As we posted on Tuesday, the Federal Trade Commission (FTC) has at long last issued its final regulatory rule banning virtually all existing and future U.S. non-compete agreements. In this series, we will unpack some of the more nuanced questions surrounding the final rule. Although the series is generally applicable, today’s post is particularly geared toward non-profit organizations.

Does the final rule apply to entities claiming tax-exempt status as non-profits?

It depends. In the commentary to the final rule, the FTC explains that Congress empowered the agency to prevent “persons, partnerships, or corporations” from engaging in unfair methods of competition. To fall within the definition of “corporation” under the FTC Act, an entity must be “organized to carry on business for its own profit or that of its members.” These FTC Act provisions have been interpreted in commission precedent and judicial decisions to mean that the FTC lacks jurisdiction over corporations not organized to carry on business for its own profit or that of its members.

That said, the FTC also opines in the final rule commentary that both judicial decisions and agency precedent recognize that not all entities claiming tax-exempt status as non-profits fall outside the agency’s jurisdiction. Citing a federal appeals court decision, the FTC notes that “Congress took pains in drafting § 4 [15 U.S.C. 44] to authorize the Commission to regulate so-called non-profit corporations, associations and all other entities if they are in fact profit-making enterprises.”

The final rule commentary then goes on to state that the FTC applies a two-part test to determine whether a corporation is organized for profit and thus within the agency’s jurisdiction, stating that “[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 FTC 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.”

The FTC further opines that, while merely claiming tax-exempt status in tax filings is not dispositive, if the IRS concludes that an entity does not qualify for tax-exempt status, such a finding would be meaningful to the FTC’s analysis of whether that entity is a corporation under the FTC Act. On that point, the final rule commentary points to several examples of administrative proceedings and judicial decisions involving the FTC or the IRS that have identified 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, thus bringing it within the FTC’s jurisdiction.

The FTC concludes its commentary regarding non-profit organizations by stating that, “[a]s has been the case for decades, under Commission precedent and judicial decisions construing the scope of the Commission’s jurisdiction, any entity satisfying the two-prong test falls within the Commission’s jurisdiction. Such entities would thus be bound by the final rule.”

Stay tuned for our next post in this series.