On January 5, 2023, the Federal Trade Commission (FTC) published a Notice of Proposed Rulemaking (NPRM) that would, if adopted, prohibit non-compete clauses as an unfair method of competition within the meaning of Section 5 of the FTC Act. The FTC requested comments to the NPRM, which were due by April 19, 2023. We expect many comments were submitted including the breadth of the NPRM regulation, which as drafted applies to both large and small businesses.
If adopted as proposed, an employer cannot enter into, attempt to enter into, or maintain a non-compete clause with a worker. A “worker” includes an employee, independent contractor, intern, extern, volunteer, or solo proprietor, whether paid or unpaid. Relationships between franchisors and franchisees are exempt from the non-compete prohibition but would apply to their workers. The NPRM excludes the sale of a business when the non-compete clause applies to a “substantial owner,” currently defined as one who owns at least 25% of the business.
The NPRM would prohibit any contractual term between an employer and a worker that prevents the worker from seeking or accepting employment or operating a business post-employment. A functional test is adopted to determine whether the contractual term is a non-compete clause. An example of a de facto non-compete clause regardless of the nomenclature can include broad confidentiality clauses that effectively preclude the worker from other employment.
To the extent adopted, employers would be required to rescind any existing non-compete clauses by providing written notice to workers and former workers in an individualized communication. The NPRM provides model language for this written notice. The NPRM would preempt inconsistent state laws but keep “more stringent” state laws intact, similar to HIPAA.
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Healthcare Justifications
Although seeking comments, the FTC Commentary justified the non-compete prohibition in healthcare by relying upon various studies to support that enforcing non-compete clauses may result in higher healthcare costs and reduced physician earnings. One study relied upon by the FTC examined the impact that removing non-compete clauses had on physician earning growth. The suggestive evidence and extrapolation found that removal of a non-compete clause may increase a physician’s earnings with 10 years of experience by 12.7%. Similarly, a physician with just one year of experience may have a 37.4% earnings increase. The FTC also conceded that many state laws provided exemption for physicians from non-compete prohibition and actively encouraged comments such as whether skilled and higher-paid individuals should be excluded from the NPRM prohibition.
Another study cited by the FTC estimated the impact of physician non-compete clauses on overall healthcare costs. The study estimated that moving from the lowest to the highest non-compete clause enforcement could increase healthcare prices by 53%. Extrapolating from this study methodology, the FTC estimated healthcare spending would decrease by $140.8 billion annually by implementing the NPRM.
NPRM Implications on the Business of Dentistry
Publication of the NPRM may not only invite increased scrutiny but also political interest of non-compete clauses on a state level. For example, a number of states, including California, North Dakota, and Oklahoma, adopted statutes rendering non-compete clauses void or seriously eroding their enforceability.
Although vocal opponents will exist on both sides of this issue, healthcare entities should be aware of this NPRM and take affirmative steps to protect trade secrets separate from reliance on non-compete clauses. The best protection against departing employees from using your trade secrets is to take proactive steps before their departure. These steps should include assessing the current state of their trade secret and proprietary information protections and taking other appropriate actions, such as limiting access, preventing copying, bolstering cyber security limitations, and effectively training the workforce on proper and improper use of company information and detecting improper use within their organizations.
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Because the NPRM excludes non-competes in the context of the sale of a business for owners that own at least 25% of the business, this NPRM should not have a material negative impact on the majority of dental transactions. Specifically, non-competes are a critical part of any dental transaction, including DSO affiliation transactions, and at least with respect to owners who own at least 25% of the dental organization, the non-compete should continue to be enforceable. However, on the other hand there are many situations where an owner who owns less than 25% of the organization is still essential to the business and in these instances this rule can potentially be problematic and may lead to creative pre-transaction ownership restructuring so that the non-competes can remain enforceable as to all sellers.
The rule does have the potential to fundamentally change the day-to-day operations of a dental practice and the very business of dentistry. Specifically, dentist owners have counted on non-competes as a critical component of any employment agreement with associate dentists to prevent them from learning the ins and outs of operating a dental practice and then taking that knowledge and using it to directly compete against their former employer in the same neighborhood as the practice they formally worked at. While this rule may result in increased opportunities for associate dentists, it will likely have a negative impact on the financial performance of DSOs and group dental practices that employ numerous associate dentists in that it will make it convenient for associates to job-hop, thereby causing sudden lost revenue to their former employers that will have to be replaced. This could potentially result in overall lower valuations for DSOs and group practices because of the added risk associated with associate flight. It may also lead to more creative employee incentive plans designed to discourage associates from leaving their employer.
In any event, whatever form of this rule is enacted after the comment period is likely to be tied up in litigation for a lengthy period of time. Specifically, FTC commissioner Christine Wilson, who has since resigned from the FTC, predicted in her opposition to the rule that “numerous and meritorious legal challenges…undoubtably will be launched against the noncompete rule.” By way of example, the U.S. Chamber of Commerce stated that the FTCs actions were “blatantly unlawful” and vowed “to go to court if necessary to stop the legally baseless ban on noncompete clauses.”
Many legal scholars have raised serious doubts as to whether the FTC is acting within its statutory and constitutional authority to issue a rule of this nature. It would not be surprising if these legal challenges ultimately ended up before the United States Supreme Court to decide. Given the present composition of that Court, there is a strong chance that the validity of the NPRM will not be upheld. Should the NPRM ultimately survive the numerous anticipated legal challenges, it will not go into effect until the conclusion of the legal challenges, which could take several years. But for now, the dental industry will be closely watching the NPRM for the latest developments.
If you have any questions about the information in this article, please contact Brian Colao.
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Brian Colao is the Director of Dykema’s Dental Service Organizations Group. He has been serving the dental industry for over 25 years and is widely regarded as one of the foremost authorities in the United States on DSO formation, DSO business structures, DSO-related mergers and acquisitions, and the full array of regulatory compliance requirements for DSOs. Brian was named a “2019 DSO Influencer” by Group Dentistry Now.
Dykema Dental Service Organization Group
Dykema Dental Service Organization Group is a multi-disciplinary team of experts providing top-tier legal representation and “go-to” strategic counsel to more than 350 dental organizations in all 50 states and 6 Canadian provinces, supporting deals globally, handling hundreds of dental transactions per year, and a broad range of other issues.