Recently, the Federal Trade Commission has proposed a rule that would ban all non-compete clauses in employment contracts. These clauses have been common for physicians, so what would the impact be?
A non-compete clause is a type of restrictive covenant that prevents an employee from working for one of their employer’s competitors. Non-compete clauses typically specify a duration of time that the former employee cannot work for a competitor (typically 1 year) and the geographic range that the former employee is prohibited from working in. A related clause is the “non-solicitation clause” which prohibits employees from taking customers (patients) with them if they leave their job. Non-solicitation clauses can also be written to prohibit a former employee from recruiting other current employees to come work for them.
- Many physicians are bound by contractural non-compete clauses
- The FTC has recently proposed elimination of all non-compete clauses
- For many specialties, non-solicitation clauses are more appropriate than non-compete clauses
- For other specialties, non-compete clauses provide important financial protection for hospitals
- Academic hospitals may be more impacted than non-academic hospitals by non-compete clause elimination
Although results of different surveys of physicians vary, the best estimate is that approximately 40% of U.S. physicians are bound by a non-compete clause. A frequently raised question is: “but is it enforceable?”. The answer is… maybe. In the United States, each state has its own laws regarding non-compete clauses with several states (such as Oklahoma, North Dakota, and California) banning them altogether. The enforceability of non-compete clauses is also state-specific and usually based on legal precedents from previous judicial decisions in that particular state. In general, physicians do not want to have non-compete clauses in their contracts but employers (hospitals or group practices) do want to have non-compete clauses.
I have been on both sides of the physician non-compete clause controversy – as a physician who had to sign my own employment contract and as an employer who had to help write physician contracts. As a practicing physician, I had two components of my clinical practice: as an inpatient critical care physician working in our hospital intensive care unit and as an outpatient pulmonologist who was one of the very few in Central Ohio specializing in interstitial lung disease. These two components of my practice had very different implications for non-compete clauses. As an employer, I had roles as the treasurer of our clinical department, an elected board member of our health system’s physician practice group, and the medical director of one of the hospitals in our health system. Each of these employer-related roles gave me a different vantage point on physician non-compete clauses. After dealing with the pros and cons of these clauses for more than 30 years, here are some of my thoughts.
When are physician non-compete clauses NOT appropriate?
Fundamentally, non-compete clauses are used to prevent harm to the employer. For some physicians, leaving one hospital to go work for another hospital in the same city poses little to no risk of harm to their employer. This is primarily true for specialties that do not depend on physician referrals, particularly if there is no significant physician shortage in that particular speciality. For these specialties, non-compete clauses should either be non-existent or should be less restrictive. Typically, these physicians are hospital-based and the patients that they care for are not referred specifically to them by some other physician. Instead, they get patients who choose to come to that particular hospital but do not choose to see that specific doctor. Many of these physicians do shift work. Examples include:
- Critical care physicians
- Emergency medicine physicians
If one of these physicians leaves to go work for the hospital’s competitor, they do not take patients with them. The hospital may have financial harm from having to recruit another physician in the same specialty to take their place but the hospital is unlikely to lose patients who would chose to go to a different hospital simply because that physician now practices there. The hospital can also be financially harmed if its most experienced and most productive physicians leave since that hospital will likely have to replace those physicians with younger, less experienced and less productive physicians. However, this would be equally the case whether the senior physician leaves to work in a hospital across the street or leaves to work in a hospital in a different part of the country, outside of the hospital’s geographic area of patient referrals.
Much of the criticism of physician non-compete clauses have come from primary care physicians and it is not really clear whether primary care physicians ever need a non-compete clause. There have been emotional stories of family physicians who wanted to leave their hospital-owned practice to work in public health clinics caring for uninsured patients but were contractually prohibited by the hospital. However, the reality is that most primary care physicians leave for another practice because of better working conditions or better pay. As long as a primary care physician does not take their patient panel with them, there is little effect on a hospital because it is relatively easy for that hospital to hire a new primary care physician to assume care for that patient panel. In this case, a non-solicitation clause that prohibits the primary care physician from actively taking their patient panel with them would be more appropriate. These non-solicitation agreements generally do not prohibit a patient from voluntarily seeking out that primary care physician at their new practice location but do prohibit the physician from actively trying to persuade (solicit) that patient to follow the physician to their new practice.
