The Federal Trade Commission (FTC) issued a new rule on April 23, 2024, banning new non-compete agreements in all employment contexts. The highly anticipated rule has been summarized by our Holland & Knight colleagues. (See Holland & Knight's previous alert, "New FTC Rule Bans Non-Compete Agreements in All Employment Contracts," April 23, 2024.) This rule will have impacts on healthcare providers and their investors, including how healthcare transactions, compensation arrangements and day-to-day operations are structured.

Background

The FTC final rule banning non-compete agreements for employment is intended by the FTC to bring transformative changes to the healthcare industry, including by increasing employee mobility and compensation and by reducing spending on physician and clinical services by an ambitious $74 billion to $194 billion over the next 10 years. The FTC's 560-page report repeatedly addresses the expected impact on the healthcare industry – perhaps more than any other – and cites to "thousands" of comments from veterinarians, optometrists, physicians, physician assistants, nurse practitioners and other healthcare providers complaining about their non-competes.

Healthcare provider businesses – physician, dentist, optometrist and other practices, and the management service organizations that serve them – are, fundamentally, about people. No matter the specialty, these companies only survive if their revenue from healthcare services provided by their people exceeds the cost of compensating them, plus the rising cost of rent, insurance, equipment, supplies, technology and infrastructure.

In recent decades, healthcare providers have attracted billions of dollars of capital to expand infrastructure, increase services and build lower-cost outpatient alternatives to hospitals, such as ambulatory surgery centers and office-based laboratories. To maximize their ability to obtain this capital, most healthcare provider businesses require each of their individual physicians or other revenue-generating licensed personnel – i.e., their most important assets – to agree to non‑competes for the collective benefit of the group as a whole.

Impact on Employment Terms

Non-compete agreements have traditionally been used in the healthcare sector as part of a suite of provisions that help to ensure continuity of the labor force for employers for a certain period of time, including for a period of time after leaving the job. This practice has helped mitigate the risk of losing highly trained staff and proprietary knowledge. It also is intended to help ensure continuity of care for patients, especially when paired by notice periods for physicians and other providers prior to termination of their contracts. These afford the employer a meaningful opportunity to retain the patients treated by the departing physician by transitioning them to another employed provider, subject of course to the patient's right to choose his or her physician.

However, with the FTC's ban on these restrictions, healthcare professionals will be able to move between jobs more freely and immediately compete with their former employer for the same patients they were treating with that former employer. This will lead to a more aggressive job market, particularly in specialties for which there already is a shortage of skilled workers – causing healthcare labor costs to skyrocket over the last few years.

To combat this, employers will likely seek longer term employment agreements and longer notice periods for termination of those agreements, and employers will likely be forced to pursue damages for employees who do not serve the entire length of their agreements (including the notice periods). Notably, the FTC commented that fixed-duration employment agreements would be available for employers and physicians to agree, for a period of time, not to terminate employment without cause and meanwhile not to compete during the employment period.

Existing non-competes with senior executives will remain in effect. Senior executives are defined as policymaking employees earning more than $151,164. Policymaking positions include presidents, CEOs or equivalent positions with final authority to make policy decisions that control significant aspects of an entity or enterprise. It is not clear, however, whether senior executives would include all partners in a business, such as physician partners of an independent physician practice, if they do not have input with respect to how the practice is run. What does appear to be clear, however, is that a physician working within a hospital system without any policymaking authority would be unlikely to qualify. Hospitals, in particular, as well as large physician practices may find themselves with highly compensated physicians who are no longer bound by enforceable non-compete provisions after employment ends, resulting in costly bidding wars to secure (and keep) top talent when employment ends (or during the period when a renewal is being negotiated). The FTC correctly noted that employers will likely pursue non-solicitation and non-disclosure covenants, as well as restrictions on assignment of inventions.

Impact on Equity Arrangements

Many private equity-backed groups, as well as large independent physician practices, have sought to expand the availability of equity as a form of compensation for their senior doctors, often taking advantage of tax-favorable treatment of profits interests for service providers. In its commentary, the FTC observed that its prohibition on non-competes should apply whether or not the service provider receives an economic benefit in the form of direct employment or as an equity owner. By implication, non-competes in equity grants to service providers via profits interests or stock options could fall under the new rule, especially if such equity interests are compensation-like as opposed to purchased by the senior doctor.

The rule does not specifically address non-competes in joint ventures. Although they might fall within the sale of business exception or not involve an employment relationship, the FTC commented that its rule would apply to owners of a business who provide services to the business, even if they are not employees.

