Noncompetes: What the FTC’s Rule May Mean for Health Care & Life Sciences Providers
On April 23, 2024, the U.S. Federal Trade Commission (FTC or “Commission”) finalized a rule, by a vote of 3-2, abolishing the vast majority of employee covenants not to compete across the United States (the “Noncompete Rule” or “Rule”). Once effective (120 days from the date the Rule is published in the Federal Register), and unless it is successfully challenged in federal court, the Rule will ban noncompete agreements with employees of all ranks and seniorities in virtually all industries across the United States. Although the Rule has not yet been published, the effective date is likely to fall in late August or early September of 2024. Our firm’s overview and summary of the Rule is available here.
Immediately following the issuance of the Rule, the U.S. Chamber of Commerce and other groups filed lawsuits challenging the Rule, seeking injunctive relief to delay the effective date as well as a ruling to vacate the Rule in its entirety. Litigation over the Rule will raise a host of interesting constitutional, statutory, and administrative issues. One of the leading grounds for a challenge will be the so-called “major questions doctrine,” which requires clear Congressional authorization before an administrative agency will be found to have the power to decide major policy questions. The precedents that will guide the various courts that will consider the Rule are difficult to reconcile, and it is possible that different courts may decide these cases in seemingly inconsistent ways. There is even a potential for different results to apply in different parts of the country. Indeed, two of the FTC’s five Commissioners expressed concerns about the legality of the Noncompete Rule, with one Commissioner stating that she believes the Rule likely will not survive legal challenge.
Health Care & Life Science’s Response to the Proposed Rule
Noncompete agreements have long been a feature in contracts entered into by health care & life sciences industry participants — including physicians, senior clinicians, and executives. These arrangements are viewed as critical to maintaining the value of the businesses with whom the aforementioned individuals are employed, especially given the personal relationships many of them have with patients, customers, vendors, and suppliers of such businesses.
In response to the proposed Rule, thousands of industry participants provided comments to the FTC. Certain participants argued for a health care industry-wide exemption from the Rule, which the FTC rejected. While certain health care providers will be exempted from the Rule, many will not. As such, and if the Rule survives legal challenge, health care industry participants — including physician groups, nonprofits, management services organizations, and ambulatory surgery centers — should carefully consider how the Rule will impact their recruitment and retention strategies going forward.
Overview of the FTC’s Noncompete Rule
The FTC’s Noncompete Rule has three main components:
- For the great majority of workers, the Noncompete Rule declares it an “unfair method of competition” to enter into or enforce a noncompete agreement. “Workers” are defined broadly to include employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors. In other words, employers will no longer be able to force employees to sign covenants not to compete or to enforce such covenants against most employees.
- Before the effective date of the Rule, employers that have noncompetes subject to the Noncompete Rule must notify affected employees that their noncompete will not and cannot be enforced. The Rule includes model language to this effect that can be shared with employees.
- To the extent that a noncompete agreement may be permitted under state law, the Noncompete Rule states that it preempts such state law.
As noted above, the Noncompete Rule is scheduled to go into effect 120 days after its publication in the Federal Register. The effective date is likely to fall in late August or early September.
FAQs
Q1: Does the Noncompete Rule apply to all health care entities and employers?
A: Not all, but many health care entities and employers will be subject to the Noncompete Rule.
Notably, and importantly, the Rule will not apply to some nonprofit health care entities such as certain tax-exempt hospitals and health systems (which fall under Section 501(c)(3) of the Internal Revenue Code)[1]. This exemption is not policy-based but instead reflects that the FTC Act only reaches corporations that are “organized to carry on business for its own profit or that of its members.” One will not find this exemption in the text of the Rule itself.
The above notwithstanding, there are ambiguities in the Rule that will need to be carefully considered. For example, even though tax-exempt organizations generally fall outside the scope of the FTC Act, the scope of that exemption is unsettled and can be hazy. For example, the FTC in the past has successfully brought actions against physician-hospital organizations or independent physician associations that, despite being organized as nonprofits, functionally existed to profit their members. Additionally, some health care organizations use for-profit medical groups or professional corporations to employ physicians and other professionals that are otherwise subject to a “corporate practice of medicine” prohibition. Additionally, nonprofit hospitals sometimes contract with for-profit staffing companies to provide staffing coverage. These for-profit entities may well be subject to the Noncompete Rule. Hospitals and health systems should be careful to identify those members of their corporate families that may be subject to the Noncompete Rule — and those that may not.