When ARE physician non-compete clauses appropriate?
Two situations when non-compete clauses do make sense for physicians are when the hospital has invested money in a physician’s training or invested money in a physician’s practice ramp-up period. In both of these situations, the hospital can experience direct financial harm if a physician leaves to go work for a competitor.
One example of employers investing money in physician training is military medicine. Medical students agree to work for the military for a specified number of years and in exchange, the military agrees to pay for all or some of the medical student’s educational expenses. Another example is when a hospital pays for a physician to get advanced training in order to fill a clinical or administrative need at that hospital. For example, a hospital that sends one of its physicians to get training in quality assurance to prepare the physician for a hospital quality directorship. Or when the hospital decides to buy a surgical robot and sends one of its surgeons to get trained to use the robot. In these situations, the hospital has a direct financial investment in that physician’s training and the hospital should expect to receive a return on that investment.
In many specialties, physician contracts will include a practice ramp-up, whereby the hospital will subsidize that physician’s income for a specific number of years while that physician builds their practice and develops a referral base. The duration of time for this ramp-up depends on the specific specialty. For example, it may only take a new gastroenterologist 1 year to build up a sustainably-sized patient panel. On the other hand, it may take 5 years for a plastic surgeon specializing in aesthetic surgery to build a sustainable referral base. A typical ramp-up contract would be for a relatively large subsidy for the first year of practice and then smaller amounts for subsequent years. For hospital-employed, salaried physicians, the ramp up is often expressed as annual RVU targets. For example, a hospital-employed gastroenterologist might be contractually expected to generate 6,000 wRVUs the first year and then 8,000 wRVUs in subsequent years. During that first year, the gastroenterologist’s salary is guaranteed and not dependent on RVU production. For non-hospital-employed physicians, the ramp up is often in direct monetary payments. For example, the hospital might pay the plastic surgeon $200,000 year 1, $150,000 year 2, $100,000 year 3, and $50,000 year 4. In either case, the hospital has a direct financial investment in developing the physician’s practice and once again, the hospital should expect a reasonable return on that investment.
If physicians take patients with them to a new hospital, the original hospital will lose money. Those patient now go to a different hospital for their lab tests, their x-rays, and their surgeries. This “down-stream revenue” can be substantial – not only as a loss of income to the hospital but also as a loss of patient care income to the pathologists, radiologists, surgeons, and specialists who practice at that hospital and are dependent on that patient population remaining at their hospital. This can occur with primary care physicians who have a large patient panel. But it can also occur with outpatient specialists who maintain large populations of patients who regularly see them in the office. As with primary care physicians, a non-solicitation clause may be more appropriate for these specialists than a non-competition clause.
Specialists can also create financial harm to a hospital by leaving and taking their referrals with them. Specialists cultivate referral bases over years of practice. So, for example, if a joint replacement surgeon who has established a referral network of rheumatologists and primary care physicians leaves to go work for another hospitals, those rheumatologists and primary care physicians will now be sending their patients needing joint replacement surgeries to a different hospital. As an alternative to non-compete clauses, non-solicitation clauses can be written to prohibit specialists from actively seeking referrals from their previous referral base. When a physician in our practice group resigned, announcement letters to that physician’s patients had to be written by or approved by the practice administrators so that the physician could not advertise to patients about their new practice location.
So, what is the solution?
Physician non-compete clauses should not be a “one size fits all” proposition. Most physicians do not need a non-compete clause as there are more effective ways to ensure their loyalty. For those physicians who do need non-compete clauses, the details of those clauses should be tailored to the degree of financial loss faced by the hospital (or employing group practice) should they leave.
