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1-800 Contacts Ruling Illustrates IP Hurdle For Antitrust Cases

By Christopher Casey, Sean McConnell, Brian Pandya and Sarah O'Laughlin Kulik
July 8, 2021

1-800 Contacts Ruling Illustrates IP Hurdle For Antitrust Cases

By Christopher Casey, Sean McConnell, Brian Pandya and Sarah O'Laughlin Kulik
July 8, 2021

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The Federal Trade Commission's recent losses in the appellate courts, particularly in cases involving intellectual property rights, pose a challenge for federal antitrust enforcers as they pursue a more aggressive agenda in the new administration.

On June 11, the U.S. Court of Appeals for the Second Circuit ended the FTC's long-running antitrust enforcement action against 1-800 Contacts Inc.

The commission had challenged certain settlement agreements that the online contact lens retailer had signed with parties alleged to have infringed 1-800 Contacts' trademarks, claiming that by preventing 1-800 Contacts' competitors from purchasing online advertising keywords, the agreements restrained trade in violation of the law.

The Second Circuit ruled that the FTC had not met its burden to show that the agreements were anti-competitive and ordered the commission to dismiss its administrative complaint.

This setback for the FTC comes on the heels of the U.S. Court of Appeals for the Ninth Circuit's August 2020 decision in FTC v. Qualcomm Technologies Inc., another case in which an appellate court reversed a lower court ruling and rejected the FTC's attempt to police how holders of intellectual property rights enforce those rights.

In Qualcomm, the FTC alleged that Qualcomm used its dominance in the market for cellular modem chips to disadvantage rival chipmakers. The FTC challenged Qualcomm's practice of licensing its technology only to original equipment — i.e., cellphone handset — manufacturers and its "no license, no chips" policy, which required the manufacturers to license Qualcomm's patents in order to buy chips, even from competitors.

The FTC asserted that by requiring its downstream customers to license Qualcomm's patents before buying chips — whether from Qualcomm or one of its competitors — Qualcomm effectively imposed a tax on purchases those customers made of competitors' chips.

The Ninth Circuit rejected these theories, holding that Qualcomm did not have a general duty to deal with its competitors under the antitrust laws — Thus, it had no duty to license rival chip suppliers and its "no license, no chips" policy was not anti-competitive.

After the Ninth Circuit denied the FTC's petition for rehearing en banc, then-acting FTC Chair Rebecca Slaughter issued a statement that the FTC would not petition the U.S. Supreme Court for certiorari in light of the "significant headwinds facing the Commission" in that case.

These back-to-back circuit court defeats illustrate the challenge facing antitrust enforcers in bringing enforcement actions against intellectual property rights holders: Where such rights are involved, in particular, many courts take a narrow view of what constitutes anti-competitive conduct.

1-800 Contacts Decision

Factual Background

In online advertising, search engines such as Google LLC's hold auctions in which online retailers bid on keywords that determine what advertising search results are displayed in response to consumer queries.

Commonly, companies bid on their competitors' names in such auctions, so that if a consumer is searching for a competitor, the consumer may also see an advertisement for the company's competing product.

So-called  negative keywords may be used to prevent certain ads from showing. In an example used by the Second Circuit, a company may bid on the word "glasses" but include a negative keyword for "wine glasses" so that consumers looking for eyeglasses would not be shown an irrelevant advertisement for wine glasses. But negative keywords may also be deployed to specifically exclude a competitor's advertisement.

From 2004 to 2013, 1-800 Contacts entered into 13 settlement agreements to resolve trademark infringement claims in which 1-800 Contacts alleged that its competitors' online advertisements infringed 1-800 Contacts' trademarks.

As part of those settlements, 1-800 Contacts and its competitors agreed not to "bid on each other's trademarks, URLs, and variations of trademarks as search advertising keywords," and to "employ negative keywords so that a search including one party's trademarks [would] not trigger a display of the other party's ads." 1-800 Contacts affirmatively enforced the terms of these settlement agreements when it believed they were being violated by competitors.

The FTC Administrative Proceedings

In an administrative complaint that the FTC approved in 2016, the commission staff alleged that 1-800 Contacts' trademark settlement agreements violated Section 5 of the FTC Act and Section 1 of the Sherman Act by unreasonably restraining "truthful, non-misleading advertising as well as price competition in search advertising auctions."

