On April 23, 2024, the Federal Trade Commission (“FTC”) issued its Final Rule banning employers from imposing post-employment noncompete requirements on their workers (the “Final Rule”). The FTC has indicated that it will continue to prioritize enforcement in the healthcare industry, with objectives seeming to include alleviating physician shortages and improving access to healthcare. What the Final Rule means for healthcare organizations generally, and for nonprofits in particular, is not entirely clear and is likely to be challenged.
Focus on Healthcare
The FTC received tens of thousands of comments on the proposed rule and claims that 25,000 of the 26,000 comments received supported a ban on noncompetes. The FTC noted that commenters who addressed the effects of non-competes on product quality and consumer choice primarily discussed the healthcare industry, attributing physician shortages across the country and negative impacts on quality of care and patient choice in part on the prevalence of noncompetes in the industry. The FTC has made clear that the healthcare provider space will continue be a priority for enforcement of the rule, estimating that the Final Rule will reduce spending on physician services over ten years by $74-194 billion in present discounted value, will result in thousands to tens of thousands of additional patents per year, and will increase in the rate of new firm formation by 2.7%.
FTC Jurisdiction over Nonprofits
The Final Rule recognizes that the FTC’s jurisdiction under the FTC Act generally does not cover tax-exempt organizations, which the FTC notes includes 58% of hospitals in the U.S. Nonetheless, the Final Rule explains that tax-exempt organizations “are not categorically beyond the Commission’s jurisdiction” and seems to reflect that the FTC could challenge whether a nonprofit is in fact a profit-making enterprise and thus within the FTC’s jurisdiction.
The reach of the Final Rule cannot exceed the FTC’s authority under the FTC Act, which provides that the FTC is “empowered and directed to prevent persons, partnerships, or corporations” from engaging in unfair methods of competition, and defines corporations as an entity “organized to carry on business for its own profit or that of its members.” (15 U.S.C. § 44.)
That said, the scope of the FTC’s jurisdiction is not entirely clear, and an entity’s having Federal income tax-exempt status under 501(c) of the Internal Revenue Code may not put it outside of the bounds of the FTC’s jurisdiction. Accordingly, the FTC attempted to clarify this issue in the Final Rule, stating that: “To dispel this misunderstanding, the Commission summarizes the existing law pertaining to its jurisdiction over non-profits.”
The Final Rule explains that, based on judicial decisions and FTC precedent, the FTC applies a 2-part test to determine if a corporation is organized for profit and thus within the FTC’s jurisdiction, requiring: (1) that there be an adequate nexus between an organization’s activities and its alleged public purposes; and (2) that its net proceeds be properly devoted to recognized public, rather than private, interests. The FTC looks to both “the source of the income, i.e., to whether the corporation is organized for and actually engaged in business for only charitable purposes, and to the destination of the income, i.e., to whether either the corporation or its members derive a profit.”
Although the Final Rule reflects that while a determination by the Internal Revenue Service (“IRS”) that a nonprofit does not qualify for tax exemption is meaningful to the FTC’s analysis of whether that entity is subject to FTC oversight, the FTC’s analysis is separate and distinct. The Final Rule states tax-exempt status is one factor to be considered but does not preclude inquiry into an entity’s operations and goals, citing related precedent.
The Final Rule describes that FTC and IRS precedent have identified “private benefits that, if offered, could render an entity a corporation organized for its own profit or that of its members under the FTC Act, bringing it within the Commission’s jurisdiction.” The Final Rule cites examples of entities over which the FTC exercised jurisdiction, including:
- A physician-hospital organization consisting of over 100 private physicians and one non-profit hospital, because it engaged in business on behalf of for-profit physician members.
- A tax-exempt independent physician association that consisted of private, independent physicians and private, small group practices, because it was organized for the pecuniary benefit of its for-profit members and contracted with payors, on behalf of its for-profit physician members, for the provision of physician services for a fee.
- Entities that have had their tax-exempt status revoked by the IRS on the basis of ceding effective control to a for-profit partner and conferring impermissible private benefits, and paying unreasonable compensation, including percentage-based compensation, to insiders.
The FTC appears to view its oversight of nonprofits that do not meet the requirements to be exempt from FTC oversight as consistent with an increasing public scrutiny of tax-exempt hospitals. The Final Rule notes that:
“Public and private studies and reports reveal that some such hospitals are operating to maximize profits, paying multi-million-dollar salaries to executives, deploying aggressive collection tactics with low-income patients, and spending less on community benefits than they receive in tax exemptions. Economic studies by FTC staff demonstrate that these hospitals can and do exercise market power and raise prices similar to for-profit hospitals.”
