In a prior post, we discussed the FTC’s recently-issued Proposed Rule that would, if finalized in its current form, and with only limited exceptions, prohibit employers from using non-compete clauses.
With respect the Rule’s impact on healthcare employers, we focused on the threshold question of whether and to what extent the Rule is applicable to nonprofit healthcare organizations, and in particular organizations that have been recognized by the Internal Revenue Service as tax-exempt organizations under Section 501(c)(3) of the Internal Revenue Code.
We explained that while this question is not specifically addressed in the proposed rule, there is language that supports the conclusion that the Rule, if finalized in its present form, will not apply to many, if not most of these organizations, and we explored preliminarily both the basis for this conclusion and some questions with respect to its scope.
We also noted that in a subsequent blog post we would review some previously decided court cases and FTC advisory opinions that provide useful guidance in addressing these and related issues.
What follows is a review of two cases that nicely illustrate how courts have typically addressed the issue of FTC jurisdiction over nonprofit corporations under Section 5 of the FTC Act, the section under which the FTC has issued the Proposed Rule. Also briefly discussed is an FTC informal advisory opinion that sheds light on how the FTC itself has considered the issue.
Community Blood Bank v. F.T.C, 405 F.2d 1011 (8th Cir. 1969)
A good starting point is the decision of the Eighth Circuit Court of Appeals in Community Blood Bank v. FTC, 405 F.2d 1011 (8th Cir. 1969). There, the Eighth Circuit considered the question whether the FTC had jurisdiction over Community Blood Bank of the Kansas City Area (“Community”), a nonprofit corporation which operated a blood bank, and Kansas City Area Hospital Association (“AHA”), also a nonprofit. The jurisdiction issue arose on account of a suit filed by the FTC seeking a cease and desist order in connection with an alleged attempt by Community and AHA to hinder the development of two commercial blood banks in violation of the Section 5(a) of the FTC Act. The Court concluded that jurisdiction was lacking.
Community and AHA argued that the FTC lacked jurisdiction over them because they were not “corporations” as described in Section 4 of the FTC Act which defines the term “corporation” for purposes of invoking Section 5 jurisdiction. This they asserted was because they were not organized to “carry on business for [their] own profit or that of [their] members….”
The FTC in turn argued that because in the case of nonprofit corporations without capital stock, there are no stockholders to whom profits can be distributed, any nonprofit corporation that receives income in excess of expenses is carrying on business for its own profit assuming it is thus capable of self-perpetuation or expansion.
In rejecting the FTC’s interpretation of the phrase “carry on business for its own profit” and holding that the FTC lacked jurisdiction, the Court did acknowledge that Congress in drafting Section 4 of the FTC Act made clear that the FTC has jurisdiction to regulate nonprofit corporations if “they are in fact profit-making enterprises.” Nevertheless, the Court concluded that Community and AHA were not such enterprises.
In reaching this conclusion the Court relied heavily on the fact that:
- Community and AHA were nonprofit corporations that had been recognized as tax-exempt by the IRS;
- Neither had shares of capital or capital stock;
- Both organizations had articles of incorporation that specifically provided that they were organized exclusively for charitable and educational purposes;
- Community’s articles provided that no part of its earnings could inure to the benefit of any member or any other individual or corporation and upon dissolution any assets available for distribution were required to be distributed to nonprofit organizations;
- AHA’s articles similarly required that it assets upon dissolution be disposed of in accordance with the state nonprofit corporation law;
- No part of any funds received by Community and AHA had ever been distributed or inured to the benefit of members, directors or officers;
- All receipts had been used exclusively for the purposes authorized by law and their articles of incorporation;
- All funds received by Community originated from gifts, loans and grants, replacement blood donations and payment of responsibility and processing fees; and
- AHA received its funds from grants, loans, gifts and dues of member hospitals.
(Interestingly and presumably not critical to its conclusion, the court did state that “[o]f added significance is the finding that the receipts by Community have not been sufficient to meet expenses and to repay outstanding loans.”)
California Dental Ass’n v. FTC, 526 U.S. 756 (1999)
The Community Blood Bank case should be contrasted with the U.S. Supreme Court’s subsequent decision in California Dental Ass’n v. FTC, 526 U.S. 756 (1999). In this case, the Court held that the FTC had jurisdiction for purposes of Section 5 of the FTC Act over Community Dental Association (“CDA”), a nonprofit association of dentists that provided desirable insurance and preferential financing arrangements for its members, and also engaged in lobbying, litigation, marketing, and public relations for its members’ benefit. CDA was exempt from federal income tax under Section 501(c)(6) of the Internal Revenue Code.
In reaching this result, the Court explained that the Act gives the FTC authority over a corporation organized to carry on business for its own profit or that of its members. While acknowledging that the Act does not cover all membership organizations of profit-making corporations without more, the Court concluded that in this case the economic benefits conferred upon CDA’s profit-seeking professionals plainly fell within the object of enhancing its members’ profit, which is the Act’s “jurisdictional touchstone.”
