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The Second Circuit Tells the FTC to Check Its Proscription on 1-800 Contacts

June 21, 2021

On Friday, June 11, 2021, the Second Circuit Court of Appeals ruled that the Federal Trade Commission (“FTC”) failed to show that 1-800 Contacts violated antitrust law by entering into and enforcing trademark infringement settlement agreements against competitors that restricted certain bidding in online advertising auctions conducted by search engines, such as Google.  The Second Circuit’s decision reverses the FTC’s finding that these agreements violated Section 5 of the FTC Act.  The Second Circuit held that, while trademark settlements are not immune to antitrust scrutiny, the FTC applied an incorrect standard of review in concluding that they were “inherently suspect” and violated the antitrust law and, applying a proper “rule of reason” analysis, the Second Circuit concluded that the FTC had not shown direct evidence of anticompetitive harm and failed to properly acknowledge the clear procompetitive benefits of trademark enforcement. 

The FTC’s Case Against 1-800 Contacts

In August 2016, the FTC issued an administrative complaint against 1-800 Contacts, alleging that it was unreasonably restraining advertising and price competition in online search advertising auctions for contact lenses.  The FTC focused on certain trademark infringement settlement agreements (the “Challenged Agreements”) that 1-800 Contacts  entered into with various competitors from 2004-2013.[1]  Each settlement agreement included language that prohibited the parties from bidding on each other’s trademarks, URLs, and variations of trademarks as keywords, and required the parties to implement “negative keywords” so that a search including one party’s trademarks would not trigger a display of the other party’s ads.  According to the FTC, these agreements prevented 1-800 Contacts’ competitors from serving ads that would have informed consumers that the same contact lenses were available at a cheaper price from other online retailers, which thereby reduced competition and made it more difficult to compare competitor prices.

After a trial before an Administrative Law Judge, the Commission classified the Challenged Agreements as “inherently suspect,” thus enabling a “quick look” analysis and obviating the need to establish direct evidence of harm and proof of market power.  Alternatively, the Commission also found direct evidence of anticompetitive effects on consumers and search engines.  The Commission rejected 1-800 Contacts’ argument that the benefit of protecting trademarks outweighed the potential harm to consumers, explaining that while this was a “cognizable and facially plausible” justification, 1-800 Contracts had failed to show that it had a “basis in fact” and was thus not valid.

Second Circuit’s Decision

1-800 Contacts appealed the decision and nearly three years later, the Second Circuit struck down the FTC’s findings, vacating the Commission’s decision and ordering it to dismiss the administrative complaint.  Although the Court agreed that settlement agreements are not immune to antitrust scrutiny, it held that the FTC had failed to provide evidence of anticompetitive harm that resulted from the Challenged Agreements.

First, the Court determined that the Commission had erred in classifying the Challenged Agreements as “inherently suspect” such that a full rule-of-reason analysis was not required.  The court explained that “even if restraints on truthful advertising have a tendency to raise prices, the fact that a practice may have a tangential relationship to the price of the commodity in question does not mean that a court should dispense with a full rule-of-reason analysis.”  Moreover, “if an arrangement might plausibly be thought to have a net procompetitive effect, or possibly no effect at all on competition, more than a ‘quick look’ is required,” and “the restraints at issue here could plausibly be thought to have a net procompetitive effect because they are derived from trademark settlement agreements.”  The Second Circuit additionally noted that “[c]ourts do not have sufficient experience with [trademark bidding restriction agreements] to permit the abbreviated analysis . . . undertaken by the Commission.”  Furthermore, the Challenged Agreements were “not so obviously anticompetitive to consumers that someone with only a basic understanding of economics would immediately recognize them to be so,” as is required to apply the inherently suspect framework.