Another — more complicated — question, which is unsettled, is how health care entities that are part of or sponsored by state or local governments, such as university-based hospitals or faculty practice plans, will be treated under the Rule and the application of the “State Action Doctrine,” which generally exempts state actors from liability under the federal antitrust laws when they act pursuant to a clearly articulated legislative policy of displacing competition and are otherwise subject to active state supervision.
Other than as described above, all other health care entities and employers will be subject to the Rule.
Q2: Does the Noncompete Rule apply to all employees?
A: The Rule applies to all “workers,” which is defined broadly to include employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors. In practice, the great majority of workers will be subject to the Rule. See Page 95 of Rule.
However, the Rule does not disturb noncompete agreements made before the Rule’s effective date for those workers the FTC defines as “senior executives” (as further defined in question three below). Instead, the Rule declares it an “unfair method of competition” to enter into or enforce a noncompete agreement with a senior executive when that agreement is made after the Rule’s effective date. In other words, it will not be a violation of the Rule to enforce a pre-existing noncompete against a senior executive, but after the Rule’s effective date employers may not enter into a new noncompete with such senior executives. Existing contracts with “senior executives” that, by their terms, do not expire should remain valid. However, contracts that must be renewed would likely be viewed by the FTC as a new noncompete agreement prohibited by the Rule.
For workers who are not “senior executives,”, pre-existing noncompetes will no longer be enforceable after the Rule’s effective date. See Page 2-3 of Rule.
Q3: Who is a “senior executive”? Will physician employees be deemed to be “senior executives”?
A: A “senior executive” is defined as a worker who earns at least $151,164 per year (the 2025 salary threshold for a “highly compensated employee” under the Fair Labor Standards Act) and serves in a “policy-making position” with the organization. For example, physician employees or owners of a private physician practice with authority to make policy decisions about the whole business are likely to qualify as senior executives. In contrast, a physician who works within a covered hospital system or as a non-owner employee of a physician practice likely will not have policymaking authority with respect to the business and thus is unlikely to qualify as a senior executive. See Page 269-270 of Rule.
Importantly, whether a worker has “policy-making authority” is assessed based on the business as a whole, not a particular office, department, or other sublevel. The Rule requires considering the authority a worker has to make policy decisions that control a significant aspect of a business without needing a high-level worker’s approval. By way of example, the FTC noted that neither the head of a covered hospital’s surgery practice nor a physician who runs an internal medical practice that is part of a covered hospital system would be senior executives, assuming they are decision-makers only for their particular divisions. See Page 272-273 of Rule.
It is noteworthy that the FTC specifically stated that “many” physicians will not qualify as senior executives because, despite the high median income for physicians, they are not typically in policy-making positions within their employer organizations. See Page 550 of Rule.
Q4: Is there a size limit (of employees) which may exempt an employer?
A: No. The Noncompete Rule is expansive and covers employers of all sizes (with limited exceptions for employers who are outside of the FTC’s jurisdiction, including certain nonprofit, tax-exempt entities, as discussed in question one above).
Q5: Does the prohibition on a noncompete apply while the employee is employed, or does it apply only after employment?
A: The Noncompete Rule applies to agreements that restrict workers from taking work with another employer “after the conclusion” of their employment. Therefore, subject to state law, an employer would still be able to prohibit current employees from working at the same time for a competitor (e.g., on a part-time basis).
Q6. Does it matter how the employment of an employee is terminated?
A. No. The Noncompete Rule applies irrespective of how an employee’s employment is terminated.
Q7: What constitutes a “noncompete,” and does that concept include nondisclosure agreements, non-solicit clauses, no-hire clauses, liquidated damages clauses, etc.?
A: Under the Noncompete Rule, “traditional” noncompete clauses, i.e., prohibitions on work after employment ends, are forbidden. The Noncompete Rule also applies to provisions that “penalize” a worker (e.g., liquidated damages, forfeiture of severance or equity, buyout clauses, no-hire clauses) for seeking or accepting work after the conclusion of the person’s employment. Further, the Rule includes a catchall provision to capture other types of agreements that “function[ ] to prevent” a worker from accepting different work after the conclusion of their employment. This catchall language may potentially encompass other forms of restrictive covenants, including non-solicitation agreements.
