FTC Rule Addressing Noncompete Covenants: Impact on Individual Worker Agreements in the Health Care Industry

This is the first in a series of alerts discussing the impact of the Rule on the health care industry. ArentFox Schiff’s Trade Secrets, Noncompetes & Employee Mobility team also provides ongoing analyses regarding the Rule’s broad impact across business sectors.

New Prohibition on Noncompetes

The Rule bans all new noncompetes executed on or after the September 4 effective date and renders most existing noncompetes unenforceable. A noncompete is a legal agreement between two parties, often an employer and an employee, in which an individual agrees not to enter into competition with the other party for a defined period of time. Noncompete covenants may have the restrictive effect of preventing workers from seeking or accepting other work in a particular field, for a specified period of time and generally within a certain geographic area.

For existing noncompetes, the Rule distinguishes between “senior executives” (as defined in the Rule) and all other employees. Existing noncompetes with senior executives remain enforceable after the Rule’s effective date. However, existing noncompetes with non-senior executive employees are unenforceable beginning September 4. For this latter category of individuals, employers must notify those workers that any existing noncompetes are no longer enforceable. Additionally, employers will be prohibited from enforcing any new noncompetes with senior executives entered into after September 4.

The Rule also analyzes other restrictive covenants commonly found in employment agreements, including confidentiality and non-solicitation provisions. While the Rule does not expressly prohibit these types of provisions, the FTC stated that other restrictive covenants satisfy the definition of a noncompete under the Rule where they have the same functional effect of a noncompete. Therefore, confidentiality or non-solicitation covenants may be subject to the FTC’s ban to the extent they are deemed to restrain a worker from engaging in other business opportunities. The FTC further stated that, regardless of whether a restrictive covenant falls under the ambit of the Rule, restrictive covenants are still subject to the general prohibition on unfair methods of competition under Section 5 of the Federal Trade Commission Act (FTCA).

“Senior Executive” Exception

The Rule defines “senior executive” as an individual 1) who has been paid at least $151,164 in total annual compensation in the preceding year, and 2) who holds a policy-making position.

Agreements with senior executives that contain noncompetes and that are currently in effect or that take effect prior to September 4 will remain enforceable after that date. However, noncompete covenants contained in agreements executed on or after the Rule’s effective date will not be enforceable. The ban will apply prospectively to all workers, regardless of senior executive status.

Senior Executive Exception’s Impact on Health Care Workers

First Element of the Exception: Compensation Threshold

Due to a variety of factors, including overall market compensation trends for both staff and practicing clinicians, a significant percentage of health care workers likely meet the compensation prong of the senior executive exception.

Second Element of the Exception: Hold a Policy-Making Position

The Rule defines a policy-making position as one in which the individual has the final “policy-making authority” to make decisions that control significant aspects of a business entity or a “common enterprise” of integrated business entities. Individuals whose roles are limited to advising on or exercising influence over policy decisions do not meet the requirements in the definition. In a single physician practice, the chief executive officer (CEO), who is responsible for developing and implementing policies affecting the entire practice, likely qualifies as a senior executive under the Rule.

However, the senior executive analysis becomes more complicated for larger health care organizations that consist of multiple business entities and business lines. In this context, the FTC considers a worker’s level of authority in an organization. For example, if a business is operating in multiple states, with each state operation organized as its own corporation, the directors of each state corporation may not qualify as senior executives. However, individuals employed at the parent company making policy decisions for the common enterprise in its entirety likely do qualify as senior executives.

The FTC’s commentary to the Final Rule offers a helpful guideline for larger hospital systems, pharmaceutical companies, and life science companies operating in multiple geographic regions. However, employers should take care to examine the senior executive exception in the context of their specific organizational structure and evaluate a worker’s role in an individual capacity and across the organization.

One area in which employers may grapple in determining which of its employees qualify as senior executives is with respect to leaders and directors of subsidiaries and affiliates of common enterprises. The FTC generally does not view these workers as holding policy-making positions, but acknowledges that a subsidiary or affiliate’s workers may make policy decisions for the common enterprise and therefore would qualify as senior executives under the Rule.