For specialties that do not warrant non-complete clauses, paying end-of-the year bonuses is a good way to ensure that the physicians remain with the hospital for at least one year. It costs money to recruit and hire physicians when considering the cost of job advertising, interviewing, travel, moving expenses, signing bonuses, and on-boarding. But an unhappy physician is not going to be a productive physician and moreover, that unhappy physician can poison the culture of the hospital’s medical staff – in the long run, a poisoned culture can be very expensive. Ensuring that physicians remain employed for at least one year of employment in order to get their bonus gives the hospital enough time to recruit another physician to replace the one who is leaving. If the physician leaves before 1 year is up, the hospital can use the money it would have paid that physician in bonus pay for new physician recruitment, instead.
For specialties that do warrant non-compete clauses, sometimes other restrictive covenants can be equally effective or even more effective. For example, a non-solicitation clause in a primary care physician’s contract can prohibit that physician from taking their panel of patients with them to a new employer. This can mean prohibiting the physician from taking patient medical records with them and contacting patients to offer to see them at the physician’s new office. Non-solicitation clauses can also be used to prohibit the physician from recruiting other physicians or hospital employees to come work at their new place of employment.
When hospitals agree to provide a financial ramp-up as a physician builds their practice, it is reasonable for that hospital to insert a non-compete clause. Before our health system put non-compete clauses in our physician employment contracts, we would regularly have surgeons and specialists who would receive ramp-up subsidies totaling as much as $400,000 over several years. All too often, as soon as the surgeon or specialist completed their ramp-up period, they would be recruited by another hospital in town that would pay them a $50,000 signing bonus. This was a bargain for the other hospital since it only had to pay a small signing bonus and did not have to pay the more expensive ramp-up, thus saving that hospital a net $350,000. However, hospital want to have to keep an unhappy surgeon or specialist on the medical staff. So, a solution is to have a buyout for the non-competition clause to offset the hospital’s initial investment in that surgeon or specialist. This buyout should be equal to the amount that the hospital has subsidized that physician with a diminishing amount after the ramp-up period commiserate with the hospital’s subsequent return on investment from the physician’s contribution to the hospital’s patient care revenue. For example, let’s take a surgeon specializing in surgery of the right little toe who needs 3 years to build his toe surgery referral base and get his OR team efficient with toe surgeries. His buyout might look like this:
Ramp-up periods are used not just to build referrals but also to build expertise. In my experience, it takes about 7 years for a newly trained surgery resident or fellow to reach maximum surgical efficiency as an attending physician. In those 7 years, the surgeon is building their operative team and learning how to hone his or her skill: Which patients to operate on and which to not operate on. How to reduce the operative time it initially takes to perform a particular surgical procedure. How to anticipate and avoid surgical complications. For non-surgical specialists, the time to reach maximum productivity may be a bit shorter. But regardless, in the first several years after completion of formal training, the physician is still learning and the hospital generally is covering part of the cost of that on-the-job training. Even if the heart surgeon is paid based on wRVU productivity and thus gets paid less in their first few years after fellowship, the hospital loses money from paying the OR nurses and anesthesiologist to do 2 open heart surgeries in a day rather than 3 open heart surgeries in the same amount of time while the surgeon is learning how to be efficient.
Hospitals should be willing to waive buyouts and non-competes under certain circumstances. For example, a few years ago, we had a non-productive but somewhat famous specialist at our hospital who we were losing money on and we considered terminating him. A hospital 5 miles away was simultaneously recruiting him, believing that they were making a hiring coup by poaching a famous doctor from us, not realizing that he was a financial disaster. We waived his non-compete and did not ask for a buyout because we were happy to have him gone (and now dragging down the competition’s finances). Similarly, academic physicians who have worked at a university medical center for several years and then get passed up for academic promotion should have any non-competes waived.
Non-compete geographic limits
Most physician non-compete clauses contain geographic restrictions that correspond with the hospital’s patient population geography. For example, a community hospital might have a 10-mile restriction if most of its patients live within that 10-mile radius. On the other hand, a tertiary referral hospital might have a 50-mile radius non-compete restriction if it depends on referrals from a lot of community hospitals within that 50-mile radius.
