FTC narrowly passes final rule prohibiting non-compete clauses
Legally Speaking
Robert M. Portman, JD, MPP, is a health care attorney with Powers Pyles Sutter & Verville, in Washington, DC, and serves as legal counsel for the AAD and AADA.
By Natalie Lorenz, JD, Ben Tesdahl, JD, LLM, and Robert M. Portman, JD, MPP, June 1, 2024
Every month, DermWorld covers legal issues in “Legally Speaking.” This month’s authors are health care attorneys with Powers Pyles Sutter & Verville PC in Washington, D.C. Portman is also outside general counsel for the AAD and AADA.
In January of this year, DermWorld published a Legally Speaking article alerting dermatologists that the Federal Trade Commission (FTC) had issue a proposed rule for public comment that would impose a nationwide ban on the use of non-compete clauses in employment contracts. On April 23, 2024, by a narrow 3-2 vote, the FTC approved its final non-compete rule, which differs in only a few ways from the original proposed rule.
The final rule, which becomes effective 120 days after it is published in the Federal Register, is summarized below, along with an analysis of its likely impact on physician practices.
Summary of the final noncompete rule
With a few exceptions discussed below, the final rule prohibits any employer from entering into, attempting to enforce, or representing that a worker is subject to a non-compete clause.
The final rule defines a “non-compete clause” as follows (with emphasis added):
Non-compete clause means: (1) A term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from: (i) 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 (ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.
Notably, the definition above is not limited to written contracts. Rather, it encompasses workplace policies that prohibit a worker from, or function to prevent a worker from, seeking or accepting work for another business or operating a business following the worker’s termination.
The final rule applies to a wide variety of workers and not just employees. Specifically, the final rule defines a “worker” as follows (with emphasis added):
“Worker” means a natural 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, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person.
The final rule also requires that by its effective date, companies must inform all workers who are subject to non-compete clauses (other than existing agreements with senior executives as discussed below) that such agreements are no longer enforceable. The notice must: (1) be individually sent to the worker; (2) be delivered to the worker by hand, by mail to the worker’s last known address, by email to the worker’s work email or last known personal email address, or by text message; and (3) identify the non-compete and the parties to the non-compete. The FTC has developed a suggested notice for this purpose in several languages.
Final rule exceptions
The final rule has four narrow exceptions. Specifically, the rule does not apply to (1) existing non-compete clauses with “senior executives”; (2) non-competes entered into in connection with the sale of a business; (3) non-compete clauses imposed by nonprofit organizations; and (4) non-competes in franchisor/franchisee relationships. The first two of these are discussed below, along with some alternative provisions that would be permissible. The other two exceptions are generally not relevant to privately owned dermatology practices.
1. Senior executives
The final rule does not invalidate existing non-competes with “senior executives,” but employers are prohibited from entering into new non-competes with such senior executives. A “senior executive” is defined as any worker earning more than $151,164 annually who is in a “policy-making position.”
“Policy-making position” is defined as “a business entity’s president, chief executive officer, or the equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity similar to an officer with policy-making authority.”
“Policy-making authority” is defined as “final authority to make policy decisions that control significant aspects of a business entity or common enterprise and does not include authority limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary of or affiliate of a common enterprise.”
Unfortunately, the final rule does not define “final authority,” “policy decisions,” or “significant aspects,” so there is still likely to be considerable uncertainty as to exactly who fits into the senior executive category.
2. Sale of a business
Additionally, the final rule does not apply to a non-compete clause that is entered into “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.” A “bona fide sale” is defined as one made by two independent parties at arm’s length. Notably, the final rule does not have any ownership percentage threshold, whereas the proposed rule would have limited business sale non-compete clauses to those sellers owning at least 25% of a business.
3. Nondisclosure and non-solicitation provisions
The final rule does not prohibit employers from relying on trade secret laws or having nondisclosure provisions or non-solicitation provisions that preclude former employees from soliciting company employees or customers. At the same time, however, the FTC noted that whether a contractual provision constitutes a non-compete clause depends on whether it “functionally prevents” a worker from getting a different job and not how it might be labeled, suggesting that some restrictive covenants that are not labeled as a non-compete clause may still run afoul of the final rule.
State law: An exception to the exceptions
The final rule supersedes state law only to the extent that state law provides less protection, but not if it provides more protection to workers. For example, physician non-compete clauses are completely void in some states, including in Colorado, Delaware, Massachusetts, New Hampshire, and Rhode Island. Other states, like California, ban all non-competes (including those applying to physicians) with a few narrow exceptions. So, in states with total bans on non-competes, the FTC’s exception for “senior executives” will only prevent the FTC from enforcing the final rule, but state law would still prohibit such non-competes.
Effective date and legal challenges
The FTC’s final rule will go into effect 120 days after it is published in the Federal Register. Notably, however, shortly after the final rule was announced, at least two lawsuits were already filed to challenge it, so it is possible a court may postpone the implementation of the final rule or eventually overturn it.
In the interim, dermatology practices and other covered employers should identify current workers who qualify as “senior executives” and whose non-compete clauses can remain in effect, as well as identify other current and former workers who have active non-compete clauses and who are eventually entitled to notice (after the final rule goes into effect) that those clauses are no longer enforceable. Employers also should review their personnel policies to see if any of them have the practical effect of imposing a non-compete on workers.
During the 120-day period after the final rule is first published in the Federal Register, employers should also consider whether to enter into new non-compete provisions with workers (assuming non-competes are permitted under state law), realizing that such non-competes may only be effective for a relatively short period of time until the new rule goes into effect. On the other hand, they could possibly last much longer if implementation of the final rule is delayed or blocked by a court challenge.
Impact on health care entities and practitioners
The final rule, if it survives legal challenges, could create a very uneven playing field. For instance, if most tax-exempt hospital systems are able to keep non-compete restrictions on their employed physicians, they would have a competitive advantage over for-profit health care systems that would be subject to the final rule. Likewise, academic medical centers may not be subject to the final rule, giving them an advantage over physician-owned practices. That said, the FTC has been less than clear as to which tax-exempt organizations will be covered by the final rule and which will not, creating substantial uncertainty about the application of the final rule to nonprofit organizations.
The final rule also raises many unanswered questions, including those relating to the definition of “senior executive.” Consequently, covered health care employers may struggle to determine with certainty who qualifies as a senior executive and, therefore, can still be subject to any currently existing non-compete provisions.
The majority of the FTC Commissioners, on the other hand, see nothing but benefits from the final rule. In its preamble to the final rule, the FTC wrote: “[T]he Commission estimates that the 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 the rate of new firm formation by 2.7%.”
Additional resources
This article is provided for informational and educational purposes and is not intended to provide legal advice and should not be relied upon as such. Readers should consult with their personal attorneys for legal advice regarding the subject matter of this article.
