Administrative Law Judge Upholds FTC Complaint Alleging That 1-800 Contacts Violated Section 5 Of The FTC Act By Unlawfully Restricting Online Competitor Advertising Through Anticompetitive Settlement Agreements
11/07/2017On October 27, 2017, the Federal Trade Commission announced a ruling by Administrative Law Judge D. Michael Chappell finding that online contact lens retailer 1-800 Contacts unlawfully restrained competition in violation of Section 5 of the FTC Act by restricting its competitors’ online search-based advertising through series of settlement agreements resolving trademark litigation it had filed against those competitors. In the Matter of 1-800 Contacts, Inc., Docket No. 9372 (U.S. Trade Commission, Oct. 27, 2017). In upholding the FTC’s complaint, ALJ Chappell found that the FTC had proved that the restrictions on the use of certain keywords in search-based advertising caused actual harm to consumers and competition in the market for the online sale of contact lenses in the United States and that the respondent 1-800 Contacts had failed to prove that the settlement agreements had countervailing procompetitive benefits that outweighed their harm to competition. As relief, the ALJ issued a broad remedial order prohibiting 1-800 Contacts from, inter alia, entering into any agreement that restricts a competitor’s ability to participate in search advertising auctions. Just as the Supreme Court’s landmark decision in Federal Trade Commission v. Actavis, Inc., 133 S. Ct. 2223 (2013), raised difficult questions as to how litigants could resolve patent disputes over pharmaceutical products, this decision raises difficult questions over potential settlements of trademark disputes, particularly in the context of internet search advertising.
Online contact lens retailers such as 1-800 Contacts and its competitors use online search engines such as Google and Bing to advertise their wares. These companies bid on particular “keywords,” that is, words an advertiser believes a potential customer is likely to enter into a search engine when searching for the advertiser’s products. The search engine then delivers advertisements to consumers based on these keywords. From 2007 through 2013, 1-800 Contacts filed a series of lawsuits against its online contact lens retail competitors, alleging that those competitors purchased 1-800 Contacts’ trademarks and variations thereof as keywords to trigger paid search advertising and/or that the competitors failed to implement negative keywords to prevent the triggering of the defendant competitors’ advertisements in response to a consumer searching “1-800 Contacts.” 1-800 Contacts settled thirteen of these lawsuits with similar settlement agreements that prohibited each party from causing advertisements to appear in response to an internet search for the other party’s trademarks or URLs. These settlements not only prohibited the use of allegedly infringing terms as keywords but required the use of “negative keywords.” Negative keywords are words or phrases that prevent an advertisement from being triggered by a certain word or phrase.
The FTC alleged that these settlement agreements violated Section 5 of the FTC Act, which prohibits unfair methods of competition. The analysis of whether an agreement constitutes an unfair method of competition tracks the analysis of whether an agreement unreasonably restrains trade under Section One of the Sherman Act. The FTC pursued three different avenues to seek to prove that the settlement agreements unreasonably restrained trade: (1) the restraints are inherently suspect and unjustified and may be condemned without proof of defendant’s market power or actual anticompetitive effects (the so-called “quick look” analysis); (2) the settlement agreements resulted in actual anticompetitive effects; and (3) 1-800 Contacts had sufficient market power and the restrictions in the settlement agreements are likely to result in anticompetitive effects. As explained below, ALJ Chappell’s ruled that the FTC had met its burden under the second avenue, finding that the settlement agreements had actual anticompetitive effects.
With regard to market definition, the FTC argued that the relevant product market to analyze the effects of the settlement agreements was the online sale of contact lenses, while 1-800 Contacts argued the product market should be defined more broadly, to encompass all retail sales of contact lenses in the United States, including sales by online retailers and by independent eye care practitioners (“ECPs”), optical chains, and mass merchants. ALJ Chappell found that the relevant product market was the online sale of contact lenses based on a number of factors. ECPs are not close substitutes to online retailers because convenience is a key factor in determining where consumers buy contact lenses and that consumers who tend to shop online place a high premium on the convenience of online shopping, home delivery and low prices. Other facts also supported that product market definition: 1-800 Contacts’ and other online contact lens retailers’ internal documents, 1-800 Contacts’ specialized facilities for fulfillment service, the distinct prices charged by online lens retailers vs. brick and mortar retailers, and the ECPs’ use of unilateral pricing policies. The parties did not dispute that the relevant geographic market was the United States.