Geographic limits should also be based on the specialty. For example, a primary care physician probably will not draw patients from further than 10 miles from their current practice whereas a specialist might draw patients from 100 miles away. This can be particularly true for a physician specializing in a very unique condition such as a kidney transplant surgeon or an interstitial lung disease pulmonologist (such as myself), who may be the only physician practicing in that specialty in a several county area.
What is considered a reasonable geographic distance in non-compete clauses is often contentious and the cause of many employment-related lawsuits. A non-compete clause for the kidney transplant surgeon specifying metropolitan Columbus might be reasonable but specifying all of Ohio is probably unreasonable.
Hospitals will not voluntarily eliminate physician non-compete clauses
No hospital wants to be the only hospital in town to eliminate non-compete clauses. Otherwise, there would be unidirectional movement of physicians from that hospital to all of the other hospitals in town that do have non-compete clauses. So, for those hospitals that would be willing to drop their non-compete clauses from physician employment contracts, if the FTC makes non-compete clauses illegal, then they could finally eliminate non-competes without worrying about being at a competitive disadvantage to their hospital competitors. In other words, the FTC ruling would essentially level the playing field.
Academic hospitals and non-academic hospitals will be affected differently. Historically, many physicians have left jobs in academic medicine to go into private practice at non-academic hospitals. But the reverse is very rare: physicians generally do not give up their private practice to go into academic medicine. There are always exceptions – our health system acquired a local private practice electrophysiology cardiology group and a local vascular surgery group, for example. But by and large, physician movement between academics and private practice is a one-way street. If physician non-compete clauses are outlawed, then academic hospitals will be at risk of losing more physicians to local non-academic hospitals but the reverse is unlikely to occur. On the other hand, physician movement between different non-academic hospitals is very common. Individual physicians leave one group practice to join another group practice. Hospitals contract with one hospitalist group one year and a different group the next year. Elimination of non-compete clauses will likely affect physician movement between different non-academic hospitals fairly similarly. As a consequence, no academic hospital ever wants to give up its physician non-compete clauses but non-academic hospitals will be willing to give up non-competes as long as all of the other non-academic hospitals in town have to also give up theirs.
Because of this one-way movement of physicians from academic to non-academic hospitals, these two types of hospitals will have ramp-up costs affected differently by global elimination of non-compete clauses. Academic hospitals who lose physicians to non-academic hospitals immediately after their ramp-up costs are paid will stand to lose those ramp up costs. However, if a non-academic hospital pays ramp-up costs for a physician who is then poached by another non-academic hospital, then the original hospital can poach a different doctor from the second hospital so that the ramp-up costs end up balancing out. Because of this, academic hospitals will likely lose more money in ramp-up expenses than non-academic hospitals if non-compete clauses are outlawed.
The economic risk of eliminating all physician non-compete clauses
No one has a crystal ball to predict all of the effects of a blanket elimination of non-compete clauses and history shows us that with every government policy decision comes unintended consequences. Here are some of the possible effects of eliminating physician non-compete clauses:
Increased healthcare costs. One of the concerns of the FTC’s proposed complete elimination of non-compete clauses is that it will be inflationary at a time when our economy is reeling from the highest inflation rates in 40 years. After all, a primary goal of banning non-compete clauses is to increase worker wages by increasing employer competition for those workers. Employers would then transfer the increased expenses of employee wages to consumers by increasing the price of goods and services. However, American medicine is a weird economy, and consumer prices are not as tightly bound to employer expenses. In the U.S., 45% of healthcare expenditures are paid by federal, state, or local governments with the largest component being Medicare and Medicaid. The price Medicare pays doctors and hospitals for any given medical service or procedure is determined every year by Congress and hospitals get paid the same amount no matter what their costs are to provide that service or procedure. If hospital costs go up because they have to pay doctors more, Medicare does not pay that hospital more money. Instead, hospitals increase the amount that they charge commercial insurance companies and self-pay patients. The danger of eliminating physician non-compete clauses is therefore an increase in commercial health insurance premiums to working Americans and an increase in the cost of healthcare to those who pay for healthcare out of pocket.
