Court of Appeals' Reversal of the FTC's 1-800 Contacts Decision Draws Internet Keyword Advertising Agreements into Focus for Trademark Holders

Alerts / June 28, 2021

Antitrust regulators around the globe are heavily scrutinizing online advertising platforms. That scrutiny extends to the activities of advertisers making use of those platforms. On June 11, 2021, the Second Circuit Court of Appeals in 1-800 Contacts, Inc. v. Federal Trade Commission reversed a Federal Trade Commission (FTC or Commission) decision finding antitrust liability regarding a company’s agreements to protect its trademark in its web advertising.

1-800 Contacts is an internet-based retailer of contact lenses. 1-800 Contacts, like its competitors, advertises its product online to potential customers using search advertising. Search engines sell paid search advertisements via a bidding system: advertisers bid on relevant keywords at an auction hosted by the search engines, and the highest bidder’s ads are displayed at the top of the Search Engine Results Page (SERP) above the “organic” search results. 1-800 Contacts’ competitors were bidding to place advertisements on the SERP that appears when online shoppers searched for “1-800 Contacts.” Beginning in 2002, 1-800 Contacts filed complaints and sent cease-and-desist letters to competitors alleging trademark infringement regarding the competitors’ use of the 1-800 Contacts trademark. Resulting settlement agreements prohibited the parties from bidding on one another’s trademarks as search advertising keywords. The settlements also required the parties to include the trademarks as negative keywords, so that, for example, a user’s search for “1-800 Contacts” would not result in a party placing an ad in response to the user’s search because one of a party’s keywords was “contacts.” The FTC issued an administrative complaint against 1-800 Contacts, alleging that the trademark settlement agreements restrained trade in violation of Section 5 of the FTC Act. An administrative law judge and later the Commission found that the settlement agreements violated Section 5, prompting 1-800 Contacts to appeal the judgment to the Second Circuit Court of Appeals.

The Commission characterized the conduct as agreements among competitors to restrain advertising competition. After rejecting 1-800 Contacts’ argument that trademark settlements are immune from antitrust review, the Commission had to select the proper form of antitrust analysis: either the full rule of reason, the truncated rule of reason or per se analysis. The Commission decided to analyze the restraint under the full rule of reason and the truncated rule of reason. Under the full rule of reason, in the first step of a three-step analysis, the government must demonstrate that the respondent’s challenged practices cause actual harm to competition. Under the truncated rule of reason, the government need only establish that the conduct is inherently suspect; that is, it is obvious that such conduct would restrain competition. The Commission found that the evidence satisfied the first step under both these forms of analysis. As far as the full rule of reason was concerned, the Commission concluded that direct evidence of price increases and restrictions on truthful advertising supported a finding that the agreements were anticompetitive.

The Second Circuit agreed with the Commission that trademark law did not immunize the agreements at issue but held that the truncated rule of reason was not applicable to intellectual property agreements of the sort at issue. The court had ample authority from the Supreme Court’s decision in FTC v. Actavis,[1] which held that settlement within the potential scope of a patent had to be resolved under the rule of reason. The court next rejected one prong of the Commission’s full rule of reason analysis because the Commission lacked sufficient evidence that the restraint had increased prices. However, the court did not decide whether restrictions on truthful advertising would satisfy the government’s burden of proof in the first step of its rule of reason analysis.

When a plaintiff has satisfied the anticompetitive step in the analysis, the burden shifts to the respondent in step 2 of the analysis to prove that it has a procompetitive justification for the restraint. The Commission found no merit in 1-800 Contacts’ procompetitive justification because trademark law did not give it the right to exclude competitors from bidding for advertising using “1-800 Contacts” as a keyword. The fundamental trademark issue is whether the advertising enabled by keyword bidding is likely to confuse consumers. The Commission found that it did not. According to the Commission, “[T]he weight of authority overwhelmingly points to non-infringement.” The bidding on keywords “has never been found to violate the trademark laws,” and in fact 1-800 Contacts had lost its only litigation on this point. The Commission’s approach is set forth in the U.S. Department of Justice and the Federal Trade Commission Antitrust Guidelines for the Licensing of Intellectual Property[2] and in the leading treatise on antitrust and intellectual property:[3] If the IP claim is not valid or not infringed, it cannot be used as a procompetitive justification for the restraint. In effect, the antitrust tribunal can then analyze the restraint without further considering the IP claim.

The court disagreed, asserting “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 … even though a trademark agreement inherently prevents competitors ‘from competing as effectively as [they] otherwise might.’” According to the court, even if the Commission’s analysis of the trademark claim were correct, trademark agreements that “only marginally advance trademark policy can be procompetitive” because they “serve the competitive purpose of furthering trademark policy.”