As to competitive effects, the FTC alleged and ALJ Chappell agreed that consumers were harmed by having reduced access to advertisements and pricing information about other online contact retailers’ offerings and by paying for prices that are higher than they would without the search limitations. First, ALJ Chappell found that restricted advertising and the reduced flow of information itself can constitute consumer harm, even in the absence of a proven price effect. Second, the ALJ found that at least some consumers have paid, or will pay, higher prices as a result of the challenged agreements. Support for this finding included a post-settlement reduction in bidding for even generic search terms such as “contacts,” internal business documents, and economic modeling by the FTC’s expert witnesses, as well as evidence that the restrictions and consequent reductions on informative advertising by 1-800 Contacts lower-priced competitors led some consumers to buy contacts at higher prices than they would have absent the agreements.
After the FTC demonstrated anticompetitive effects, thereby establishing its prima facie case, the burden shifted to 1-800 Contacts to prove legitimate, countervailing procompetitive justifications for the settlement agreements. 1-800 Contacts argued that the avoidance of litigation costs, protection of its trademarks, prevention of consumer confusion, reduced consumer search costs, and increased purchases of contacts lenses by consumers who searched for the 1-800 Contacts trademarks were countervailing procompetitive benefits of the settlements. ALJ Chappell rejected all of these as sufficient to outweigh the anticompetitive harm.
Avoiding litigation costs constitutes a benefit to the private litigants but the ALJ found that the 1-800 Contacts failed to connect this to a benefit to consumers. The ALJ did not expressly resolve the FTC’s contention that the settlements went farther than necessary to protect legitimate trademark interests. He acknowledged that “bidding on a competitor’s trademark as a keyword is now generally considered a ‘use’ under trademark law,” but expressed serious doubt as to whether trademark law would require the use of negative keywords to block matches based on generic terms and he noted that 1-800 Contacts had lost on summary judgment in the only case that went to judgment on the issue of likelihood of confusion. Nonetheless, the ALJ expressly refused to delve into the merits of the underlying lawsuits, while ultimately concluding that respondent’s trademark protection justification was inadequate. Similarly, the ALJ was not persuaded by 1-800 Contacts’ expert witnesses’ testimony as to the likelihood of confusion or the reduction of search costs, or that the challenged restrictions led to increased sales.
ALJ Chappell’s order bars 1-800 Contacts from reaching an agreement with contact lens retailers that prohibits or restricts the retailer from participating in search advertising auctions. Moreover, the order also bars 1-800 Contacts from instructing search engines to restrict or prohibit any seller’s use of any keywords or negative keywords. The order also bars 1-800 Contacts from regulating or otherwise limiting a retailer’s use of truthful, non-deceptive, and non-trademark-infringing advertising or promotions. Finally, the order requires 1-800 Contacts to stop enforcing or attempting to enforce any provision in any existing agreement that imposes a condition on a retailer that would be inconsistent with the order. ALJ Chappell’s initial decision is subject to review by the full Federal Trade Commission at the request of any party and 1-800 Contacts has already stated that it will appeal ALJ Chappell’s decision.
Intellectual property holders who seek to unilaterally enforce their intellectual property rights through litigation ordinarily cannot be subjected to antitrust liability unless the litigation is a “sham,” that is, both objectively and subjectively baseless. Professional Real Estate Inv’rs Inc. v. Columbia Pictures Indus., Inc., 508 U.S. 49 (1993). When they settle, however, the settlement is subject to antitrust scrutiny under the substantially less definitive Rule of Reason standard. While there are compelling reasons for treating unilateral and joint conduct differently (as well as important constitutional reasons to treat petitioning the courts differently than private agreements), this dynamic does create some tension with the public policy in favor of settlements. Here, the ALJ recognized the public policy in favor of settlement of disputes, but, like the Supreme Court in Actavis, did not clearly address the issue of how competitors can safely resolve intellectual property disputes that may affect competition short of litigating the matter to judgment. Although the ALJ expressly declined to address the merits of the underlying cases that led to the challenged settlements, 1-800 Contact’s inability to offer case law support for its contention that the competitors’ failure to implement negative keywords in generic searches could result in infringement was clearly a key factor in undermining the trademark justification for the agreements. The lesson for parties negotiating the settlement of intellectual property disputes is that any term that restricts the ability of either party to compete must be as closely tailored to defensible and substantial intellectual property rights as possible.