Physician Recruitment and The FTC’s Ban on Non-Compete Clauses
The last time tax law had something to say about nonprofit hospital physician employment practices, the IRS issued physician recruitment guidelines in Revenue Ruling 97-21. I was always perplexed by those guidelines. The Ruling uses five examples just to say, “pay physicians what your market demands and don’t do anything illegal.” I never got the point of the ruling because it only expresses what must happen anyway. At least exempt hospitals knew they could compete for physician services by the same rules regulating for-profit hospitals. It seemed a waste of time otherwise. But the FTC’s new rule banning non-compete clauses gives new importance to the Revenue Ruling 97-21. Here’s how.
It seems that nonprofit hospitals retain at least one advantage – maybe even an unfair advantage — over for-profit hospitals in the competition for physician services. Because nonprofit hospitals are immune from the FTC’s new rule prohibiting the use of noncompete clauses. For-profit hospitals don’t like that and complain bitterly about the unfair competition the immunity enables. Nonprofit hospitals could raid for-profit hospitals for physicians undeterred by a non-compete, but for-profits would not be able to do the same if nonprofit hospital physicians remain subject to non-compete clauses. Here is some interesting commentary:
Many physicians and nurses are happy about the Federal Trade Commission’s new rule banning the use of noncompete agreements in employment contracts. But they are disappointed that it may not protect those who work for nonprofit hospitals and health care facilities, which provide most of the nation’s care and employ the largest number of medical professionals.
In April, in a 3-2 vote, the FTC approved a final rule prohibiting contracts that prevent an employee from taking a job with a competitor. Calling the noncompete agreements “a widespread and often exploitative practice,” an agency announcement described them as an unfair method of competition that depresses wages and hinders new business formation.
The rule bars employers in most industries, including health care, from using contract clauses that block employees from leaving for other jobs or starting a competing business in the same geographic area for a fixed period of time. But that doesn’t help many health professionals, because the FTC Act gives the agency authority over companies organized to operate for profit but not over nonprofit, charitable organizations, which are also tax-exempt.
Still, the agency noted some nonprofits could be bound by the rule if they do not operate as true charities. The rule establishes a two-part test to determine if the FTC has jurisdiction over a nonprofit—whether the organization is carrying on business for only charitable purposes, and whether its income goes to public rather than private interests.
Noncompete contract terms have become increasingly common for physicians, nurse practitioners, and other medical professionals in hospitals and various health care facilities. Some providers say these agreements have forced them to leave their communities and patients behind if they wanted to exit unethical or unsafe workplace conditions.
Nearly 64% of U.S. community hospitals are nonprofits or government-owned, and they employ many of the nation’s medical professionals. As of 2022, nearly three-quarters of U.S. physicians were employed by hospital systems or other companies, both nonprofit and for-profit.
Hospital executives argue that the noncompete rule will force them to compete against each other to hire physicians and other providers and ultimately cost them more, and that it advantages nonprofits over for-profits. “All it would do is increase the price of labor in a field that already has labor shortages and thin margins,” Golder said. “The nonprofit hospital across the street could pursue our employees, while their employees would be protected, and that’s a basic fairness issue,” Kahn said.
The FTC indicates that it will look for any excuse, including private benefit, to apply the ban to nonprofit health care. So the FTC’s new rule gives new importance to the Physician Recruitment Guidelines because those guidelines are based on avoiding private benefit. Although they merely express an economic truism – market demands must be met – they provide explicit notice that physician compensation can lead to private benefit. Maybe even just occasionally. And if there is private benefit, according to the FTC, the exempt healthcare organization is no longer outside FTC jurisdiction. The FTC went out of its way to make that point, and that it can determine the existence of private benefit independently of the IRS, in the preamble to the new rule (starting at page 50):
The Commission stresses, however, that both judicial decisions and Commission precedent recognize that not all entities claiming tax-exempt status as nonprofits fall outside the Commission’s jurisdiction. As the Eighth Circuit has explained, “Congress took pains in drafting §4 [15 U.S.C. 44] to authorize the Commission to regulate so-called nonprofit corporations, associations and all other entities if they are in fact profit-making enterprises.” The Commission applies a two-part test to determine whether a corporation is organized for profit and thus within the Commission’s jurisdiction. As the Commission has explained, “[t]he not-for profit jurisdictional exemption under Section 4 requires both that there be an adequate nexus between an organization’s activities and its alleged public purposes and that its net proceeds be properly devoted to recognized public, rather than private, interests.” Alternatively stated, the Commission looks to both “the source of the income, i.e., to whether the corporation is organized for and actually engaged in business for only charitable purposes, and to the destination of the income, i.e., to whether either the corporation or its members derive a profit.”
This test reflects the Eighth Circuit’s analysis in Community Blood Bank of Kansas City Area, Inc. v. FTC and “the analogous body of federal law which governs treatment of not-for-profit organizations under the Internal Revenue Code.” Under this test, a corporation’s “tax-exempt status is certainly one factor to be considered,” but that status “does not obviate the relevance of further inquiry into a [corporation’s] operations and goals.” Merely claiming tax-exempt status in tax filings is not dispositive. At the same time, if the Internal Revenue Service (“IRS”) concludes that an entity does not qualify for tax-exempt status, such a finding would be meaningful to the Commission’s analysis of whether the same entity is a corporation under the FTC Act.
Administrative proceedings and judicial decisions involving the Commission or the IRS have identified numerous private benefits that, if offered, could render an entity a corporation organized for its own profit or that of its members under the FTC Act, bringing it within the Commission’s jurisdiction. For instance, the Commission has exercised jurisdiction in a section 5 enforcement action over a physician hospital organization because the organization engaged in business on behalf of for-profit physician members. That organization, which consisted of over 100 private physicians and one non-profit hospital, claimed tax-exempt status as a nonprofit.
Similarly, the Commission has exercised jurisdiction over an independent physician association claiming tax-exempt status as a nonprofit. The association consisted of private, independent physicians and private, small group practices. That association was organized for the pecuniary benefit of its for-profit members because it “contract[ed] with payers, on behalf of its [for-profit] physician members, for the provision of physician services for a fee.” Under IRS precedent in the context of purportedly tax-exempt nonprofit hospitals and other related entities that partner with for-profit entities, where the purportedly nonprofit entity “has ceded effective control” to a for-profit partner, “conferring impermissible private benefit,” the entity loses tax-exempt status. The IRS has also rejected claims of nonprofit tax-exempt status for entities that pay unreasonable compensation, including percentage-based compensation, to founders, board members, their families, or other insiders.
darryll k. jones