Number of noncompetes is likely to decrease
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On May 7, the Federal Trade Commission issued a final regulation in the Federal Register that, if it takes effect, will ban most noncompete clauses in for-profit entities.
According to a FTC release, the final rule is expected to lead to new business formation, drive innovation, higher earnings for workers, estimated earnings increases and lower health care costs by up to $194 billion during the next decade.
“Noncompete clauses keep wages low, suppress new ideas, and rob the American economy of dynamism, including from the more than 8,500 new startups that would be created a year once noncompetes are banned,” Lina M. Khan, FTC chair, said in the release. “The FTC’s final rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business or bring a new idea to market.”
Full implications
Understanding the full implications of the final rule is difficult for several reasons. First, there are already legal challenges to the rule, so it is possible the rule will not take effect Sept. 4 as planned. Predicting the future is difficult. However, I would say, at least in the health care context, the probability that the challenge results in at least a temporary suspension of the rule seems very high.
Perhaps the biggest reason for the complexity of the rule, particularly in the health care context, is the FTC has limited jurisdiction. Specifically, it has oversight only over a corporation “organized to carry on business for its own profit or that of its members.”
Position of the courts
Courts, and even the FTC, have taken the position that nonprofits are generally outside the scope of the FTC’s authority. The limitation on noncompetes will apply only to for-profit entities, like most physician clinics, but also to a much smaller percentage of hospitals. Although there are some large for-profit hospital systems, most hospitals are beyond the scope of this rule.
The rule bans for-profit entities from imposing noncompete clauses on employees, except in limited situations. Nonprofit hospitals and clinics would be permitted to impose a noncompete clause unless some other law, like a state law, prohibited it. That is a weird result and one reason I believe the courts will intervene.
The FTC recognizes the inconsistency, but when presenting the rule, asserted some entities that claim nonprofit status may be effectively for-profit. The FTC cited cases where courts have ruled that if a nonprofit has “ceded effect control” to a for-profit partner, then the entity can lose its tax-exempt status.
That observation is true, but misleading because it has been exceedingly rare. It would be revolutionary for the government to assert that most or even many nonprofit entities do not actually qualify for that status.
Noncompete agreements
According to the FTC as published in the Federal Register, 58% of hospitals claim tax-exempt status, with another 19% being state or local organizations that are also outside the FTC’s reach. In other words, the FTC admits that, absent extenuating circumstances, 77% of hospitals are outside the scope of the new rule. There are certainly some people who would like to eliminate tax-exempt status for hospitals, but that is a separate policy question, well outside the scope of this final rule. Courts are likely to be troubled by a rule that only applies limitations to about 25% of an industry.
For individuals employed by a nonprofit or government-run facility, the rule has no impact. For those who are employed by a for-profit organization, whether a hospital or clinic, if the rule takes effect Sept. 4 as it will unless there is court intervention, in many cases their existing noncompete provisions would be invalid.
The regulation will prohibit enforcement of any current noncompete for any non-executive employees with the exception of those associated with the sale of a business. However, it allows employers to continue to enforce noncompetes already in place with “senior executives.” The rule will prohibit new noncompetes for senior executives that are signed after Sept. 4.
Senior executives are workers who are in a policy-making position and earn more than $151,164 a year. It is likely, particularly in physician-owned clinics, that a number of employees will have enough policy influence to be considered senior executives. That said, the odds that the rule will take affect seem very low. Courts are likely to be concerned about the inconsistent treatment of for-profit and nonprofit hospitals. A court injunction seems probable.
Trends in the law
It is worth noting that even if a court prevents the rule from taking effect, it is part of a trend against noncompetes. The FTC noted that there are provisions in Colorado, Florida, Indiana, Iowa, Kentucky, New Mexico, South Dakota, Texas and the District of Columbia that limit noncompetes for at least some health care professionals. The list also ignores broader noncompete limitations that exist in places like California, Minnesota, Oklahoma and North Dakota that impose broader restrictions on noncompetes.
I will close with a personal thought. I discourage my clients from imposing noncompetes because I think these often cause litigation as departing employees “drum up” a reason to void the noncompete. I understand the argument that when a clinic hires a new physician, it is providing the physician with an easier path to success than if the person started alone. But if that physician leaves before becoming a shareholder, then the odds the physician will be able to compete effectively with the group seem low.
Perhaps more importantly, I think the strongest groups remain together because the physicians choose to stay, not because they are forced to stay. I think avoiding a noncompete can help you recruit the best physicians and avoid the sort of expensive litigation that adds stress and expense to a group.
Even if you can impose a noncompete clause, then you may be better off refraining from doing so. Moreover, given the trends in the law, whatever happens to the FTC rule, the number of noncompetes is likely to continue to decrease.
- References:
- https://www.ftc.gov/news-events/news/press-releases/2024/04/ftc-announces-rule-banning-noncompetes. Published April 23, 2024. Accessed May 1, 2024.
- https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf. Published April 23, 2024. Accessed May 1, 2024.
- https://www.ftc.gov/legal-library/browse/rules/noncompete-rule. Accessed May 1, 2024.
- https://www.govinfo.gov/content/pkg/FR-2024-05-07/pdf/2024-09171.pdf. Published May 7, 2024. Accessed May 7, 2024.
- For more information:
- David M. Glaser, JD, is a shareholder and chair of health care fraud and compliance for Fredrikson & Byron, P.A. in Minneapolis. He can be reached at dglaser@fredlaw.com.
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