On June 11, 2021, the U.S. Court of Appeals for the Second Circuit dismissed the Federal Trade Commission (FTC)'s administrative order against 1-800 Contacts Inc., the nation's largest online retailer of contact lenses. The FTC had originally found that 1-800 Contacts unlawfully entered into anticompetitive agreements with rival online contact lens sellers over search ads in the form of trademark litigation settlement agreements. Key takeaways from the decision are as follows:

• Agreements among a company asserting trademark rights and competitors specifying that the competitors will not bid on the company's name as a keyword in search advertising are not "inherently suspect" and should be treated like normal trademark settlements.
• Such agreements require a full-scale rule of reason assessment, not a quick-look analysis under the "inherently suspect" framework.
• Showing that prices changed after alleged anticompetitive conduct does not suffice as direct evidence of anticompetitive harm. Empirical evidence showing that the alleged conduct caused an anticompetitive effect must be provided.
• Reduced litigation costs and protection of asserted trademark rights can be viable procompetitive justifications.
• Deference should be given to the scope of settlement agreements negotiated by the parties in finding a less restrictive alternative.

Applying the Second Circuit's rationale, competing companies would now presumably be free to reach agreements that impose restrictions on keyword bidding on a competitor's name as part of resolving their trademark conflicts. This is contrary to what the expectation had been since the FTC's initial decision in 2018 which found such conduct to be anticompetitive, and may have impact on other pending keyword bidding cases.¹ However, it would be hasty to assume such practice to completely have escaped antitrust scrutiny, as we expect the FTC petition for a writ of certiorari to the Supreme Court.²

FTC's Initial Win Against 1-800 Contacts

In August 2016, the FTC brought a Section 5 suit under the FTC Act (unfair method of competition) against 1-800 Contacts, alleging that it unlawfully orchestrated and maintains a web of anticompetitive agreements with rival online contact lens sellers.³ According to the commission's administrative complaint, 1-800 Contacts entered into bidding agreements with at least 14 competing online contact lens retailers which effectively eliminated competition in auctions to place advertisement on the search results page generated by online search engines such as Google and Bing. The FTC's complaint alleged that these agreements resulted in two anticompetitive effects: 1) they artificially reduced prices for the ads, and 2) they caused consumers to pay more for online purchases of contact lenses due to restrictions on truthful, non-misleading advertising.

By way of background, search engines like Google or Bing display organic results that the engine's algorithm deems most relevant to the user's search. The search engine often displays advertisements near the organic search results. Advertisers bid and pay for those ads to be shown in response to the keywords entered by users. Advertisers may also use "negative keywords" to prevent its ad from displaying in response to a certain query.⁴ In this instance, 1-800 Contacts made agreements with competitors to prohibit them from bidding in auctions for online search advertising for the company's trademarks such as "1-800 Contacts." 1-800 Contacts' repeatedly sent cease-and-desist letters alleging trademark infringement to competitors whose search advertising displayed in response to queries involving "1-800 Contacts" and its variations. As part of a settlement, the contacts lens competitors also reached reciprocal agreements to list their trademarks as negative keywords. Thus, users searching for "1-800 Contacts" would not see advertisements for a competitor (and vice versa), but if a user searched for a more generic term like "contact lenses," he or she could see advertisements from a number of competing sellers.

In November 2018, despite vigorous efforts by 1-800 Contacts to rebut the FTC's allegations, the FTC Commissioners voted 3-1 to rule that the agreements between 1-800 Contacts and 14 online contacts lens sellers constitute unfair methods of competition.⁵ The FTC analyzed the agreements under the "inherently suspect" framework, which reduces the initial burden on the FTC and shifts the burden to the defendant to show procompetitive justifications for the conduct at issue.

1-800 Contacts Prevails on Appeal

On appeal, the Second Circuit held for 1-800 Contacts and dismissed the FTC's administrative order. In vacating the FTC's final order, the Second Circuit explained: "although we hold that trademark settlement agreements are not automatically immune from antitrust scrutiny, the Commission's analysis of the alleged restraints under the 'inherently suspect' framework was improper."⁶

1. The mere fact that an agreement implicates intellectual property rights does not immunize an agreement from antitrust scrutiny.

