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I-800 Contacts v. FCT. Trademark Settlement Agreements are Not Inherently Illegal

Posted by Giselle Ayala Mateus | Aug 24, 2021 | 0 Comments

In a Second Circuit decision issued this year, a court analyzed the legality of trademark settlement agreements entered into by I-800 Contacts, Inc and several competitors that allegedly infringed the company's trademarks. The ruling results from a lawsuit instituted by I-800 Contacts against a decision by the Federal Trade Commission alleging that the trademark settlement agreements were unlawful under Section 5 of the FTC Act. 

Context 

Between 2004 and 2013, 1-800 Contacts, Inc. ("1-800") entered into thirteen trademark settlement agreements. The Agreements were entered into between the parties when 1-800 discovered that competitors were using the company's trademarks for search advertising. The Agreements contained provisions restricting specific terms on which the parties could "bid" when participating in auctions held by companies that operate search engines. 

For purposes of context, Search Advertising is a method of placing online advertisements on web pages that show results from search engine queries. Through the same search-engine advertising services, ads can also be placed on Web pages with other published content. (Source: Wikipedia) Using this advertising method, search engines determine which advertisements to display on a search results page based partly on the relevance or relation of the consumer's search to various words or phrases called "keywords."

"...Advertisers bid on these keywords during auctions hosted by the search engines. The highest bidders' ads are typically displayed most prominently on a page, though search engines consider other factors when determining where to place an ad on a results page, such as an ad's quality and relevance to a consumer's search. Search engines generally do not limit the keywords available to advertisers at auction. As a result, competitors often bid on each other's brand names so that their ad runs when a consumer searches for a competitor..."

To protect the 1-800 trademarks, the Agreements also included language that prohibited the parties from using each other's trademarks, URLs, and variations of trademarks as search advertising keywords, as well as the use of negative keywords so that a search including one party's trademarks would not trigger a display of the other party's ads. 

In August 2016, the Federal Trade Commission ("FTC" or the "Commission") issued an administrative complaint against 1-800, alleging that the Challenged Agreements unreasonably restrained truthful, non-misleading advertising as well as price competition in search advertising auctions. In particular, the FTC considered that 1-800 sells contacts lens at prices higher than other online retailers. Accordingly, the Agreements obstructed consumers' access to important information like the price and products of 1-800 competitors. The FTC claim was tried before an Administrative Law Judge (ALJ). The Judge decided the matter in favor of the FTC and issued an Initial Decision and Order finding that the Agreements violated antitrust law.  

"He found that the agreements constituted a "contract, combination, or conspiracy" as required by the Sherman Act and held that the advertising restrictions in the agreements harmed consumers by reducing the availability of information, in turn making it costlier for consumers to find and compare contact lens prices."

The Analysis of the Agreements 

The Court referred to the Actavis case and explained that the Agreements were not immune from antitrust review. In Actavis, the Supreme Court analyzed the legality of "reverse payment" patent settlements, i.e., agreements under which manufacturers of brand name drugs pay manufacturers of generic drugs to keep the generic manufacturers from litigating the validity of the brand name manufacturers' patents. In Actavis, the Court rejected the idea that the conduct at issue was immune from antitrust scrutiny just because it occurred within the context of a patent litigation settlement. Here, the Court explained that the mere fact that an agreement implicates intellectual property rights does not immunize such an agreement from an antitrust attack. Additionally, as in any antitrust case, the court must determine whether the restraints in the agreements are reasonable in light of their actual effects on the market.

Which Legal Standard Should be Applied?

The Court explained that to determine the validity of the Agreements, the applicable legal standard was the "Rule of Reason". Under the Rule of Reason, a judge must examine both the positive and negative effects of an agreement before determining whether it violates antitrust laws. The Court explained that to prove an antitrust violation, the FTC must establish (1) a contract, combination, or conspiracy exists that (2) unreasonably restrains trade. The FTC bears the initial burden of showing that the challenged action has had an actual adverse effect on competition as a whole in the relevant market. After a prima facie case of anticompetitive conduct has been established, the burden shifts to the defendant to proffer procompetitive justifications for the agreement. Thereafter, if the defendant can provide such proof, the burden shifts back to the government to prove that any legitimate competitive benefits offered by the defendant could have been achieved through less restrictive means.

