FTC’s proposed ban of employer non-competes: Are non-profits exempt?

As we previously reported, the FTC’s proposed rule defines a non-compete as a contractual agreement between an employer and worker that prevents the worker from seeking or accepting employment with another employer, or operating a business, after the conclusion of the worker’s employment with the employer. Under the proposed rule, such non-compete agreements (with one limited exception for certain non-competes involving acquisitions) are unlawful “unfair methods of competition” under Section 5 of the FTC Act.

The proposed rule covers not only non-compete agreements with employees, but also extends to agreements with independent contractors, interns and externs, volunteers, apprentices, and sole proprietors who provide a service to a client or customer. Effectively, the rule would make post-employment noncompete agreements per se illegal for employers subject to the rule (i.e., the existence of the agreement alone violates the law, and a plaintiff need not meet the high burden under existing antitrust law of proving that the agreement had an adverse effect on competition).

According to the FTC, nearly 1 in 5 U.S. workers is covered by a non-compete,¹ but the percentage may be even higher among employed physicians and other health care providers.²

FTC’s Section 5 enforcement authority

As noted above, the NPRM relies on Section 5 of the FTC as its legal underpinning. The NPRM explicitly notes that some employers, including most non-profits, would be exempt from the proposed rule.³ The reason for the exemption is that the FTC can only enforce Section 5 against “persons, partnerships, or corporations^.4 Critically, the FTC Act defines “corporations” as those entities “organized to carry on business for [their] own profit or that of [their] members.”⁵ Accordingly, the FTC Act does not give the FTC the ability to enforce Section 5 against non-profit entities unless the non-profit is organized by and operates for the benefit of for-profit members, or the non-profit status of the organization is based on a sham. As a threshold matter, therefore, most non-profits would effectively be exempt from the proposed rule, if adopted.

State laws increasingly limit non-competes and other restrictive covenants

Even though the proposed rule, if finalized, generally would not apply to non-profits, non-profits still face ever-increasing scrutiny under state laws that limit the right of employers—including non-profit employers—to enter into post-employment non-competes or other restrictive covenants with workers.

Non-profits already face the challenge of crafting non-competes and other restrictive covenants that are enforceable under the laws of varying jurisdictions. Some examples of these challenges include:

• Bans on post-employment non-competes, such as in California, North Dakota, and Oklahoma.

• Bans on post-employment non-competes for workers earning below a certain threshold. For example, in the District of Columbia, employers generally may offer non-competes only to workers who earn at least $150,000 per year (and in the case of physicians, at least $250,000 per year).

• Technical notice requirements that, if violated, will invalidate a non-compete. For example, Colorado, Massachusetts, and the District of Columbia require that employees receive advanced notice of a non-compete.

• Specific restrictions on how long a post-employment non-compete may last (e.g., no longer than a year in some jurisdictions); the scope of conduct that may be restricted; and the geographic area where the non-compete may apply.

• Limitations on other restrictive covenants such as employee or customer non-solicitation agreements (e.g., Illinois prohibits such agreements for workers earning $45,000 a year or less).

• Penalties and causes of action against employers that violate the laws. For example, a recent Colorado law imposes potential civil and criminal liability against employers who violate it.

State common law also poses obstacles to enforcement. State courts (and federal courts applying state law) regularly strike down non-competes that are deemed unreasonable or against public policy under the law. When it comes to hospitals and health systems, courts tend to give closer scrutiny to the geographic and functional scope and duration of non-competes and other restrictive covenants entered into with physicians and other health care providers and sometimes strike down non-competes as a violation of public policy because they restrict the ability of health care providers to practice medicine.

Although other non-profits, such as universities, may not typically impose post-employment non-competes on their employees, they must consider how state laws may limit their ability to use other restrictive covenants. For example, in 2021 the District of Columbia passed a non-compete law banning “anti-moonlighting” policies that would have invalidated reasonable conflict of interest and conflict of commitment policies imposed by higher education institutions; however, the law was subsequently amended to carve out such policies (as described in our prior blog post).

Status of Non-Profit Non-Compete Agreements Going Forward

Notwithstanding the fact that the FTC’s proposed rule generally would not cover non-profit entities, non-profits, including non-profit health systems and universities, should carefully consider the non-competes and other restrictive covenants they include in their contracts and policies.

• As noted above, and separate from the NPRM, non-profits must comply with state and District of Columbia laws that impose restrictions or prohibitions on entry into restrictive covenants and particularly non-competes.

• The existence of the proposed rule (or the final rule, if approved) is likely to create significantly more scrutiny of, and interest in, the impact of non-competes and other restrictive covenants in general. We expect that non-competes will be more under the microscope going forward, including those involving non-profit entities, and the subject of non-competes will garner more academic and political interest. In particular, we expect that the proposed rule may cause some state legislatures to consider whether to tighten their own non-compete laws further, or ban non-competes altogether.

• While the FTC is not attempting in the proposed rule to assert jurisdiction over non-profit entities, non-profits should bear in mind that the FTC can always refer potential violations of the antitrust laws to the Department of Justice Antitrust Division (“DOJ”), which does have jurisdiction over non-profit entities. Private plaintiffs also could seek to challenge non-competes. These parties, however, would have to demonstrate that the use of non-compete agreements has led to an adverse effect on competition in a relevant market (as the FTC must do generally until the proposed rule is adopted).

• For non-profit entities entering into transactions that require Hart-Scott-Rodino Premerger Notifications, the FTC may investigate the use of non-competes pursuant to its authority to enforce Section 7 of the Clayton Act. While the FTC again would be unable to challenge the transaction based on an alleged violation of Section 5 of the FTC Act alone, an investigation of a company’s non-competes during a merger investigation could significantly affect the timing of the overall review and the FTC may push for consent decree provisions governing the non-competes as a condition to closing its investigation of a proposed transaction, or use them as a basis for alleging anticompetitive effects in a court challenge.⁶

We expect that the FTC’s proposed rule will likely take considerable time to wind its way through the administrative process; moreover, it will likely meet substantial legal challenges, and its ultimate fate is uncertain. But in the short run, just by making the proposal, the FTC has ratcheted up the scrutiny of such agreements that has already been increasing under state and District of Columbia laws in recent years.