The complaint alleged that the agreements prevented 1-800 Contacts' competitors from advertising that the same contact lenses were available at a cheaper price from other online retailers, thus reducing price competition between competitors and ultimately leading to higher prices for contact lenses sold online.

An FTC administrative law judge ruled in the FTC's favor, applying the rule of reason standard — which requires the plaintiff to make a prima facie showing of anti-competitive effects from the challenged conduct, after which the burden shifts, first to the defendant to show pro-competitive justifications for the conduct and then to the plaintiff to show that there are less anti-competitive alternatives — and concluding that the agreements were unlawful.

1-800 Contacts appealed the administrative law judge's ruling to the commission. In a split decision, the FTC affirmed the decision that 1-800 Contacts had violated antitrust laws.

But the majority applied a different standard than the administrative law judge, an abbreviated rule of reason analysis, akin to a "quick look" review, called the "inherently suspect" standard. 1-800 Contacts filed a petition for review with the Second Circuit.

The Second Circuit Decision

As a threshold matter, the Second Circuit rejected 1-800 Contacts' argument that under the Supreme Court's reasoning in FTC v. Actavis Inc.― in which the high court in 2013 permitted antitrust scrutiny of reverse payment settlement agreements resolving Hatch-Waxman Act patent infringement lawsuits ― the trademark litigation settlement agreements at issue were immune from antitrust review because they were not within the narrow scope of claims subject to antitrust review under Actavis.

Citing Actavis, the Second Circuit noted that "the mere fact than an agreement implicates intellectual property does not 'immunize [an] agreement from antitrust attack,'" and ruled that, "[a]s in any antitrust case, we must 'determine whether the restraints in the agreement[s] are reasonable in light of their actual effects on the market and their pro-competitive justifications.'"

But the court held that a full rule-of-reason analysis must be applied, and accordingly, the Commission's application of the "inherently suspect" framework to the challenged agreements was incorrect.

The FTC uses the "inherently suspect" standard in analyzing the types of restraints that, while not in the per se unlawful category — such as price-fixing, bid-rigging and market-allocation agreements, raise competitive concerns and require less elaborate proof of harm to establish illegality.

Courts have held that this truncated rule of reason approach is appropriate to use where the harm to competition is facially evident from the type of restraint at issue.

In 1-800 Contacts, the Second Circuit held that it was improper for the FTC to use such a truncated analysis because the agreements at issue were "not so obviously anti-competitive to consumers that someone with only a basic understanding of economics would immediately recognize them to be so," noting the commission's citation and reliance on expert economic data analysis to demonstrate harm.

In fact, the court said, "Crucially, the restraints at issue here could plausibly be thought to have a net pro-competitive effect because they are derived from trademark settlement agreements."

In applying the full rule of reason analysis, the Second Circuit determined that 1-800 Contacts had demonstrated pro-competitive justifications for the agreements, finding that "[t]rademarks are by their nature non-exclusionary, and agreements to protect trademark interests are 'common, and favored, under the law.'"

The Second Circuit also concluded that the FTC could not carry its burden of showing that a less restrictive alternative existed to achieve 1-800 Contacts' legitimate competitive benefits.

The FTC's proposed alternative — that the parties to the agreements could have agreed to require clear disclosure in each search advertisement of the identity of the rival seller rather than prohibit all advertising on trademarked terms — did not give appropriate deference to the parties' business reasons for entering into the challenged agreements: "'[I]t is usually unwise for courts to second-guess' trademark agreements between competitors" because "in this context, what is 'reasonably necessary' … is likely to be determined by competitors during settlement negotiations."

Because the Second Circuit ruled in favor of 1-800 Contacts on the second and third prongs of the rule of reason burden-shifting framework, the court declined to decide whether the FTC had even carried its initial burden to show anti-competitive effects of the challenged agreements on the market.

However, the court expressed skepticism regarding the FTC's showing regarding anti-competitive effects, noting that the FTC's proffered evidence of increased prices was not direct evidence but merely "theoretical and anecdotal" because it did not "show an actual anti-competitive change in prices after the restraint was implemented."

The court also noted, in evaluating the FTC's argument that "disrupted information flow" is an anti-competitive effect and that a reduction in the quantity of advertisements is direct evidence of that effect, "to our knowledge, no Court of Appeals has held that a reduction of truthful information is necessarily a manifestation of anti-competitive harm."