Importantly and by way of contrast, the Court noted that an organization like CDA devoted solely to professional education might lie outside the FTC Act’s jurisdictional reach even though the quality of professional services ultimately affects the profits of those who deliver them. The Court explained that in reaching its conclusion with respect to CDA, it was not deciding whether the FTC has jurisdiction over nonprofit organizations that do not confer profit on for-profit members but do, for example, show annual income surpluses, engage in significant commerce, or compete in relevant markets with for-profit players. For example, it stated that it was not deciding whether a purpose of contributing to profit only in a presumed sense, as by enhancing professional educational efforts, would implicate the FTC’s jurisdiction.
In holding for the FTC, the Court also stated that its conclusion was consistent with the Eighth Circuit’s holding in Community Blood Bank as well of the holdings of the Courts of Appeal in FTC v. National Comm’n on Egg Nutrition (a nonprofit association organized for the profit of the egg industry, fell within the FTC’ s jurisdiction) and in American Medical Assn. v. FTC (the “business aspects,” of the AMA’s activities brought it within the FTC’s reach).
According to the Court, the consistency with the Community case followed from the fact that CDA contributed to the profits of at least some of its members. The Court stated that for purposes of jurisdiction, the FTC Act does not require that members of an entity turn a profit on their membership, but only that the entity is organized to carry on business for members’ profit, i.e., an entity organized to carry on activities that will confer greater than de minimis or presumed economic benefits on profit-seeking members falls within the FTC’s jurisdiction.
The reasoning and the result in these two contrasting cases supports the interpretation suggested in our prior post with respect to the reach of the Proposed Rule in the case of health care organizations that have qualified as Section 501(c)(3) organizations, are organized and operated exclusively for exempt purposes, and none of whose net earnings inure to any private shareholder or individual. That is, they should not be considered corporations subject to the FTC’s jurisdiction under Section 5 of the FTC Act (the section the FTC invokes for purposes of promulgating the Rule) and therefore should not be subject to the prohibitions contained in the Proposed Rule, and further that this should be the case notwithstanding that they may have net earnings from the carrying on of exempt purposes, where those net earnings are exclusively used/dedicated to exempt purposes.
The reasoning and results in those cases is further supportive of the proposition that this result should not change on account of the fact that a Section 501(c)(3) health care organization has a member that is itself a Section 501(c)(3) organization and even if the Section 501(c)(3) “subsidiary” makes contributions or transfers assets to the parent provided they are used for Section 501(c)(3) purposes.
FTC Informal Staff Advisory Opinion 99-04
An FTC informal staff advisory opinion from 1999 (Advisory Opinion 99-04) dealing with certain FTC requirements relating to franchising and commercial relationships analyzed the question of commerciality by reference to the test under Sections 4 and 5 of the FTC Act for purposes of determining whether a nonprofit corporation is organized to engage in business “for its own profit or that of its members” and it analyzed the question in a manner similar to that undertaken in the California Dental Ass’n and Community Blood Bank cases.
The Opinion involved the Challenger Center for Space Science Education (“Challenger Center”), a tax-exempt organization.
In concluding that Challenger Center was not engaging in for-profit activities, the FTC stated that in determining whether a corporation carries “on business for its own profit or that of its members,” it will look beyond the technical form of a corporation’s charter and will examine the corporation’s actual activities on a case-by-case basis. In this case, a the FTC explained that a “nonprofit organization such as Challenger Center that earns income from its activities will not be deemed to engage in commercial, for-profit activities unless the evidence demonstrates that the income is used for non-charitable purposes or inures directly to those associated with the organization, such as directors, officers, or shareholders.”
The FTC’s staff concluded that the facts presented did not rebut the presumption created by Challenger Center’s tax-exempt status that Challenger Center was organized primarily for non-profit purposes.
In reaching its conclusion, the FTC’s staff stated that no evidence had been presented suggesting that Challenger Center used its income for anything other than ordinary charitable purposes and that there was no allegation that Challenger Center distributed the income to its directors or to shareholders.
In our next blog post, we will discuss some of the comments that are being received by the FTC with respect to the application of the Proposed Rule to health care providers.
A Final Note
If finalized in its current form (or in various revised forms), the Proposed Rule is likely to be subject to constitutional challenge. The challenge will almost certainly be based on the argument that the FTC lacks the authority to promulgate a rule such as this because Congress has failed to clearly delegate such authority to the FTC given the magnitude and consequences of what is involved.
The challenge will likely be based on the Supreme Court’s recent decision in West Virginia v. Environmental Protection Agency 597 U.S. ___ (2022) in which the Court held that Congress in the Environmental Protection Act did not grant the EPA the authority to devise certain emissions caps.
In reaching that conclusion, the Court applied what it calls the “major questions” doctrine pursuant to which an agency must point to “clear congressional authorization” where its exercise of regulatory authority involves decision-making of such magnitude and consequence that it would otherwise rest with Congress itself. The Court refers to these as “extraordinary cases” in which the “history and the breadth of the authority that [an agency] has asserted,” and the “economic and political significance” of that assertion, provide a reason to hesitate before concluding that Congress meant to confer such authority.
It will almost certainly be the case that the parties challenging the constitutionality of the FTC’s rule will assert that given the economic significance of a broad prohibition on non-competes, including the possibility of invalidating those already in effect, the “major questions” doctrine applies and the requisite clear delegation of regulatory authority from Congress is absent.