The FTC Analysis 

The Court analyzed the FTC determination of illegality of the Agreements. Under the Commission's analysis, the Agreements were considered "inherently suspect". This means that the agreement is unlawful under antitrust law that neither direct evidence of harm nor proof of market power is needed to show the anticompetitive effect of the restraint because the "likely tendency to suppress competition" posed by the challenged transaction makes it "inherently suspect. The FTC used the "inherently suspect" analysis arguing that the Agreements were likely to cause consumers to pay more for contact lenses. 

The problem with the FTC analysis, the Court explained, is that even if restraints on truthful advertising have a tendency to raise prices, the fact that a practice has some relationship to the change on price of a commodity is not enough to classify an agreement as inherently irregular. Moreover, as opposed to other agreements, the Agreements at issue could plausibly have procompetitive effects that required analysis under the "Rule of Reason". 

This approach is only permissible 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." Cal. Dental, 526 U.S. at 770. 

...

 In Clorox, applying the rule of reason, we considered whether a trademark settlement agreement illegally restrained trade under the Sherman Act and we explained that '[t]rademarks are by their nature non-exclusionary.' Agreements to protect trademarks, then, should not immediately be assumed to be anticompetitive — in fact, Clorox tells us instead to presume they are procompetitive. As the Challenged Agreements restrict the parties from running advertisements on Petitioner's trademarked terms, they directly implicate trademark policy.

Application of the Rule of Reason

Applying the Rule of Reason, the Court considered the Agreements' anticompetitive and procompetitive effects. The Court explained that when the government advances an antitrust claim based on direct evidence, in the form of increased prices, the question is whether it can show an actual anticompetitive change in prices after the restraint was implemented. However, in this case, the government could not make that showing because it did not conduct an empirical analysis of the Agreements' effect on the price of contact lenses in the online market for contacts. The FTC's evidence instead of being direct and substantial was only theoretical and anecdotal.

Regarding the government's allegations, that the Agreements disrupted consumer access to information about lower-priced products, the court said that, on the one hand, no Court of Appeals has held that a reduction of truthful information is necessarily a manifestation of anticompetitive harm, and on the other hand, such analysis was not required because 1-800 had shown a procompetitive justification to support the Agreement and the government had failed to carry its burden to demonstrate that the same pro-competitive effect could have been achieved through less restrictive means.

Regarding the pro-competitive effects of the Agreements, the Court recognized that the Agreements at issue reduced litigation costs and furthered the policy of protecting trademark rights at an effective cost. The Court explained that trademarks are by their nature non-exclusionary, and agreements to protect trademark interests are common, and favored, under the law. In particular, trademark agreements are favored as a means by which parties agree to market products in a way that reduces the likelihood of consumer confusion and avoids time-consuming litigation.

Finally, \rRegarding the existence of less restrictive means to achieve the same procompetitive result, the Court explained that the FTC failed to meet its burden of proof and failed to consider the overall pro-competitive effects of the Agreements. The court explained: 

In Clorox, however, we noted that "it is usually unwise for courts to second-guess" trademark agreements between competitors. 117 F.3d at 60. In this context, what is "reasonably necessary," Brown Univ., 5 F.3d at 679, is likely to be determined by competitors during settlement negotiations, Clorox, 117 F.3d at 60... absent something that would negate the typically procompetitive nature of these agreements, "the parties' determination of the scope of needed trademark protections is entitled to substantial weight." Clorox, 117 F.3d at 60.

While trademark agreements limit competitors from competing as effectively as they otherwise might, we owe significant deference to arm's length use agreements negotiated by parties to those agreements. Clorox, 117 F.3d at 59-60. Doing so may give rise to collateral harm in a relevant market. But forcing companies to be less aggressive in enforcing their trademarks is antithetical to the procompetitive goals of trademark policy. See id. at 61. And without considering the downstream effects of requiring less aggressive enforcement, the government has failed to show that the proffered alternatives achieve the same legitimate procompetitive benefits as those advanced by the Petitioner.

About the Author

Giselle Ayala Mateus

Giselle Ayala Mateus is a NY attorney with comprehensive experience in transactional law, creative agreements, business formation, and immigration law. She is also the founder of FOCUS a not-for-profit project focused on supporting entrepreneurs and artists.

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