Similarly, the terms of non-competes and related equity repurchase rights in operating agreements could be vulnerable, depending on how they are worded. For example, healthcare companies should give a fresh look to their repurchase provisions for rollover equity in purchase and sale transactions to evaluate whether they might be subject to a characterization, whether fair or not, as a term of employment rather than purchase and sale consideration. While the FTC was careful to say that it was not prohibiting non-competes in the context of a sale transaction, it also emphasized that clawback arrangements for deferred compensation would not be permitted and that it would look beyond the mere form of the arrangement to determine legality.

Additional consideration should be given to "drag" provisions, which in the physician practice space often include a requirement that, in a subsequent liquidity event, the physician equity holders – as opposed to other equity holders, such as institutional capital – must roll over a minimum percentage of their equity and agree to a renewed set of restrictive covenants. The FTC commented that "springing" non-competes would not be permitted, which introduces doubt as to whether these common "drag" terms could be challenged as forcing service providers, and only service providers, to agree to extend their non-compete.

Operational Costs and Financial Implications

The expected increase in workforce turnover among healthcare professionals could lead to higher operational costs for healthcare facilities. The costs associated with recruiting, hiring and training new staff are substantial and increased turnover will exacerbate these expenses. Healthcare organization may be hesitant to invest in training new employees or in new technologies that require substantial training knowing their trained workforce could leave and join the competitor across the street. Employers may alternatively be forced to consider cost-sharing programs or other financial disincentives for employees to receive costly training. This could slow down the progression of skills development within the sector, reduce the quality of care and discourage the adoption of innovative and potentially life-saving technologies.

Changes in Transaction Dynamics

The elimination of post-employment non-competes for the majority of the healthcare workforce will need to be accounted for in designing healthcare transactions. Healthcare entities often evaluate the stability and potential of their workforce as a significant part of their overall valuation. Non-competes help to assure potential buyers that a skilled workforce will remain in place post-acquisition, maintaining the value of their investment. Without this certainty, sellers could see lower business valuations or even reduced investor appetite for the historically attractive industry. Buyers and sellers will need to be creative in sharing the risks associated with the removal of these protections, if transactions are to be successful. Counsel will also need to differentiate the non-competes in the sale documents from non-competes tied to service.

Recognizing that non-competes provide pro-competitive benefits, particularly in the context of healthcare transactions, the proposed rule contains an exception for non-competes entered into pursuant to a bona fide sale of a business – i.e., a good faith transaction between independent parties at arm's length, in which the seller has a reasonable opportunity to negotiate the sale terms. Notably, and unlike an earlier proposed rule, the final rule does not require the seller to have a 25 percent ownership interest to rely on the bona fide sale exception. Non-competes arising out of repurchase rights or mandatory stock redemption programs are not considered bona fide sales. And, as noted above, it is unclear whether the FTC would take the position that "drag" provisions function to deprive sellers of the opportunity to negotiate, similar to how a pre‑negotiated non‑compete that "springs" into existence upon an equity repurchase functions, or if the FTC would agree that the drag provision itself was specifically negotiated in connection with the initial bona fide sale transaction.

In sum, restrictive covenants executed in connection with a sale transaction appear to be enforceable, but much care must be taken in drafting the specific terms.   

In Summary

• Existing non-compete agreements with senior executives remain enforceable.
• Existing and new non-compete agreements in purchase and sale transactions remain enforceable, so long as they are not a de facto term and condition of employment.
• Existing and new non-competes are enforceable during the term of employment; the ban only applies once employment ends.
• Employers must – before the rule's effective date – notify all workers (other than senior executives) that their employment non-competes are unenforceable. The FTC provided a model notice for employers to use, but the FTC's language may create confusion for employees who are also bound to non-competes in purchase and sale agreements.
• Healthcare employers and investors should continue to rely on their first-line tools to protect goodwill and attract and retain employees: Attractive compensation opportunities, including thoughtful equity and profit-sharing arrangements, fixed duration employment agreements, leadership roles for high performers, accountability for low performers, and non-solicitation and non-disclosure covenants.

Conclusion

Short of a court striking down this new rule, the FTC's final rule on non-competes is going to necessitate immediate action by healthcare executives and investors, starting with a notice to be delivered to current and former employees.

In the medium- and long-term, savvy business operators will find innovative ways to tackle the new competitive landscape and distinguish their employment offerings from their competitors. This has always been how the best healthcare businesses compete, particularly in states such as California that have imposed bans on post-employment non-competes for decades. The impact of this on the healthcare industry including access to care, quality of care and cost to consumer, could be transformative – to whose benefit only time will tell.