The Federal Trade Commission (FTC) has introduced a new rule banning non-compete clauses in employee agreements which, as of this writing, will go into effect September 4, 2024. The rule aims to eliminate restrictive employment practices that hinder workers from seeking new opportunities or starting their own businesses.
A gray area within the non-compete clause ban, however, is whether this new rule applies to non-profit entities. Here’s a detailed look into this issue.
FTC’s Authority and the New Rule
The FTC, under Sections 5 and 6(g) of the Federal Trade Commission Act, has the power to prevent unfair competition methods and make rules to enforce its provisions. The new rule, codified as 16 C.F.R. § 910, broadly defines a non-compete clause as any employment term that restricts a worker from pursuing new employment or business opportunities after leaving their current job.
This includes not only explicit non-compete agreements but also any workplace policies or contractual terms that functionally prevent or penalize a worker for competing.
Application to Non-Profits
The FTC Act specifies that the FTC can only regulate a corporation if it is ‘‘organized to carry on business for its own profit or that of its members”; non-profit entities generally fall outside the FTC’s jurisdiction because they do not operate for profit. However, the situation is more nuanced for organizations claiming non-profit status. If a non-profit entity provides a “private benefit” that makes it a de facto profit-making enterprise, the FTC’s jurisdiction—and thus the new rule—applies.
What Constitutes a “Private Benefit”?
The FTC uses a two-part test to determine whether an entity is truly non-profit:
- Source of Income: The entity must be organized for and actually engaged in business for only charitable purposes.
- Destination of Income: Neither the entity nor its members derive a profit.
Entities merely claiming tax-exempt status are not automatically exempt from FTC regulation. For instance, a non-profit that benefits private individuals or pays unreasonable compensation to its members can be deemed a profit-making enterprise.
Examples of FTC Jurisdiction Over Non-Profits
The FTC has historically exercised jurisdiction over entities claiming to be non-profits in certain circumstances:
- Physician Hospital Organizations: Non-profit entities that engage in business on behalf of for-profit physician members.
- Independent Physician Associations: Non-profits that are organized for the financial benefit of for-profit members and, for example, contract with payers on behalf of for-profit physicians.
- Non-Profits Partnered with For-Profits: Non-profits that lose their tax-exempt status because they have ceded effective control of the non-profit to a for-profit partner.
- Non-Profits that Provide Unreasonable Compensation: Entities that pay unreasonable compensation, including percentage-based compensation, to founders, board members, their families, or other insiders.
Staying Informed and Compliant
For most non-profit entities, the FTC’s new rule banning non-compete clauses will not apply. However, organizations must be vigilant to ensure they do not provide private benefits that could classify them as profit-making enterprises. This means maintaining clear non-profit operations, avoiding excessive compensation to members, and not partnering in ways that confer undue private benefits.
Employers should continue to monitor the implementation of the rule and any legal challenges it might face. As of this writing, three pending court cases are challenging the rule’s legality. These cases may delay the implementation of the rule. We will keep you updated.
Restrictive covenants should be drafted carefully to protect legitimate business interests and remain enforceable under the changing legal landscape. Ultimately, non-profit healthcare providers should be able to use non-compete clauses, provided they adhere strictly to their non-profit status.
By staying informed and compliant, non-profit entities can navigate the FTC’s new regulations effectively while maintaining their operational integrity. If you have any questions about whether or not your organization is exempt from the FTC’s non-compete clause, please contact us.