Second Circuit Takes Closer Look at Advertising Restrictions in Trademark Settlement Agreements
Considering whether trademark owners can enter into settlement agreements that restrict the parties’ search advertising without violating U.S. antitrust laws, in 1‑800 Contacts, Inc. v. FTC, the Second Circuit held the restrictions permissible. In doing so, the Second Circuit overturned the Federal Trade Commission’s conclusion that when 1-800 Contacts, Inc., settled multiple trademark infringement suits through agreements preventing its competitors from purchasing search advertising keywords containing 1-800 Contacts’ trademarks, it violated section 5 of the FTC Act, 15 U.S.C. § 45(a)(1).
Search advertising—which triggers the “ads” or “sponsored” results that often appear at the top of internet search results—is a large part of the advertising budget of many companies. Search engines like Google and Bing auction certain words or phrases, known as “keywords,” and the highest bidders’ ads are typically displayed most prominently in search results (although other factors may also be considered). Keywords can include generic terms like “eyeglasses,” but they can also include trademarked terms such as “1‑800 Contacts.” Over the course of several years, 1-800 Contacts sued many of its competitors for trademark infringement when they bid on its trademarked name as a keyword. And it settled thirteen of these suits using agreements that prohibited the parties from using each other’s trademarks, trademark variants, and URLs as search advertising keywords. The agreements also required the parties to use “negative keywords,” which operated to ensure that a search including one party’s trademarks would not display the other party’s ads. The agreements did not, however, prohibit the parties from bidding on generic keywords such as “contacts” or “contact lenses.”
The FTC filed an administrative complaint against 1-800 Contacts in 2016, alleging that the restrictions in 1-800 Contacts’ settlement agreements unfairly restricted competitors’ search advertising practices in violation of section 5 of the FTC Act. The Administrative Law Judge agreed that 1-800 Contacts violated section 5, and the Commission (on a 3-1 vote, with one Commissioner not participating) sustained that ruling and issued an order prohibiting 1-800 Contacts from executing any agreement that limited a competitor’s search advertising activities. 1‑800 Contacts then challenged the Commission’s order in the Second Circuit, which disagreed with the Commission, vacated the order, and remanded the case for dismissal.
The Second Circuit’s decision contained three parts, each examining the Commission’s decision under a different lens.
Actavis Considerations: Are Trademark Settlement Agreements Immune from Antitrust Scrutiny?
First, the court held that the Commission correctly followed FTC v. Actavis, Inc., 570 U.S. 136 (2013), in determining that trademark settlement agreements are not immune from antitrust scrutiny. In Actavis, the Supreme Court found that a “reverse settlement” agreement—in which a patent owner pays an accused infringer to stop challenging the scope and validity of a patent—was not automatically immune from antitrust review. 1-800 Contacts argued that Actavis should be narrowly construed as only applicable to specific types of patent settlement agreements, not trademark settlements, but the court disagreed. Citing Actavis and Second Circuit precedent involving the antitrust scrutiny of other trademark agreements, the court found that the challenged agreements could be reviewed under section 5.
Which Legal Standard Should Apply to the Challenged Agreements?
Second, the court determined that the Commission had applied the wrong framework in determining whether the challenged settlement agreements violated section 5. The court recognized three possible frameworks. Under the first framework, agreements or practices that are recognized to lack “any redeeming virtue”—such as horizontal price fixing—are presumed to be unreasonable and are thus “deemed per se illegal.” The second and more common approach analyzes the challenged activity under “the rule of reason”—which requires a plaintiff to demonstrate that a particular activity is “unreasonable” and anticompetitive before it can be found unlawful. A third framework is available in cases where the challenged actions are not so bad as to be considered per se illegal, but where the “great likelihood of anticompetitive effects can easily be ascertained” such that a full-blown rule-of-reason analysis is unnecessary. Under this framework—which the Commission called the “inherently suspect” framework but is sometimes referred to as the “quick-look” approach—neither direct evidence of harm nor proof of market power is required.
But the middle-ground “inherently suspect” approach is allowed, the Second Circuit said, only when “an observer with even a rudimentary understanding of economics could conclude that the arrangements in question would have an anticompetitive effect on customers and markets.” The Second Circuit rejected the conclusion that this standard was met when considering the restrictions in 1-800 Contacts’ settlement agreements. On the contrary, it said, those restrictions “could plausibly be thought to have a net procompetitive effect because they are derived from trademark settlement agreements.” Accordingly, the court determined that the Commission erred in applying the “inherently suspect” framework and needed to employ a deeper analysis under the “rule of reason.”
Did the Settlement Agreements Violate the Rule of Reason?
Third, although the Commission had found the agreements inherently suspect, it also concluded, alternatively, that the agreements violated the rule of reason. Again, however, the Second Circuit disagreed. In particular, it found, the rule of reason framework is a three-step process: first, the plaintiff must establish a prima facie case that the challenged action adversely affects competition; second, if that’s been done, the burden shifts to the defendant to “proffer procompetitive justifications for the agreement”; and third, if procompetitive justifications have been showed, the burden shifts again and the plaintiff must show that a “less restrictive alternative” existed to accomplish “the same legitimate competitive benefits.”
Here, the Second Circuit held that the Commission had failed to provide direct evidence of any anticompetitive effect, i.e., evidence that the search advertising restrictions harmed consumers by raising the prices of contact lenses. Instead, the court found that the Commission had conducted no “empirical analysis” of the online prices for contract lenses and had instead offered only evidence that was “theoretical and anecdotal” and not “direct.” This failure, the court said, meant that the Commission’s conclusion that the agreements resulted in anticompetitive effects was “not supported by substantial evidence.”
Further, the court determined that the Commission was wrong in rejecting the procompetitive justifications that 1-800 Contacts had offered in support of the settlement agreements. Under its case law, the court said, “agreements to protect trademark interests are ‘common, and favored, under the law,’” and it added that “[e]fforts to protect trademarks, even aggressive ones, serve the competitive purpose of furthering trademark policies.” And here, the court said, the Commission had not shown that the challenged agreements were the “product of anything other than hard-nosed trademark negotiations.”
Finally, the court found that the Commission had not shown that a less-restrictive alternative existed. In particular, the court noted that “[w]hile trademark agreements limit competitors from competing as effectively as they otherwise might, [it] owe[d] significant deference to arm’s length use agreements negotiated by parties to those agreements.” Also, the court added, it would have been “antithetical to the pro-competitive goals of trademark policy” to “forc[e] companies to be less aggressive in enforcing their trademarks.”
The Second Circuit viewed 1-800 Contacts’ settlement agreements as reflecting the procompetitive underpinnings of trademark policy via hard-but-fair trademark enforcement strategies. Unlike the Commission’s decision, the court’s holding reflects an unwillingness to second guess negotiated trademark settlement agreements.
The case is 1‑800 Contacts, Inc. v. FTC, 2021 U.S. App. LEXIS 17508 (2d Cir. June 11, 2021).