FTC Issues Final Rule Banning Noncompetes: Implications on Nonprofit Health Care Systems Are Uncertain

Posted by on May 08, 2024

On April 23, 2024, the Federal Trade Commission (“FTC”) issued its final rule regarding noncompete clauses, and which determined that such clauses are an unfair method of competition and therefore violate section 5 of the Federal Trade Commission Act (“FTC Act”). See 16 CFR Part 910. Since its release, the rule has generated some uncertainty in the health care industry because the ban’s ultimate applicability to nonprofits is unclear. Nonprofit hospitals make up the majority of all hospital systems in the United States, with the American Hospital Association (“AHA”) having indicated that as many as 58% of hospital systems claim tax-exempt status as nonprofits. Notably, nonprofit health care organizations regularly use noncompetes with physicians.

Because Section 5 of the FTC Act only grants the FTC jurisdiction over persons, partnerships, and corporations and the rule was promulgated under Section 5 of the FTC ACT, on its face, nonprofits seem exempt from the rule. More to the point, a “corporation” is defined as an entity that is “organized to carry on business for its own profit or that of its members,” which further suggests that nonprofit entities are beyond the reach of the FTC 15 U.S.C. § 44. However, the uncertainty stems from the question of whether federal or state tax-exempt entities which are typically understood to be nonprofits may actually be considered “corporations” by the FTC, such that they are subject to the newly issued rule.

According to the FTC’s comments to its final rule, “not all entities claiming tax-exempt status as nonprofits fall outside the [FTC]’s jurisdiction [under Section 5].” To determine whether an entity is “organized for profit” such that it does fall within the FTC’s jurisdiction over corporations in Section 5, the FTC will use a two-part test which 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,”. In essence, under this test, a corporation’s tax-exempt status is considered, however its tax-exempt status does not end the inquiry into how the corporation operates and its goals. Of particular concern, is the FTC’s scrutiny of source of income.

Therefore, the question remains as to which federal or state tax-exempt organizations may be determined to be “organized for profit” and therefore subject to the ban on noncompetes. The question may be particularly relevant to large organizations like health systems and/or their component parts, particularly those that operate in areas that were typically carried on a for-profit basis like physician practices. As a result of the FTC’s proclaimed two-part test, the answer may be particular to each nonprofit entity or health system.

Certain information in this blog post was sourced from the FTC final rule.

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