In Actavis, the Supreme Court rejected the idea that agreements between brand and generic pharmaceutical companies are immune from antitrust scrutiny just because they occur within the context of a patent litigation settlement.⁷ 1-800 Contacts argued that Actavis is an exception to the general rule against subjecting IP settlements to antitrust scrutiny because patents are inherently exclusionary and the reverse payment scheme at issue in Actavis was "unusual." The Second Circuit rejected this idea and held that "the mere fact that an agreement implicates IP rights does not immunize an agreement from antitrust attack."

2. A full rule of reason analysis is warranted for trademark agreements because trademarks are by their nature non-exclusionary and presumed to be procompetitive.

The FTC argued that the settlement agreements at issue were a form of "bid rigging" that are "inherently suspect" and thus do not require a full rule of reason analysis. The Second Circuit rejected this, emphasizing that "courts do not have sufficient experience with this type of conduct to permit [the FTC's] abbreviated analysis," and the trademark agreements should be presumed procompetitive. The court further noted that the FTC itself recognized that 1-800 Contacts' proffered justification was "cognizable and, at least, facially plausible," further supporting the need for a rule of reason analysis.

3. When claiming direct evidence in the form of increased prices (or output reductions), the plaintiff must show the alleged restraint caused the purported effect.

Under the full rule of reason analysis, the FTC was required to provide direct evidence of anticompetitive effects in order to avoid a detailed market analysis or showing of market power. Although the FTC claimed that it established such direct evidence, the court held that the FTC failed to prove with empirical evidence that the settlement agreements resulted in anticompetitive effects. With respect to the impact on the price for search engine ads, the court held that the FTC's evidence was too narrow and failed to show direct evidence of a market-wide effect. Regarding consumers' prices, the court faulted the FTC for putting forth mere "theoretical and anecdotal" evidence.

4. Protection of trademark interests can be a viable procompetitive justification.

1-800 Contacts persuaded the court that it established two procompetitive justifications: reduced litigation costs and protection of its trademark rights. The court expressly stated that the protection of trademark interests constitutes a valid procompetitive justification for the settlement agreements. It heavily relied on Clorox Co. v. Sterling Winthrop, Inc.,⁸ in which the Second Circuit had found "it is difficult to show that an unfavorable trademark agreement creates antitrust concerns" even if it prevents competitors "from competing effectively as [they] otherwise might[.]"⁹ The court however cautioned that it does not mean that every trademark agreement has a procompetitive justification. If the provisions relating to trademark protection are auxiliary to an underlying illegal agreement between competitors, or if there were other exceptional circumstances, the agreement might not reflect a true procompetitive justification, the court added.

5. The court will not "second-guess" trademark agreements between competitors.

The FTC argued that the parties could have agreed to less restrictive alternatives, such as requiring clear disclosure in each search advertisement of the identity of the rival seller rather than prohibiting all advertising on trademarked terms. However, the Second Circuit, again relying on Clorox, said that it would give "significant deference to arm's length use agreements negotiated by parties," and found that the FTC failed to show that the proffered alternative would achieve the same procompetitive benefit.

More Guidance Is Needed for Agreements on Keyword Bidding on Digital Advertisement

While it remains to be seen whether the FTC would challenge the Second Circuit's decision, there are significant pending issues that reasonably call for a second look. First, it should be noted that no court has ever found bidding on trademark keywords to constitute trademark infringement, absent some additional factor, such as a misleading use of the trademark in the ad text that confuses consumers as to the advertisement's source, sponsorship, or affiliation.¹⁰ This lack of precedent puts in doubt the legitimacy of such agreements and whether they should be presumed procompetitive in nature like the Second Circuit says.¹¹ Second, confusion is created as to the application of the ‘inherently suspect' framework, because the Second Circuit's decision seems somewhat inconsistent with prior rulings that have applied the framework to cases involving advertising restrictions. For example, in the Three Tenors case, it was determined that the agreement between joint venturers to prohibit discounts and advertising on one recording (while still competing on prior recordings) was inherently suspect.¹² While not all advertising restrictions should be treated necessarily inherently suspect, more clarity is needed for different types of horizontal agreements imposing such restrictions, if the distinction is to be made at all as to which is inherently suspect and which is not.

With growing regulatory focus on online platforms and digital advertising, online advertisers should stay tuned for the FTC's next steps and how the courts respond to balance the IP rights.

