As we recently reported, in its Final Rule banning most worker non-competes, the Federal Trade Commission (“FTC”) previously warned of its intent to vigorously enforce its non-compete ban wherever possible, which may include self-styled nonprofit and not-for-profit entities. This warning threw most hospital systems in America, which are non-profit, into the chaos of unsettled expectations surrounding the current litigation over the Rule.
In a recently submitted brief to the Northern District of Texas for Ryan LLC v. FTC, the American Hospital Association (“AHA”) and the Federation of American Hospitals (“FAH”) (collectively, “Amici”) acknowledged this warning, while further emphasizing the distortions this rule will cause on the health care industry, as well as pointing out the key benefits to non-competes.
The Amici first highlighted the disproportionate impact of the Final Rule applying only to taxpaying hospitals given these hospitals compete directly with nonprofit hospitals for the same employees in the same market. Specifically, the Amici cited to previous data in the AHA comments to the Final Rule which indicates 78.8% of for profit hospitals are located in the same Hospital Referral Region (HRR) as one nonprofit hospital. The Amici further noted such disparate treatment “will produce an uneven playing field among hospitals” contrary to the Final Rule’s purported goal and will likely create “significant, unstudied, and anticompetition distortions” in the already-challenging workforce shortage experienced by America’s hospital systems. Specifically, the AHA comments to the Final Rule indicate the Final Rule’s application would decrease the supply of labor with respect to for profit hospitals, increase the price for such labor, and create market instability. The Amici also highlighted how the FTC’s intent to regulate “some portion” of nonprofit hospitals but, by its own admission, not all nonprofit hospitals further exasperates the issue of distortion by producing an even more uneven playing field between taxpaying and nonprofit hospitals which are purportedly subject to the Final Rule and those nonprofit hospitals which are not. Pertinently, by including the FTC’s intent to regulate nonprofit hospitals wherever possible in their distortion arguments, the Amici implicitly recognized the FTC’s warning as more than just an empty threat.
Even more alarming for nonprofit hospitals is the FTC’s emphasis in the Final Rule and elsewhere on case law where self-styled nonprofit and not-for-profit entities have lost their tax-exempt status. To be exempt under Section 501(c)(3) of the Internal Revenue Code, an organization must be both organized exclusively for one or more of the exempt purposes specified in that section and operated exclusively for such purposes. Tikar, Inc. v. Comm’r of Internal Revenue, 121 T.C.M. (CCH) 1408 (T.C. 2021). An organization loses its tax-exempt status if “more than an insubstantial part” of its activities are not in furtherance of an exempt purpose specified under Section 501(c)(3) of the Internal Revenue Code. Id. In conducting this test, courts have considered a host of situations as disqualifying a self-styled nonprofit or not-for-profit entities’ tax-exempt status, which deserve their own blog post.
The general nature of the test for determining an organization’s tax-exempt status under Section 501(c)(3) of the Internal Revenue Code and the breadth of situations where self-styled nonprofit or not-for-profit entities lost their tax-exempt status is a sobering reminder that such organizations, including nonprofit hospitals, may not in fact be beyond the FTC’s reach.
However, on a less ominous note, the Amici did raise some positives in their brief to the Northern District of Texas. Specifically, the Amici highlighted extensive empirical evidence from a physician-specific study in the AHA comments to the Final Rule regarding the benefits of non-competes. Indeed, the Amici noted non-competes increase: (1) competition and earnings for physicians; (2) the continuity and quality of patient care; (3) the accessibility of healthcare in rural communities; and (4) the efforts and investments made in medical training, innovation, and development overall. This empirical evidence directly combats the purely anecdotal and self-serving statements of alleged “exploitation and coercion” which purportedly results from non-competes as advanced by the FTC in its Final Rule.
This empirical evidence also highlights how an overbroad, sweeping, and one-size-fits-all approach like the Final Rule is not the remedy for “evening the playing field” given the benefits non-competes pose for certain jobs, industries, and/or markets. Indeed, state legislatures are better equipped at limiting non-competes in a narrowly tailored scope and many have already done so. Specifically, Texas law requires a physician non-compete to provide for a buy-out at a reasonable price to be enforceable. See Tex. Bus. & Com. Code § 15.50. Moreover, Pennsylvania’s governor recently signed a bill where health care practitioner non-competes will only be enforceable if (1) the non-compete lasts no more than one year; and (2) the health care practitioner voluntarily separates from the employer. As such, state legislatures are in a better position to regulate and enforce non-competes as they can better understand the individual needs of certain jobs, industries, and/or markets than the FTC’s Final Rule.
The Northern District of Texas will issue a final ruling on the merits of the challenge to the FTC’s Final Rule on or before August 30, 2024 prior to it taking effect—if it ultimately does take effect—on September 4, 2024. As previously reported, at least one other district court has denied relief to a plaintiff challenging the Final Rule, instead upholding the FTC’s authority to regulate restrictive covenants through is rulemaking powers. More recently, however, another district court enjoined the application of the Final Rule to the challenging plaintiff, holding the Final Rule violated the Constitutional Major Questions doctrine.
Regardless of the next steps in this ever-changing legal maelstrom, nonprofit hospitals should work closely with legal counsel in examining their activities, affiliated entities, structure, and revenue to determine whether they are in fact safe from the FTC’s reach or need to become compliant with the restrictions posed in the Final Rule.