The implications of whether a hospital or other health care organization CEO qualifies as a senior executive when the organization is structured as a subsidiary of a parent company will be discussed in our next alert.

Pending Challenges to the Rule

The Rule was challenged on the day of its publication. The plaintiff, Ryan, LLC, a tax services and technology company, was the first to file suit and was subsequently joined by multiple entities including the United States Chamber of Commerce. Ryan originally pleaded for relief based on the following primary legal theories: 1) the FTC lacked or exceeded the statutory authority to issue the Rule; (2) the Rule is an unconstitutional delegation of legislative power; and (3) the Rule is arbitrary and capricious. Ryan, LLC v. FTC, No. 3:24-cv-00986 (N.D. Tex. Apr. 23, 2024). The court has indicated that it will issue a ruling by July 3 on a motion for a preliminary injunction and to stay the effective date of the Rule.

Organizational To-Do List

Health care organizations should review their employment agreements to identify restrictive covenants. The following categories of agreements should be prioritized:

1. Existing Employment Agreements

Employers should analyze all existing employment agreements to determine whether any employees qualify as a senior executive. Noncompete provisions in existing agreements with senior executives are enforceable under the Rule, but noncompetes contained in existing agreements for non-senior executives will be unenforceable. Agreements for non-senior executives should be closely reviewed to identify references to any compliance with laws or reformation of contract provisions. The agreements may contain provisions that require immediate amendment or potentially allow for termination of the agreement if the agreement is out of compliance with applicable law. The review will also serve as an internal quality control measure to verify that, for non-senior executive workers, any other restrictive covenants do not have the same functional effect as an express noncompete in a manner inconsistent with the Rule.

It is advisable to begin the reviews now to avoid a last-minute rush, but not to take any actions in terms of offering new agreements or rescinding current agreements until the Ryan court’s ruling is issued. In the event the Rule withstands challenge, employers should take note of the below sample notice to employees contained within the text of the Rule.

For senior executives, employers should also evaluate whether an amendment to an existing employment agreement with a noncompete will implicate the Rule.

2. Employment Agreements Executed Prior to September 4

Noncompete provisions in employment agreements for senior executives that are executed before September 4 remain enforceable under the Rule. Employers should review proposed job descriptions to determine whether the position meets that qualification when drafting the employment agreement. Noncompete provisions in employment agreements for non-senior executives executed before September 4 will not be enforceable. However, employers may consider including those covenants, making sure to include the compliance with laws contractual and reformation provisions. If the Rule is successfully challenged, then existing noncompete agreements will remain in place.

3. Employment Agreements to be Executed On or After September 4

Employers should track any employment agreements that are scheduled for execution on or after September 4. Noncompete covenants contained in any employment agreements, including senior executive agreements, will be void as a matter of law if executed on or after September 4, 2024, provided the Rule survives legal challenge.

Key Takeaways

Health care organizations will face administrative challenges as they work to implement and confirm their internal employment policies. In addition to the steps outlined above, employers should prepare for the Rule’s effective date by assessing whether employee handbooks, policies, and training materials will require revision in order for future employees to understand that noncompete provisions are void as a matter of law. Employers should also analyze employment agreements to determine the scope of any additional restrictive covenants and verify that the language is not overly broad such that the Rule or Section 5 of the FTCA are implicated. While employers should begin the assessment and audit process now, it is not recommended that they take any steps to change policies or procedures or to rescind any agreements until such time as the currently pending legal challenges to the Rule play out.

Finally, employers should also work with their legal and human resources departments to develop updated employment agreement templates for both senior executives, including physicians, and all other workers in a manner that does not implicate the Rule. However, given that the Rule is not effective for approximately four months and is currently being challenged in court, hasty action is not necessary at this time.

ArentFox Schiff’s Health Care Group will continue its analysis of the Rule’s applicability to health care subsidiary and affiliate organizations, the sale of businesses, and the ongoing legal challenges in future alerts.