Second Circuit Overturns FTC Ruling That Trademark Agreements Violated Section 5

At a time when antitrust enforcers, federal legislators and courts are heavily focused on technology platforms and digital advertisers like Google and Facebook, on June 11, 2021, the Second Circuit vacated an administrative order by the Federal Trade Commission (FTC), which held that agreements between competitors not to bid on certain trademarked terms in internet search engine auctions violated Section 5 of the FTC Act as an unfair method of competition.¹

The court’s decision absolving 1-800 Contacts, the largest online seller of contact lenses, of antitrust liability in the FTC’s long-running case for enforcing allegedly anticompetitive settlement agreements in trademark litigation establishes several noteworthy points for intellectual property right holders.

Case Overview

Starting in 2002, 1-800 Contacts (1-800) sent cease-and-desist letters and filed complaints against competing internet retailers of contact lenses contending their search engine advertisements infringed 1-800’s trademarks. Over the following decade, these trademark disputes were settled through agreements which prohibited 1-800’s competitors from, among other things, using terms trademarked by 1-800 as search engine keywords. As a result, competing retailers agreed not to bid on specific trademarked terms like “1-800 Contacts” in search engine keyword auctions and, as a result, not to advertise their products when consumers searched for those terms in search engines like Google or Bing.

In August 2016, the Federal Trade Commission filed an administrative complaint against 1-800, alleging that the settlement agreements, and 1-800’s enforcement of them, constituted unfair competition under Section 5 of the FTC Act for unreasonably restraining truthful advertising and price competition in online advertising auctions.² After a trial, the FTC’s administrative law judge (ALJ) held the agreements violated Section 5 and issued an order barring 1-800 from entering into an agreement with any marketer or seller of contact lenses to limit participation in search advertising auctions or to prohibit or limit search advertising.³

1-800 appealed to the full Commission. In November 2018, the FTC upheld the ALJ’s initial decision in a 3–1 vote with a dissent by Commissioner Phillips.⁴ 1-800 appealed again, to the Second Circuit. In its decision, the Second Circuit sided with Commissioner Phillips’ dissent, vacating the FTC’s order. The court’s opinion offered three insightful rulings.

First, the court rejected 1-800’s argument that its trademark litigation settlement agreements are immune from antitrust scrutiny under the Supreme Court’s Actavis decision, noting that exclusionary intellectual property rights do not include permission to violate the competition laws.⁵

Second, the court rejected the FTC’s reliance on the abbreviated “quick look” — or “inherently suspect” — method of antitrust analysis for scrutinizing 1-800’s allegedly anticompetitive agreements.⁶ By classifying the search advertising agreements as inherently suspect and a form of bid rigging, the Commission skipped an elaborate market analysis and weighing of anticompetitive effects against procompetitive benefits required by the full-blown rule of reason framework. The court ruled that agreements to protect trademarks should not be assumed anticompetitive; to the contrary, they could be presumed procompetitive, based on prior Second Circuit precedent.⁷

Third, the Second Circuit then conducted a rule of reason analysis of the advertising constraints and found they did not violate Section 5 of the FTC Act as unfair competition because they were not unreasonable restraints of trade under Section 1 of the Sherman Act.⁸ The court concluded the FTC failed to establish direct evidence of anticompetitive effects through increased prices because the Commission failed to conduct an “empirical analysis of the [trademark settlement agreements’] effect on the price of contact lenses in the online market for contacts.” In addition to the lack of robust evidence of anticompetitive effects, the court held the trademark agreements had the procompetitive purpose of protecting trademark rights and reducing litigation costs. Finally, the court ruled that the FTC’s recommended alternative to the settlement agreements’ prohibition of advertising on trademarked terms – to wit, a disclosure in the search engine advertising of a competing seller’s identity – was not less restrictive and did not achieve the same procompetitive goal of promoting trademark protection.

After the decision, the FTC secured an extension until August 2021 to petition for rehearing en banc, given that newly confirmed FTC Commissioner Lina Khan was designated as Chair of the agency on June 15, 2021.

Antitrust Implications for Companies

The intersection of intellectual property and antitrust is fraught with tension, given the potential for the enforcement of IP rights to inhibit competition. In the antitrust arena, the 1-800 Contacts decision offers several insights for companies seeking to protect their trademarks in an age of ubiquitous consumer internet searching, and not run afoul of the antitrust laws:

• Trademark litigation settlements are not immune from antitrust scrutiny;
• The proper standard for reviewing litigation settlements that restrict rivals from bidding on a company’s marks in keyword search engine auctions is the traditional rule-of-reason antitrust analysis, not the quick-look, inherently suspect standard of review;
• The FTC must show proof of anticompetitive effects through evidence that is empirical, not anecdotal; and
• Procompetitive justifications for trademark settlements include lower litigation costs and increased trademark protection.

Although the Second Circuit’s decision (barring further appellate review) establishes that courts do not have sufficient antitrust experience with trademark litigation settlement agreements to presume them anticompetitive under the antitrust laws, the FTC Act and Sherman Act still apply to them. As a result, companies should scrupulously document the procompetitive benefits of these settlement agreements and aim for settlements that would not be anticompetitive under a rule of reason analysis. In addition, understanding the effect of trademark settlement agreements on market-wide consumer pricing may help counter any claim that such agreements harm competition.

The antitrust laws are nuanced and complex, and their application to particular business situations is a fact-specific inquiry. Businesses concerned about how recent developments will impact their risk of violating the antitrust laws are strongly advised to consult with legal counsel.