Another way to state the court’s holding is that so long as the challenged agreements prohibit conduct falling within the potential scope of the protection afforded by trademarks, it is immune from the antitrust laws. If not in direct conflict, there is, at least, substantial tension between this holding and the Supreme Court’s Actavis decision. In Actavis, the Court was addressing a litigation settlement where a patent holder had paid the alleged infringer to stop competing with the patent holder for some time. The majority concluded that this flow of money was moving in the wrong direction—from the patent holder to the alleged infringer—which suggested that the patent was weak. The Court believed that this normally would be sufficient to rebut the defendant’s assertion that the settlement was within the scope of the patent and thus justified. But where money is not moving in the wrong direction, it would seem that the scope of the patent would have to be litigated to decide whether the settlement satisfied plaintiff’s burden in step 2 of the rule of reason analysis. The Actavis dissent disagreed, arguing that a settlement within the potential scope of the patent should not violate the antitrust laws. The Court of Appeals’ 1-800 Contacts decision appears more reminiscent of the dissent than the majority when it concluded that restricting competitive bidding for keywords did not violate the antitrust laws if the restrictions were within the potential scope of the trademark at issue—even if the restrictions were not within the actual scope of the trademark.

Once a procompetitive agreement has been established, the burden shifts back to the government to establish a less restrictive alternative that accomplishes the procompetitive objective. The Commission concluded that there was a viable less restrictive alternative: The parties could have agreed to disclose in each search advertisement the rival seller’s identity.

The court was not persuaded. It first noted that “the parties determination of the scope of the needed trademark protections is entitled to substantial weight.” It then observed that the Commission did not adequately consider how onerous enforcing the less restrictive alternative would be. The court thereupon concluded that the agreements that protected 1-800 Contacts’ trademarks do not violate the antitrust laws.

Some Takeaways:
  • If not overruled en banc or by the Supreme Court, the Court of Appeals’ decision is favorable to parties settling trademark disputes within the potential scope of the protection that trademark law affords trademark holders.
  • Even if the FTC were to persist in challenging such agreements, the Court of Appeals’ decision will create significant hurdles to the FTC and private plaintiffs trying to bring antitrust suits challenging trademark settlements. Most respondents to FTC administrative complaints can choose to appeal adverse decisions to the Second Circuit, making it very difficult for the FTC to sustain a judgment that similar restraints are in fact unlawful.
  • However, if the FTC is determined to continue to pursue similar restraints, it could adopt the strategy it employed to achieve its victory in Actavis: It could bypass the administrative proceeding and bring its complaints on this issue directly to the federal court, giving it the opportunity to select a more favorable forum. And of course, private plaintiffs could strategically select their forum as well.
  • In addition, as the FTC reported, there is not much in the way of precedent that supports the underlying trademark claim at issue here. And it may be that courts that have rejected this sort of trademark claim in litigated trademark matters would be less sympathetic to antitrust defendants that have settlements similar to the settlements of 1-800 Contacts.
  • Of course, while the FTC only named 1-800 Contacts in its complaint, another plaintiff could name all the parties to the settlement in its complaint.
  • Future antitrust tribunals will likely demand a full rule of reason analysis in trademark settlement cases. That requires a showing of market power or direct evidence of anticompetitive effects. So restrictive trademark agreements are more likely to survive an antitrust challenge if they are entered into by parties without market power and where it is hard for plaintiffs to demonstrate that the restraint led to price increases. But this is not the end of the story, because the 1-800 Contacts court did not decide whether the diminution of truthful advertising satisfies the first step in the rule of reason. Nevertheless, if the 1-800 Contacts opinion survives appeal, it is doubtful the FTC would issue a complaint against trademark holders without market power operating in a market where price increases cannot be well established.
  • The Court of Appeals did not heavily focus on its rationale for immunizing agreements on negative keywords from the antitrust laws. There is a relevant distinction, as the parties would not be using the competitor’s trademark to place an ad. Given this distinction and the court’s failure to grapple with the anticompetitive effect of truthful advertising, this may be an area to continue to watch.

The 1-800 Contacts decision also has ramifications for other forms of intellectual property and for the FTC’s approach to restraints at the intersection of IP and antitrust. But these are subjects that will have to wait for future discussion.

Authorship Credit: Marc Schildkraut, Ann O’Brien and Joshua Jowdy

[1] 570 U.S. 136 (2013).
[3] Hovenkamp, Janis, Lemley, Leslie and Carrier, IP and Antitrust: An Analysis of Antitrust Principles Applied to Intellectual Property Law, Chapter 7.

Baker & Hostetler LLP publications are intended to inform our clients and other friends of the firm about current legal developments of general interest. They should not be construed as legal advice, and readers should not act upon the information contained in these publications without professional counsel. The hiring of a lawyer is an important decision that should not be based solely upon advertisements. Before you decide, ask us to send you written information about our qualifications and experience.