers since 2019.
Yet the gradual shift away from non-compete provisions at the state level has been overshadowed by federal regulatory action taken in recent months. Historically, non-compete clauses were scrutinized under state law; federal courts rarely analyzed whether employer-employee non-compete agreements violated the Sherman Act. Section 1 of the Sherman Act holds that agreements between companies that restrain trade are illegal, whereas Section 2 makes it unlawful for a single firm to “monopolize or attempt to monopolize” a market. However, when addressed by federal courts, antitrust claims concerning non-compete clauses have been met with scrutiny and analyzed under the rule of reason, which considers both the anti- and pro-competitive effects of the restraint.
This year, the FTC, utilizing its powers under Sections 5 and 6(g) of the FTC Act (15 U.S.C. §§ 45, 46(g)), proposed a rule to prohibit employers from using non-compete clauses with workers. As background, Section 5 of the FTC Act prohibits “[u]nfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce….” In interpreting Section 5, the Supreme Court has held that the “standard of ‘unfairness’ under the FTC Act is, by necessity, an elusive one, encompassing not only practices that violate the Sherman Act and the other antitrust laws… but also practices that the Commission determines are against public policy for other reasons….”
In November 2022, the Commission announced a “State of Enforcement Policy” indicating that the enforcement agency would “rededicate” itself to utilizing Section 5, including with respect to practices that do not necessarily “violate the Sherman Act or other antitrust laws.” Shortly thereafter, on January 4, 2023, the Commission filed three separate complaints alleging violations of Section 5 against companies utilizing various types of non-competes. The next day, the Commission, in a 3-to-1 vote, issued a proposed rule that creates a nationwide ban on non-compete clauses under Section 5 of the FTC Act. The Commission contended that the rule will eliminate anticompetitive effects of non-compete agreements in labor markets, which limit worker mobility and “reduce[] wages for workers across the labor force—including workers not bound by non-compete clauses.”
The proposed rule is broad. As drafted, the rule makes it an unfair method of competition for an employer to (1) enter into (or even attempt to enter into) a non-compete clause with a worker, (2) maintain an existing non-compete clause, or (3) represent to a worker, under certain circumstances, that the worker is subject to a non-compete clause. The Commission defines “worker” to include not just employees, but also independent contractors, interns, and unpaid volunteers, and seeks to ban restrictive covenants that serve as de facto non-compete clauses. There is an exception: the proposed rule would not apply to non-compete clauses restricting competition by a person selling or disposing of interest in a business where the person is a “substantial” owner, member, or partner in the business. This would allow a company to protect the value of the business if a substantial owner sells and seeks to compete against it. The Commission estimates that the proposed rule would result in workers’ earnings increasing by nearly $300 billion annually and claims consumers will see a decrease in prices, including in the healthcare sector.
Upon submission to the Federal Register, the proposed rule was open to public comments, and to date, over 25,000 comments have been received. In addition to seeking general comments, the Commission has requested the public’s input on “proposed alternatives” to a blanket restriction on non-competes, including whether there should be exemptions for certain categories of workers or whether the Commission should, in the alternative, enact a disclosure or reporting rule.
The proposed rule has received some fierce criticism. For example, in her dissent, former commissioner Christine Wilson, who stepped down on March 31, 2023, stated that the proposed rule and the Commission’s reliance on Section 5 was a “radical departure from hundreds of years of legal precedent” and noted that the Commission’s “little enforcement experience… with employee non-compete provisions… fails to demonstrate harm to consumers and competition.” Wilson also noted that any such rule likely faces a number of legal challenges, including that the Commission lacks authority to engage in such rulemaking or undertake this initiative and that the Commission’s actions may be an “impermissible delegation of legislative authority under the non-delegation doctrine.”
If the rule survives legal challenges, its scope could be somewhat curtailed by the empowering statute. The FTC Act permits the Commission to act against “persons, partnerships, or corporations,” and defines a “corporation” as any company “organized to carry out business for its own profit or that of its members.” As a result, the Commission’s authority generally does not extend to nonprofit entities—unless they are organized to carry out business for profit of its members. The FTC Act also does not grant a private right of action, so no private plaintiff would be able to enforce the regulation (although they or other enforcers could potentially bring an action based on other laws). Nonetheless, if the proposed rule (or a substantially similar version) goes into effect, employers and employees in the healthcare industry will need to reevaluate their business practices and employment agreements to ensure they are compliant.
As employers adapt to the changing landscape governing non-compete clauses and monitor their labor costs, they must also be aware of the risks associated with “no-poach” agreements (i.e., agreements between employers not to recruit, solicit, or hire each other’s employees) and “wage-fixing” agreements (i.e., agreements between employers to fix employees’ salaries or compensation). Despite their different structures, non-compete, no-poach, and wage-fixing agreements all implicate antitrust concerns about potential anticompetitive restraints in labor markets, which can deprive employees of job opportunities, limit their mobility, and suppress their wages or benefits.
The concerns about no-poach and wage-fixing agreements are not limited only to companies that compete in the same market to provide goods and services to customers. Under the DOJ/FTC Antitrust Guidance for Human Resource Professionals, “From an antitrust perspective, firms that compete to hire or retain employees are competitors in the employment marketplace, regardless of whether the firms make the same products or compete to provide the same services.”
No-poach and wage-fixing agreements, including those in healthcare industry, have come under increased scrutiny by federal antitrust enforcers, state attorneys general, and private antitrust plaintiffs. In 2016, the DOJ announced its “inten[tion] to criminally investigate naked no-poaching or wage-fixing agreements that are unrelated or unnecessary to a larger legitimate collaboration between the employers.” Although the DOJ has faced some setbacks prosecuting criminal no-poach or wage-fixing cases, these cases serve as a stark reminder to employers to heed antitrust laws when adjusting their business practices in response to potential bans on non-compete clauses.
Non-compete provisions have been part of employment agreements, particularly in the healthcare industry, for decades. During that time, employers and workers navigated a patchwork of state laws governing the reasonableness and enforceability of such provisions. If enacted, the FTC’s proposed rule will result in a widespread ban on non-compete agreements for employers and employees. While the rulemaking process plays out, healthcare employers should work with counsel to ensure current compliance with ever-evolving state laws and prepare for the possibility that non-compete provisions could be invalidated by federal regulations in the near future. Moreover, given federal and state enforcers’ and private plaintiffs’ continued concerns with anticompetitive practices in labor markets, employers must remain vigilant in ensuring that their attempts to adapt to a potential ban on non-compete provisions do not set them on a course toward illegal no-poach or wage-fixing agreements.
