FTC Rule Addressing Noncompete Covenants: Impact of Senior Executive Exception on Health Care Entities

This may result in confusion and regulatory risk for health care providers both before and after the Rule’s effective date. The Rule is currently set to take effect on September 4, though it is subject to significant legal challenges, including two different requests for nationwide injunctions of the Rule.

This may result in confusion and regulatory risk for health care providers both before and after the Rule’s effective date. The Rule is currently set to take effect on September 4, though it is subject to significant legal challenges. On July 3, in Ryan, LLC v. FTC, 24-cv-986, the US District Court for the Northern District of Texas issued a decision and order enjoining the FTC from enforcing the Rule against the named plaintiffs. The court declined to issue a nationwide injunction, but the court stated its intent to issue a final ruling on the merits by August 30. In ATS Tree Services, LLC v. FTC, 24-cv-1743, the Eastern District of Pennsylvania previously stated its intent to rule on plaintiff ATS Tree Services, LLC’s motion for a preliminary injunction by July 10.

*This is the second in a series of alerts discussing the Final Rule’s potential impact on the health care industry. The first alert addresses the impact of the Rule on individual health care professionals.

Senior Executive Exception

The Rule provides that employers may enforce noncompete covenants with senior executives if the provisions are entered into prior to September 4. A “senior executive” is defined as an individual paid at least $151,164 in total annual compensation in the preceding year and who holds a “policy-making” position. Despite the two-pronged definition, the senior executive exception may be challenging to implement uniformly given the ambiguity around “policy-making authority” and the disparate roles and responsibilities of clinical and non-clinical executives within a health care organization.

1. Policy-Making Position

A policy-making position is generally defined as a business entity’s president, chief executive officer or the equivalent, or any other officer of a business entity or natural person that has policy-making authority over the business entity. A business entity refers generally to a partnership, corporation, association, limited liability company, division, or subsidiary.

A. Policy-Making Authority

An individual with policy-making authority has final authority over policy decisions that control significant aspects of a business entity or a common enterprise of integrated business entities. Notably, this authority does not include merely advising or exerting influence over such policy decisions or having final authority to make policy decisions for a subsidiary or affiliate of a common enterprise.

B. C-Suite Leadership

The FTC states in the Rule’s preamble that “presidents, chief executive officers, and their equivalents are presumed to be senior executives” and that many C-suite members are likely senior executives if they are making policy decisions that control significant aspects of the business. Note that the FTC does not state that C-suite members qualify as senior executives by default. The C-suite member must hold a position that has final authority over policy decisions that control significant aspects of the organization.

The FTC intentionally broadened the definition of policy-making position to include “chief executive officer or the equivalent” as an acknowledgement of varying organizational structures. Job titles and functions may vary significantly from company to company. Take note that the Rule’s definitions focus on an individual’s job duties, not the individual’s title.

2. Sole Community Provider

The application of the Rule is straightforward in the context of a sole community provider with no affiliates or subsidiaries. C-suite members would likely qualify as senior executives as they would generally be tasked with policy-making that affects or controls significant areas of the organization and report directly to the organization’s board of directors.

3. Multi-Provider Systems

The senior executive analysis becomes more complicated in the case of a multi-hospital or integrated health system that maintains affiliates or subsidiary entities.

C-suite members or those holding equivalent roles within the health system’s parent company (a “common enterprise” under the Rule) would likely qualify as senior executives due to their maintaining final policy-making authority over the parent and provider entities. It is less clear whether the C-suite members of wholly owned subsidiaries would also qualify as senior executives.

This is because while a CEO is in a policy-making position, it is possible that the CEO of a subsidiary may not hold final policy making authority for the business entity, since the parent company may exert significant control and influence over the policies of their subsidiaries and affiliates. Therefore, consider whether a CEO or CFO of a wholly owned subsidiary qualifies as a senior executive if their decisions are limited to management and operational control of the subsidiary, and the CEO or CFO do not have final policy-making authority over the common enterprise.

However, a business entity’s status as a subsidiary or affiliate is likely not dispositive of whether its leaders qualify as senior executives. The Rule leaves open the possibility that the medical director of a health system’s subsidiary, for example, might qualify as a senior executive if, in addition to holding policy-making authority over the subsidiary, the physician also maintains final policy-making authority for the health system. It is vital for employers to examine the job functions and responsibilities of all officers and directors of a health care system’s subsidiaries and affiliates to determine whether those positions include final policy-making responsibilities.

For example:

A. CEO of a Subsidiary Hospital

Medicare’s Conditions of Participation require a hospital’s governing body to appoint a CEO who is responsible for managing and operating the hospital. Given the scope of the CEO’s management responsibilities, it is reasonable to conclude that in most cases the position includes policy-making authority for the hospital. However, to the extent a hospital is owned or controlled by a parent organization, while the hospital CEO may hold management and operational authority over the hospital as required by Medicare and other licensing bodies, the CEO’s authority to also set policies for the entire health system may be limited, and therefore the potential exists that the CEO would not be classified as a senior executive and any applicable noncompete would be invalidated.

B. Hospital Chief of Staff

A hospital’s chief of staff may be responsible for development of medical staff policies and procedures for the hospital. However, in some circumstances, the chief of staff may not be authorized to develop or implement policies affecting the medical staff without the approval of the medical executive committee. In this case, the chief of staff would likely be deemed to not have final policy-making authority as a senior executive under the Rule. The hospital would therefore be unable to enforce a noncompete covenant for the chief of staff position after September 4.

C. Hospital Department Heads

The Rule’s preamble makes clear that the FTC views company department directors or managers as generally not holding policy-making positions. A hospital’s laboratory director, for example, may exercise final authority over the operation and administration of laboratory operations and perhaps even its policies and procedures. However, the director’s authority is generally limited to the laboratory department. Therefore, the director would not qualify as a senior executive under the Rule; any existing noncompete covenants would be unenforceable.

Takeaways

Health care organizations face significant challenges in determining whether existing noncompete covenants or agreements are enforceable for members of its workforce. Employers may interpret the senior executive definition broadly and as conferring policy-making authority on the health care provider’s leadership so that the noncompete covenants remain in place after the Rule’s effective date. Therefore, employers should analyze the job descriptions and responsibilities of the organization’s CEO, CFO, and other leaders, along with the reality of the requirements of the roles, to ensure the position descriptions expressly reference and convey significant policy-making authority.

Position description audits are particularly important for any employment agreements scheduled for initial execution or renewal after September 4. Employers should make efforts to execute or renew noncompete provisions prior to the Rule’s effective date. Employers may consider including an extended employment term for identified senior executives to avoid challenges to any noncompete provisions for as long as possible.

The ArentFox Schiff Health Care team will continue to monitor the Rule and analyze its application to health care entities. Please contact the authors or the ArentFox Schiff attorney that usually handles your matters for additional guidance.