The panel decision may not be the last word on this matter. Six days after the ruling, on June 17, 2021, the FTC filed a motion, which 1-800 Contacts did not oppose, to extend the time for the filing of a petition for rehearing by the same panel or rehearing by the full Second Circuit court, en banc, from July 26 to August 9, 2021. It remains to be seen whether the FTC will ultimately decide to seek either panel rehearing or rehearing en banc.

Effect of 1-800 Contacts Decision

The Second Circuit's decision in 1-800 Contacts provides clarity on how trademark settlements are viewed under the antitrust laws. While the antitrust implications of patent settlements have been extensively litigated, there has been far less antitrust litigation involving trademark settlements. The Second Circuit's opinion makes clear that trademark settlements are not immune from antitrust scrutiny, but the "inherently suspect" or "quick look" standard should not be applied to antitrust challenges to trademark settlement agreements, because such agreements have a pro-competitive effect. The full rule of reason analysis is required in such cases.

More generally, the opinion shows that antitrust challenges to trademark settlement agreements likely face an uphill battle in light of the law's favorable view of such agreements. In this regard, trademark owners may take the same comfort from this decision that patent owners took from the Ninth Circuit's Qualcomm decision.

What to Watch For in Antitrust/IP Enforcement Going Forward

New Leadership at the Agencies

If personnel is policy, the FTC is headed in a new policy direction with an increased focus on enforcement against anti-competitive behavior, in particular against such behavior by intellectual property holders. Based upon her past writings, new FTC Chair Lina Khan is expected to take an aggressive posture toward companies using such rights to stave off competition.

Having recently made several appointments from the staff of Commissioner Rohit Chopra, who has been nominated to head the Consumer Financial Protection Bureau, including Chopra's former attorney adviser Holly Vedova as the acting director of the Bureau of Competition, Khan has signaled a pro-enforcement agenda in the IP space.

For example, in October 2019, Chopra testified before the U.S. House Judiciary Committee's Subcommittee on Antitrust, Commercial and Administrative Law, and argued that enforcement against Big Tech companies could involve "opening up the intellectual property rights to underlying technologies that power a marketplace." In addition, Khan worked for Chopra as a legal adviser in 2018 and has co-authored articles with him.

As for the U.S. Department of Justice, President Joe Biden has not announced a nominee to lead the Antitrust Division, nearly six months into his term. But there are signs that the DOJ's policies in this area are changing. During the tenure of former Assistant Attorney General for Antitrust Makan Delrahim, the DOJ had moved toward a less aggressive posture regarding holders of intellectual property rights.

Under Delrahim's "New Madison Approach," the DOJ amended a business review letter to the Institute of Electrical and Electronics Engineers Inc., or IEEE, to urge revisions to the its patent licensing policies, issued new guidance and new business review letters that affirmed the rights of holders of standard-essential patents, or SEPs, to seek injunctive relief, and generally took the view that licensing disputes―such as those concerning the obligation of SEP rights holders to license their technology on fair, reasonable and nondiscriminatory, or FRAND, terms―were best viewed as breach of contract or patent infringement, rather than antitrust, disputes.

The DOJ openly split with the FTC on these issues during Delrahim's tenure, most notably when the DOJ filed amicus briefs opposing the FTC's positions in the Qualcomm case. However, in April, the Antitrust Division withdrew the amendments to the IEEE business review letter. And in early June, during a webinar hosted by Canada's Competition Bureau, Delrahim's successor, acting Assistant Attorney General Richard A. Powers, stated that the Biden administration is rethinking its approach to issues involving antitrust and IP, and acknowledged that some criticisms of the DOJ's approach under Delrahim were justified. Powers stated that the antitrust bar should not be surprised to see policy changes from DOJ in this area in the near future.

Uphill Battles for Enforcers in Federal Court

The 1-800 Contacts decision, like Qualcomm, could prove to be an obstacle to the FTC's — and possibly the DOJ's  — renewed enforcement efforts in the intellectual property space. Appellate courts continue to rein in the government's use of the antitrust laws to police conduct involving intellectual property rights.

Going forward, enforcers will need to consider the implicit assumption underlying the Qualcomm and 1-800 Contacts cases that intellectual property rights are presumptively pro-competitive. To be successful, the government ― and private enforcers ― will need to present more powerful economic evidence to support their claims that IP rights holders have strayed too far from the protections granted by those rights. Otherwise, such cases will remain uphill battles for the enforcers.

Reprinted with permission of Law360.