The FTC eyes settlement agreements that restrict rivals’ online search terms

Litigants often enter into settlement agreements without giving much thought to whether those agreements could form the basis for an antitrust claim—and for good reason because most settlement agreements simply resolve a dispute through the payment of money. However, agreements that restrict rivals’ abilities to engage in advertising or other competitive activities could run afoul of the antitrust laws. In In the Matter of 1-800 Contacts, Inc., the Federal Trade Commission (FTC or the Commission) recently considered individual settlement agreements entered into by 1-800 Contacts, an online contact lens seller, that resolved trademark infringement actions with multiple rivals by restricting online advertising that appeared in response to internet searches for the trademarked term “1-800 Contacts.”

The agreements at issue in 1-800 Contacts, among other things, required each of the competitors to agree to limit their internet search ads and restrict their bidding in internet search auctions to ensure their ads no longer appeared in response to searches for 1-800 Contacts’ trademark terms. In a 4-1 decision upholding an administrative ruling,[1] the Commission found that such limitations and restrictions harmed (1) consumers and competition for the online sale of contact lenses by reducing the quality of online search results and (2) competition in bidding for search engine key words by artificially reducing the prices paid for search terms and by reducing the quality of the search results the engines delivered to consumers. The FTC therefore determined that the agreements unlawfully restrained trade in violation of Section 5 of the FTC Act and required 1-800 Contacts to cease and desist from enforcing the provisions in its existing agreements and from entering into similar agreements in the future.

If upheld on appeal, [2] the implications of this decision—which found unlawful an agreement among competitors to mutually restrict the use of each other’s trademarks in their rival’s online search terms—could be significant.[3]

Online search advertising and the trademark settlements[4]

Online retailers use online advertising to attract new customers. Links to webpages deemed potentially responsive to the user’s search are ranked and presented to the user on a search engine results page. Advertisers pay to have sponsored links appear on the results page. To determine which ads appear, and in what order, search engines use an auction to sell advertising positions. Advertisers bid on “keywords,” which are words or phrases that trigger the display of ads when they are determined to “match” a user’s search.

1-800 Contacts brought trademark infringement and dilution actions against competitors that employed the term “1-800 Contacts” so that their own ads would appear when internet users searched for the trademarked term “1-800 Contacts.” 1-800 Contacts resolved those actions through settlements that mutually prohibited the use of trademarked keywords and required “negative” keywords to prevent their ads from displaying whenever a search includes or contains the other parties’ trademarks. The settlement agreements do not prohibit parties from bidding on generic keywords such as “contacts” or “contact lens.”

Antitrust analysis of the settlement agreements

The Commission analyzed the settlements as agreements between horizontal competitors to restrict the information provided by advertising to consumers and found that consumers could have used the withheld information to compare and evaluate the prices and other features of competing online sellers. The Commission found that online search is an important method by which lower-priced rivals compete with 1-800 Contacts and reasoned that restrictions on advertising interfere with that flow of information between buyers and sellers and thereby raise the cost to consumers of finding the most suitable offering of a product or service.

The Commission found credible 1-800 Contacts’ two procompetitive justifications for the restrictions—(1) the avoidance of litigation costs through settlement and (2) trademark protection. But on balance, the Commission found that the restrictions were overbroad and could be achieved through less restrictive means. First, the Commission found that the agreements at issue were not narrowly tailored to protect the asserted trademark rights because they restricted advertising regardless of whether the ads are likely to be confusing to consumers.

Next, the Commission found that when rival sites appeared in consumers’ searches by using the 1-800 Contacts trademark, consumers often made purchases from those rivals at prices lower than those advertised by 1-800 Contacts. The Commission reasoned that, because the suppressed ads would have enabled consumers to learn about alternative, lower-priced sellers of contact lenses and to make price comparisons, prohibiting this particular type of advertising is likely to have substantial anticompetitive effects. The Commission acknowledged that, although trademark protection can be a legitimate justification for certain restraints, it did not justify the restraints challenged in this case because there was no evidence or case law to establish that bidding on trademark keywords constituted trademark infringement.

Anticompetitive effects on search engines

Finally, the Commission found that, in addition to harm to consumers, the agreements resulted in actual harm to search engines. By agreeing to refrain from bidding in particular search-advertising auctions, the online rivals thereby reduced the number of bidders participating in the auctions because the parties agreed not to compete. The reduction in the number of search-advertising auction participants offering relevant ads reduced the price paid by the auction winners and revenue for the search engine. The Commission further concluded that the agreements also harmed both the search engines and consumers by removing advertisements that otherwise would have been displayed, thereby decreasing the quality of the search engines’ product.

Takeaways

When resolving litigation among competitors, it is critical for counsel to focus on the potential anticompetitive effects of settlement agreements. The 1-800 Contacts matter illustrates the potential unintended consequences of crafting settlement agreements that potentially restrict advertising and marketing to consumers. This case also carries broader implications by signaling the FTC’s focus on consumer information and competition in online advertising, even when fashioning a settlement designed to protect a valuable trademark. Counsel should be sure to seek antitrust review before entering into agreements among rivals that restrict ongoing or future competitive actions.

Robin Adelstein is the US head of Norton Rose Fulbright’s Antitrust and competition group, and Gerald A. Stein is senior counsel in Norton Rose Fulbright’s US Antitrust and competition group and a former lawyer in the FTC’s Bureau of Competition.

[1] In a vigorous dissent, Commissioner Noah Joshua Phillips sharply criticized the majority by failing to give more credence “to the intellectual property at the heart of the case.” He reasoned that the majority’s analysis will “create uncertainty, dilute trademark rights, and dampen inter-brand competition” and that assigning liability to these trademark settlements “will not only chill brand investment, it will chill the very competition the majority seeks to protect.” See a copy of the Dissent of In the Matter of 1-800 Contacts, Inc., a corporation.

[2] 1-800 Contracts has stated its intention to appeal this decision, which may be reviewed by any court of appeals within any circuit where the method of competition or the act or practice in question was used or where such entity resides or carries on business. 15 U.S.C. § 45(c).

[3] In her concurring opinion, Commissioner Rebecca Kelly Slaughter noted that “this case merited the Commission’s attention because of the importance of competition in online search bidding for both consumers and for competitive entry by online sellers of goods and services.” See a copy of the Concurrence.

[4] All factual statements and analyses are summarized from the Opinion of the Commission.