US Second Circuit reverses FTC decision on online advertising restrictions


In a significant case on the competition/IP interface, which we first discussed on this blog a couple of years ago, the US Court of Appeals for the Second Circuit has recently vacated a 2018 FTC decision which found that settlement agreements regulating the use of trademarks in online search advertising violated US antitrust law. In a robust (and arguably new-Madisonian) ruling, the Second Circuit emphasised the pro-competitive benefits of trademark enforcement and held that whilst trademark settlements are not immune from antitrust scrutiny, it is typically “difficult to show that an unfavourable trademark agreement creates antitrust concerns”.

The case is 1-800 Contacts v FTC. To recap on the background, 1-800 Contacts is the leading online retailer of contact lenses in the US. Between 2004 and 2013 it settled various trademark infringement claims against rival online retailers, who were alleged to have used 1-800’s trademarks in online advertising auctions run by search engines such as Google. The settlement agreements prevented the parties from bidding on each other’s trademarks as keywords, and also required them to implement ‘negative keywords’ so that a search including one party’s trademarks would not result in the display of the other party’s adverts.

Employing a ‘quick look’ analysis, the FTC decided that the settlement agreements prevented 1-800’s rivals from using online search ads which would have informed consumers that the same products were available at lower prices from other online retailers. According to the FTC, the restrictions:

  • were particularly harmful to retail price competition because the suppressed ads often emphasised lower prices;
  • also harmed competition in bidding for search engine keywords, artificially reducing the prices that 1-800 paid for online search advertising.

1-800 appealed the FTC’s decision to the Second Circuit.

The Second Circuit’s decision

The Second Circuit held that the FTC had erred in classifying the settlement agreements as “inherently suspect”, noting that courts “do not have sufficient experience with this type of conduct” to permit the truncated analysis undertaken by the FTC. “If an arrangement might plausibly be thought to have a net pro-competitive effect, or possibly no effect at all on competition, more than a ‘quick look’ is required”, the Court said. The restraints at issue “could plausibly be thought to have a net pro-competitive effect because they [were] derived from trademark settlement agreements”.

The Court went on to apply a full ‘rule of reason’ analysis and found that the FTC failed to show that the agreements resulted in an anti-competitive increase in prices. Although the FTC put forward empirical evidence that the agreements reduced the price paid by 1-800 for each click on its keyword ads, “showing that a price for certain keywords dropped” was not “direct evidence of the effect on the market as a whole” (emphasis in the judgment).

The Court also found that, even if there were some possible anti-competitive effect, 1-800’s interest in protecting its trademarks provided a valid pro-competitive justification for the restrictions. The Court explained that trademarks “are by their nature non-exclusionary, and agreements to protect trademark interests are common, and favored, under the law”. It didn’t necessarily follow that every trademark agreement has a legitimate, pro-competitive justification. In this case, however, there was “a lack of evidence” that the agreements were the “product of anything other than hard-nosed trademark negotiations”.

Finally, the Court held that the FTC had failed to show that the legitimate pro-competitive benefits could have been achieved through less restrictive means. In particular, it rejected the FTC’s argument that the parties to the settlement agreements could have agreed to require clear disclosure in each advert of the identity of the rival retailer, rather than prohibiting all advertising on trademarked terms. In the Court’s view, private parties are generally in the best position to know what is reasonably necessary to resolve their trademark disputes and “forcing companies to be less aggressive in enforcing their trademarks is antithetical to the pro-competitive goals of trademark policy”.

What about equivalent restrictions on this side of the Atlantic?

The Second Circuit’s ruling gives significant deference to arm’s-length trademark settlements. It cannot be assumed, though, that agreements containing equivalent restrictions in the EU would be treated with similar leniency. As we discussed here, in 2018 the European Commission fined Guess Clothing just under €40 million for various anti-competitive practices. Among other things, the Commission took a dim view of a provision in Guess’s distribution agreements that prevented authorised retailers from using Guess brand names and trademarks for online search advertising. The Commission concluded that this was both restrictive of competition ‘by object’ and a hardcore restriction under Article 4(c) of the Vertical Agreements Block Exemption (VABE). The Bundeskartellamt took a similar approach in its decision against Asics.

As discussed previously (e.g. here), the Commission is currently considering how to reform the VABE and the accompanying Guidelines to make them better suited for the digital age. Last September it published a Staff Working Document evaluating the current VABE, which stated:

Online advertising restrictions, such as those that limit the use of the manufacturer’s brand for advertising purposes […], may de facto amount to a ban on online sales for smaller distributors with low traffic on their own websites which can only reach online consumers by means of advertisements on search engines or social networks. At the same time, the impact of such brand-bidding restrictions in a vertical relationship may depend on the specific form of these restrictions and on their economic context.

Drafts of the new VABE and Guidelines are due to be published later this summer. It’s to be hoped that they will shed further light on the Commission’s approach to online advertising restrictions.