For more information, please contact Jonathan Jacobson, Jeffrey Bank, Sabin Chung, or another member of the firm's antitrust and competition practice.

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[1] See e.g., Travelpass Grp. LLC v. Caesars Entm’t Corp., 5:18-cv-00153-RWS-CMC (E.D.Tex. Sep. 27, 2019). TravelPass brought an antitrust suit against multiple hotel chains and online travel agencies alleging that the hotels and agencies were involved in a horizontal conspiracy to get rid of search engines' paid search advertisements by not bidding on each other's branded keywords.

[2] Maribeth Petrizzi, acting director of the FTC’s Bureau of Competition, said that the agency is “disappointed in the ruling, and [it] will be considering [its] options.” [Bill Donahue, 2nd Circ. Rejects FTC Antitrust Case Against 1-800 Contacts, Law360 (Jun.11, 2021, 3:02 PM EDT), https://www.law360.com/consumerprotection/articles/1393272/2nd-circ-rejects-ftc-antitrust-case-against-1-800-contacts.]

[3] In the Matter of 1-800 Contacts, Inc., FTC Docket No. 9372, FTC File No. 141 0200, Compl. (Aug. 8, 2016), https://www.ftc.gov/system/files/documents/cases/160808_1800contactspt3cmpt.pdf.

[4] For example, an optometrist selling eyeglasses might use negative keywords to avoid having its ads display when users search for wine glasses.

[5] Press Release, Fed. Trade Comm’n, FTC Commissioners Find that 1-800 Contacts Unlawfully Harmed Competition in Online Search Advertising Auctions, Restricting the Availability of Truthful Advertising to Consumers (Nov. 14, 2018), https://www.ftc.gov/news-events/press-releases/2018/11/ftc-commissioners-find-1-800-contacts-unlawfully-harmed. Notably, Commissioner Noah Phillips issued a dissenting statement, stating that the rule of reason should be applied to antitrust challenges to trademark settlements like those at issue in this case, “giving appropriate credence to the fact that the conduct at issue is the settlement of legitimate trademark infringement claims.” See Noah Joshua Phillips, FTC Cmr., Dissenting Statement of Commissioner Noah Joshua Phillips [Redacted Public Version] in the Matter of 1-800 Contacts, Inc. (Nov. 14, 2018), https://www.ftc.gov/public-statements/2018/11/dissenting-statement-commissioner-noah-joshua-phillips-redacted-public.

[6] 1-800 Contracts, Inc. v. FTC Docket No. 18-3848 at 4 (2d Cir. Jun. 11, 2021). 

[7] FTC v. Actavis, Inc. 570 U.S. 136, 146-48 (2013).

[8] Clorox Co. v. Sterling Winthrop, Inc., 117 F.3d 50, 55-56 (2d. Cir. 1997).

[9] Id at 57-59.

[10] In the Matter of 1-800 Contacts, Inc., FTC Docket No. 9372, FTC File No. 141 0200, Final Order at 38-39 n.42 (Nov. 14, 2018)(citing trademark law expert reports and relevant cases). 

[11] This doubt is furthered by the fact that, as the FTC pointed out, the Tenth Circuit granted summary judgment in favor of Lens.com that rejected the settlement terms and litigated the trademark infringement case brought by 1-800 Contacts. Id. at 8 (citing 1‑800 Contacts, Inc. v. Lens.com, 755 F. Supp.2d. 1151 (D. Utah 2010), affirmed by, 722 F.3d 1229 (10th Cir. 2013)).

[12] Polygram Holdings, Inc. v. FTC, 416 F.3d 29 (D.C. Cir. 2005). Polygram Holding, Inc. and Warner Communications, Inc. formed a joint venture in distributing a concert album of the three tenors, Jose Carreras, Placido Domingo, and Luciano Pavarotti. See also, Blackburn v. Sweeney, 53 F.3d 825 (7th Cir. 1995) (finding advertising restraint that prohibited attorneys from advertising in particular geographical regions per se unlawful); United States v. Gasoline Retailers Ass’n, Inc., 285 F.2d 688 (7th Cir. 1961) (agreement between trade association and gasoline station operators that stations would not advertise—including by posting signs at the stations showing prices—or give premiums was per se Sherman Act violation).