In a footnote, the Court also dismissed the Commission’s argument that it was proper to use the inherently suspect analysis because the restrictions in the settlement agreements constituted illegal bid rigging.  Conceding that “[a]n absolute ban on competitive bidding, or bid rigging, would be anticompetitive on its face and may justify an abbreviated rule of reason analysis,” the Second Circuit explained that it was “not clear to [the Court], however, that the restrictions constitute such a ban.”  Importantly, the Challenged Agreements only prevented the parties from bidding on trademarked terms, not from participating in keyword auctions entirely. As such, the Court concluded that “[w]hether restrictions on advertisers’ use of particular terms leads to overall harm to the search engines is not obvious and therefore does not justify analyzing the agreements under the inherently suspect framework.  Nor . . . is it obvious that the restrictions constitute market division, another type of restraint that would justify an abbreviated analysis.”

After rejecting the Commission’s abbreviated analysis, the Court conducted its own full rule-of-reason analysis, finding that the government had failed to make the required showing of an actual anticompetitive change in prices after the implementation of the agreements.  Characterizing the FTC’s evidence as “theoretical and anecdotal,” the Court noted that “[e]ven accepting this as true, it is not direct evidence,” as required by law.  The Court similarly rejected the government’s argument that it had shown direct evidence of reduced revenue for search engines: “the government did not show that Google or Microsoft, the companies who control the two most popular search engines, had lower revenues after the Challenged Agreements were put into place.  Nor did the government introduce evidence that [1-800 Contacts] spent less money on search advertising than it did before the Challenged Agreements came into effect.  Instead, the government offered empirical evidence that the Challenged Agreements reduced the price paid by [1-800 Contacts] for each click on one of its keywords.”  The Court found this insufficient because empirical evidence is required to find direct evidence of an anticompetitive effect, and a “showing that a price for certain keywords dropped is not direct evidence of the effect on the market as a whole.”

The Court also found that 1-800 Contacts’ proffered justification of trademark protection had not been rebutted by the FTC and constituted a “valid procompetitive justification.”  The Court explained that “[t]rademarks are by their nature non-exclusionary, and agreements to protect trademark interests are common, and favored, under the law.  As a result, it is difficult to show that an unfavorable trademark agreement creates antitrust concerns.  This is true even though trademark agreements inherently prevent competitors from competing as effectively as they otherwise might.” 

Finally, the Court found that the Commission had failed to show that a viable less restrictive alternative existed, rejecting the FTC’s argument that the parties to the settlement agreements “could have agreed to require clear disclosure in each search advertisement of the identity of the rival seller rather than prohibit all advertising on trademarked terms.”  The Court explained that it “owe[d] significant deference to arm’s length use agreements negotiated by parties to those agreements,” and “forcing companies to be less aggressive in enforcing their trademarks is antithetical to the procompetitive goals of trademark policy.”

Key Takeaways

Companies have legitimate concerns regarding the online use of their trademarks and issues relating to brand protection, particularly where companies have spent enormous sums to build brand recognition with consumers.  Trademark protection can serve as a legitimate procompetitive justification for entering into certain agreements to prevent others from “free riding” on such trademark investments by bidding on another’s trademarked terms to show advertising to consumers.  Whether such a justification is strong enough to survive a rule of reason analysis by a court is likely to be fact specific.

Potential plaintiffs looking to challenge agreements between competitors not to bid on each other’s trademarked terms in online keyword auctions should be prepared to show harm under a rule of reason analysis rather than a “quick look” or “inherently suspect” analysis.  This is especially true of plaintiffs hoping to bring a successful claim that such agreements amount to illegal bid rigging.

Plaintiffs must also show direct evidence of anticompetitive harm in the form of increased prices that directly flows from the agreements themselves.  It is insufficient to simply point to price increases without showing a link between such price increases and the alleged anticompetitive agreements.  Bidding on keywords is not a proxy for advertising and restrictions of one does not necessarily show harm more broadly in advertising.  Also, unless you’re Google or Microsoft, showing harm to search engines is unlikely to persuade a court.

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[1] 1-800 Contacts, Inc. v. Fed. Trade Comm’n, No. 18-3848, 2021 WL 2385274, at *1 (2d Cir. June 11, 2021)