Second Circuit Puts the Focus on Search-Term Restrictions in 1-800 Contacts Decision

Advertising on the Internet is big business. It can also be cutthroat. One way companies market their goods and services online is via “search advertising.” When an online shopper uses a search engine, the search engine’s program typically returns two types of search results to the shopper, both of which provide links to websites. The second type of results are considered “organic,” and appear because the search engine’s algorithm deems them to be the most relevant to the shopper’s search. But the first type of search results are “sponsored” ads, which appear because the owner of the featured website paid for its page to appear in that space. Sponsored ads almost always appear before the organic search results.

Search engines determine which sponsored ads to display on a search results page based, in large part, on the relevance of the shopper’s search to various “keywords.” Advertisers bid on these keywords during auctions hosted by the search engines. Competitors frequently bid on each other’s brand names and trademarked terms so that their own ad runs when a consumer searches for a competitor. Imagine, for example, searching “McDonald’s” and ads for Burger King pop up first.

1-800 Contacts, Inc. (“1-800”) is an online seller of contact lenses and is, perhaps, the most recognizable name among many contact lens e-tailers. 1-800’s online competitors therefore seek to purchase “1-800 Contacts” and other of the company’s trademarked terms as keywords to ensure that when a consumer searches for 1-800, its own website appears prominently in the sponsored search results, and potentially diverts customers away from 1-800. 1-800 often charges more than other online retailers, so when its competitors’ ads appear in response to a search for 1-800’s trademarked terms, its own online sales decrease. Not surprisingly, this does not sit well with 1-800.

In response to this type of conduct, 1-800 filed more than a dozen actions for trademark infringement against its competitors for the alleged misuse of its registered trademarks, both in keywords and otherwise. Whether or not 1-800’s claims ultimately would have been meritorious, most of the competitors apparently preferred not to litigate these claims, and entered into settlement agreements. Under the terms of the settlement agreements, the competitors agreed not to bid on 1-800’s name, URLs or variations of its trademarks when participating in future keyword auctions conducted by search engines. They also agreed to use “negative keywords,” so that a search including one party’s trademarks would not trigger a display of the other party’s ads.  In effect, 1-800’s competitors agreed not to advertise their products when consumers conducted online searches using 1-800’s trademarks.

In 2016, the Federal Trade Commission (FTC) issued an administrative complaint against 1-800, alleging that its settlement agreements unreasonably restrained truthful, non-misleading advertising in violation of Section 5 of the FTC Act, 15 U.S.C. § 45. (Section 5 of the FTC Act provides that “unfair or deceptive acts or practices in or affecting commerce . . . are . . . declared unlawful.”) The FTC asserted that the settlements unfairly prevented 1-800’s competitors from disseminating ads that would inform consumers that the same contact lenses were available at a lower price from other online retailers, thereby reducing competition and making it more difficult for consumers to compare online retail prices.      

The case was tried before an administrative law judge, who concluded that a violation had occurred. 1-800 appealed to the FTC, but a majority of the Commission agreed that the agreements violated Section 5 of the FTC Act. The majority categorized the settlement agreements as “inherently suspect” and then analyzed the procompetitive justifications 1-800 offered. It rejected 1-800’s assertion that the benefits of protecting trademarks and reducing litigation costs outweighed any potential harm to consumers. 1-800 then turned to the Second Circuit.

The Second Circuit concluded that while “trademark settlement agreements are not automatically immune from antitrust scrutiny,” the FTC erred when it found that the agreements constituted an unfair method of competition under the FTC Act. According to the Second Circuit, the FTC erred by treating 1-800’s agreements as “inherently suspect,” thereby placing the initial burden on 1-800 to justify the agreements. Instead, the FTC should have undertaken a “rule of reason” analysis to determine whether the settlements restrained trade. Under that analysis, the initial burden would have fallen on the FTC to prove that the agreements had an actual adverse effect on competition as a whole before 1-800 would have had to offer procompetitive justifications for the agreements. And, if 1-800 was able to provide such proof, the burden would have shifted back to the FTC to prove that any legitimate procompetitive benefits offered by 1-800 could have been achieved through less restrictive means. By erroneously treating 1-800’s settlement agreements as “inherently suspect,” the appellate court opined, the FTC in essence found them to be per se anticompetitive, without having to demonstrate direct evidence of harm or an anticompetitive impact. 

The appellate court observed that the restrictions imposed on 1-800’s competitors via the settlement agreements “could plausibly be thought to have a net procompetitive effect because they are derived from trademark settlement agreements.” In fact, agreements to protect trademarks should be presumed to be procompetitive, the court stated, relying on Second Circuit precedent. “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,” the court concluded. 1-800’s settlement agreements restricted the parties from running advertisements on 1-800’s trademarked terms, thus directly implicating trademark policy; and the FTC failed to meet its burden of proving that they were anticompetitive.

The Second Circuit’s decision does not give online retailers free reign to enter into agreements with other retailers restricting how they advertise their own goods and services. But in the context of a bona fide trademark dispute, a settlement agreement that prevents a competitor from making keyword advertising use of the other’s marks appears to get the benefit of the doubt.

Watch List: 1-800 Contacts Files New Search Engine Suit

As this issue of Kattison Avenue was being prepared to go to press, 1-800 Contacts filed a new federal lawsuit, this time alleging (among other claims) that eyeglasses retailer Warby Parker infringed on 1-800’s trademarks by purchasing search engine keywords like “1-800 Contacts,” “1 800 contacts,” and “1800contacts” in order to advertise its recently-launched contact lens business.  1-800 Contacts Inc. v. JAND Inc., d/b/a Warby Parker, Case No. 21-cv-06966 (S.D.N.Y., filed August 18, 2021). We will keep an eye on this litigation and report on it more fully in a subsequent issue.

To read the full issue of Kattison Avenue, please click here.