Lower pay for new physicians. The second risk of physician non-compete clauses is that it could reduce income for newly trained physicians, particularly surgeons and specialists. Hospitals would no longer be incentivized to pay for ramp-up periods for new surgeons or specialists and thus there could be a wider income separation between physicians straight out of residency and fellowship compared to those who have been out in practice for several years. Although it can be argued that this is the physician’s own cost of going from inexperienced/inefficient to experienced/efficient, those same physicians who are newly trained are those who are making student loan payments and thus have less disposable income to begin with. In academic medicine, these income gradations already exist with Assistant Professors earning less than Associate Professors who in turn make less than full Professors. If non-compete clauses go away, these seniority-based salaries may become more prevalent in non-academic medicine.
Higher pay for sub-specialists. Losing a hospitalist or an ER physician to a local competitor does not affect a hospital’s financial margin much but losing a reconstructive plastic surgeon or a joint replacement orthopedic surgeon can have a huge financial impact. Hospitals will be incentivized to pay more to those physicians who bring in the most money for the hospital. Because surgical procedures usually have the greatest financial margin for hospitals, subspecialty surgeons could see an increase in their salaries.
Better coffee in the physician lounge. If non-compete clauses are eliminated then physicians will be not only drawn to work for those hospitals that provide the highest salaries but also those hospitals that have the best physician amenities. This could mean providing free parking, bigger offices, free food, and more vacation time. It is often said that trying to run a hospital full of a bunch of doctors is like trying to run a business full of a bunch of CEOs. Without non-competes, those doctors will increasingly expect to be treated like CEOs.
More hospital mergers. One way to prevent a local competing hospital from hiring your physicians is to buy that competing hospital. If you have a monopoly on the local healthcare market, then you don’t have to worry about losing your physician employees since they would have to sell their house, uproot their kids, and move to a different community to get a job with a different hospital. For larger hospitals and hospital systems, the amount that they pay to physicians is a relatively small part of the annual budget. But for smaller hospitals that are just scraping by financially, the additional costs required to retain their doctors could be enough to force them to merge with larger health systems or even close.
Non-compete clauses should not impede reasonable competition
In a free market economy, employees will go to work for the employer who offers them the best job for the best salary. The strength of a free market economy is that this competition for the best employees is the invisible hand that encourages employers to provide optimal working conditions and pay more for the best workers. Excessive use of non-compete clauses creates employment monopolies and in the long-run, monopolies end up hurting the average consumer and hurting the overall economy.
Free market employment encourages innovation and efficiency. It is why the United States has been the envy of the world for the past 150 years when it comes to revolutionary inventions, technologic breakthroughs, and economic success. Injudicious use of non-compete employment clauses risk turning “workplace of choice” initiatives into “workplace of force” realities which can stifle innovation and efficiency.
But employers should reasonably expect to recover their financial investments. No one would expect a factory to spend $250,000 to buy a new machine and then be required to give that machine away 3 years later to a competitor for free. And we should not expect one hospital to spend $250,000 to train a physician only to have that physician go work for a competitor once completing their training. So, there has to be a compromise. Non-compete clauses should not be applied to all physicians but neither should they be eliminated completely.
Non-compete clauses (with options to buyout those clauses) should be reserved for those situations when hospitals invest a significant amount of money in a physician’s career development. For other physicians, non-solicitation clauses can protect the hospitals without negatively impacting a free-market competition for physician employment. Eliminating all physician non-compete clauses is unwise… but so is the indiscriminate use of non-compete clauses across the board to all physicians in all specialties. I hope that the FTC finds a way of protecting the right of physicians to chose their workplace while protecting the right of hospitals to recover their financial investments in physician career development. The answer to the physician non-compete controversy is not that they should always be used nor should they never be used but rather that they should sometimes be used.
February 15, 2023