While the FTC’s rulemaking notice refers to non-solicitation clauses, customer- or client-based “no business agreement[s],” and non-hire agreements as “generally not noncompete clauses,” the FTC notes that such restrictions could potentially rise to the level of a prohibited noncompete based on a fact-specific inquiry. It remains an area of uncertainty where the FTC or courts would draw the line. Thus, we believe that such clauses should be narrowly tailored, not overly broad, as well as reasonably necessary to protect the employer’s legitimate business interests upon the termination of an employee’s employment. Seeking counsel when drafting such arrangements is recommended. See Page 76-842 of Rule.
Q8: Does the Noncompete Rule apply to business owners who are also employees of that business?
A: The Rule applies to all “workers,” including business owners who are also employed by the business, subject, of course, to the conditions applicable to pre-existing noncompetes for senior executives (as discussed in question three above).
However, a business owner who is also an employee may fall within the “sale of a business exception” (discussed in greater detail below in question nine) in connection with a qualifying sale of the business. In that case, a noncompete may be enforceable against the seller.
Q9: Does the Noncompete Rule apply to business owners who are not employees, such as owners of ambulatory surgery centers, imaging centers, management services organizations, etc.?
A: The Noncompete Rule does not apply to noncompetes “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.” See Page 4 of Rule. Therefore, noncompetes entered into with business owners in connection with the sale of a business will remain enforceable under the Rule.
Further to the above — and to be clear — a seller of a business entity can agree to a noncompete individually but not on behalf of any of that business’s workers. The Rule prohibits noncompetes for workers, including in a sale of business context.
Q10. Does the Noncompete Rule apply to noncompetes between businesses?
A. No. The Rule applies only to noncompetes between businesses and workers. For example, the Rule does not apply to noncompetes in franchisor/franchisee contracts, but it does apply to noncompetes between employers and workers at franchises. However, those other noncompetes, including between businesses, would still be subject to other applicable state and federal laws, including the antitrust laws.
Q11: If an employer has employees subject to noncompetes currently, what rights or obligations does an employer have?
A: Those businesses that are subject to the Rule should be prepared for the end of any noncompetes that are not made with senior executives. Before the effective date of the Noncompete Rule, businesses should also be prepared to distribute the required notices informing employees that their noncompetes will no longer be enforced. However, any senior executives who fall within the Noncompete Rule’s definition should be excluded from the distribution of that notice. Further, businesses should review their other restrictive covenants, including non-solicitation and no-hire clauses, to ensure those clauses are narrowly tailored to protect their legitimate interests. Finally, businesses should have confidentiality agreements in place with employees and should prepare for a potential wave of trade secret litigation, as employees are increasingly enticed to start their own businesses or leave to work for competitors.
Q12. What action is taken if the Noncompete Rule is violated?
A. Violations of the Rule will be deemed a violation of Section 5 of the FTC Act as an “unfair method of competition.” See Page 1-2 of Rule.The FTC can pursue adjudication under Section 5(b) of the FTC Act or seek an injunction in federal court against a party that has engaged in an unfair method of competition. The FTC cannot obtain civil penalties or other monetary relief against parties for using an “unfair method of competition;” however, the agency can obtain civil penalties in court if a party is ordered to cease and desist from a violation and fails to do so. 15 U.S. Code § 45(m); see Page 24 of Rule. Additionally, once the Rule is effective, workers and other market participants can report information on a suspected violation of the Rule to the FTC.
Q13. Can a business hire someone who had a noncompete in their prior job?
A. When the Noncompete Rule officially goes into effect, yes, so long as the worker is not a senior executive bound by a noncompete implemented before the Rule’s effective date.
Q14: Does the Noncompete Rule apply to non-employees?
A: Yes. The Noncompete Rule applies to all “workers,” a term which is defined broadly to include employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors. See Page 95 of Rule.
Q15: When does the Noncompete Rule take effect?
A: The Noncompete Rule is slated to take effect 120 days after the final rule is published in the Federal Register, which would likely put the effective date in late August or early September 2024. See Page 5 of Rule. However, the effective date may change based on the legal challenges that have been brought as discussed above.
Want to Learn More?
Join us on May 9 for the Foley hosted webinar: “The FTC Noncompete Rule: Where Do We Go From Here?”
Foley partners Ben Dryden and David Sanders will be speakers at our upcoming webinar, “The FTC Noncompete Rule: Where Do We Go From Here?”, on Thursday, May 9 at 12:00 p.m. ET. Click here to register.
[1] Other tax-exempt organizations are similarly exempted and, thus, tax-exempt philanthropic arms of hospital and health systems are likely to be exempt from the Rule.