Quasi-Public Entities
Likewise, the Final Rule reflects that it may apply to quasi-public entities or private entities that partner with states or localities, such as hospitals affiliated with or run in collaboration with states or localities, depending on whether the particular entity or action is an act of the state itself and therefore exempt from the operation of federal antitrust laws under the so-called “State Action Doctrine,” which requires a fact-specific inquiry into the organization and operation of the entity.
What the Final Rule Requires
The Final Rule provides that an employer may not enter post-employment noncompetes with its workers after the rule’s effective date (which is likely to be in early September 2024). The Final Rule defines a “noncompete” as any term or condition of employment that “prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or (2) operating a business in the United States after the conclusion of employment that includes the term or condition.” Doing so would violate Section 5 of the FTC Act, and the noncompetes will be unenforceable. Existing noncompetes (i.e., those entered prior to the rule’s effective date) are also unenforceable after the effective date with very limited exception. The Final Rule defines “worker” broadly—meaning any “person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws, including, but not limited to, whether the worker is an employee [or] independent contractor.”
There are no carve-outs from the Final Rule for healthcare providers, and prohibited noncompetes will include terms and conditions that require an employee to pay a penalty for seeking or accepting other work or starting a business after their employment ends, such as through liquidated damages or cost-sharing provisions common in physician and other provider agreements in certain states. The Final Rule also prohibits provisions which require forfeiture of compensation in the event of post-employment competitive activity and similar types of arrangements.
Exceptions
There are a few noteworthy exceptions to the Final Rule’s prohibition on noncompetes. Under the Final Rule, existing noncompetes (i.e., those in effect prior to the Final Rule’s effective date) can remain in force with senior executives (defined as workers earning more than $151,164 annually who are in “policy-making positions”). Partners in a business, such as physician partners of an independent physician practice, generally will qualify as senior executives if the partners meet the compensation threshold and have final authority to make policy decisions about “significant aspects of the business.” In contrast, a physician who works within a hospital system, even as a department head, but does not have policymaking authority over the organization as a whole, would not qualify.
The Final Rule also carves out noncompetes entered in connection with the bona fide sale of a business or a person’s ownership interest in a business entity. The FTC noted in the Final Rule that such physician partners would likely fall under the sale of business exception in if the partner leaves the practice and sells their shares of the practice.
Finally, the Final Rule’s requirements “do not apply where a cause of action related to a noncompete clause accrued prior to the effective date,” shielding ongoing litigation from immediate implications of the Final Rule.
To comply with the Final Rule, employers must provide notice to workers that the employer will not enforce noncompetes in place when the rule takes effect, and the Final Rule includes model notification language to aid compliance.
Next Steps / Resources
- Monitor developments. Responses to the Final Rule have been heated, and the Final Rule is anticipated to be challenged in court. We anticipate particular scrutiny of the Final Rule’s application to nonprofits.
- For tax-exempt organizations, focus on hot-button tax compliance issues. As reflected in the Final Rule, the FTC’s focus on nonprofit hospitals is occurring within a broader heightened scrutiny of nonprofit health systems by government regulators and the press in terms of how their financial assistance and bill collection efforts compare to their for-profit competitors and whether the benefits they provide to the community are commensurate with the valuable privilege of their tax exemption. Potential FTC scrutiny is now yet another reason for healthcare nonprofits to focus on compliance in the following areas – and to strategically highlight their compliance publicly, including on their IRS Form 990 (which are often looked to by government regulators, the press and donors):
- Financial assistance, charity care and billing and collection policies for patients – and compliance with the related Section 501(r) requirements for tax-exempt hospitals (which the IRS also recently identified as a key compliance priority).
- Executive compensation – ensuring that executive compensation is within fair market value, and preferably determined in accordance with nonprofit best practices.
- Joint ventures with for-profits – focus on IRS guidance for protecting tax-exempt status in this context, particularly given the FTC’s reference to this topic in the Final Rule.
- For nonprofit health systems, focus on taxable affiliates. Many nonprofit health systems have taxable subsidiaries that would not qualify for the nonprofit exclusion from the FTC’s jurisdiction.
- Join our webinar on May 7th. Sheppard Mullin’s Antitrust and Labor & Employment lawyers issued a prior alert about this ruling here and are hosting a webinar on May 7, 2024 to provide a factual analysis and key takeaways for contacts of the firm. Please join us for more information on how the Final Rule may impact your business and contemplated transactions.