Maintaining competition in online advertising: the US FTC’s 1-800 Contacts decision

In an important case on the intersection of IP and antitrust, the US Federal Trade Commission (FTC) has held that 1-800 Contacts, the largest online retailer of contact lenses in the US, unlawfully entered into a series of anti-competitive settlement agreements with its online rivals.  Issued on 7 November, the Commission’s Opinion provides useful insight into the mechanics of keyword search advertising and emphasises that such advertising is fundamental to competition between retailers in an e-commerce context.  The case also serves as a reminder – if any were needed – that companies cannot rely on IP settlements to shield their conduct from competition law scrutiny.

Background

Internet search engines such as Google typically generate two types of results in response to search queries: ‘organic’ results and ‘sponsored’ links.  The latter are advertisements, which are often displayed above or beside the organic results. As the name suggests, advertisers have to pay to have their sponsored links appear on a search engine results page.  To determine which ads appear (and in which order), search engines use auctions to sell advertising positions.  Advertisers bid on ‘keywords’ – words or phrases that trigger the display of ads when they are deemed to match a user’s search.  Advertisers can also specify ‘negative’ keywords. For instance, a retailer of eye-glasses might bid on ‘glasses’ but list ‘wine’ as a negative keyword to prevent its ad from appearing in response to a query for wine glasses.

Between 2004 and 2013, 1-800 Contacts sent cease and desist letters alleging trade mark infringement to a number of its competitors whose online search advertising displayed in response to queries involving ‘1-800 Contacts’ and similar terms.  It subsequently filed suit against a number of these online retailers (even if the retailers had not been bidding on the keyword ‘1-800 Contacts’ but on more generic terms such as ‘contacts’).  Rather than litigating the trade mark disputes to conclusion, 1-800 Contacts entered into settlement agreements with each of the competitors.  The agreements prevented the competitors from bidding for search advertising involving ‘1-800 Contacts’ and similar terms. The agreements also required the competitors to employ negative keywords to prevent their ads appearing whenever a search included the ‘1-800 Contacts’ trade mark (even in situations where the advertiser did not bid on the actual trade mark and the ad would appear due to the search engine’s determination that the ad was relevant and useful to the consumer). The settlement agreements were reciprocal: 1-800 Contracts agreed to the same bidding restrictions and negative keyword requirements in respect of its rivals’ trade marks.

The FTC’s decision

Anti-competitive restraints 

The FTC held that the settlement agreements prevented online contact lens retailers from bidding for online search ads that would inform consumers about the availability of identical products at lower prices.  According to the FTC, the agreements:

  • harmed competition in bidding for search engine key words, artificially reducing the prices that 1-800 Contracts paid for search advertising, as well as reducing the quality of search engine result ads delivered to consumers; and
  • resulted in price-conscious consumers paying more for contact lenses that they would have absent the restrictions.  
Whilst the FTC did not suggest that all advertising restrictions are necessarily anti-competitive, it emphasised that the restrictions in this case prevented the display of ads that would enable consumers to learn about alternative sellers of contact lenses and to make price comparisons at a time when they would be considering a purchase.  Significantly, the restrictions in the settlement agreements were not merely “limitations on the content of an advertisement a consumer would otherwise see”; they were restrictions on a “consumer’s opportunity to see a competitor’s ad in the first place”.  The restrictions were particularly harmful to retail price competition because the suppressed ads “often emphasise[d] lower prices”.

1-800 Contacts’ efficiency justifications

1-800 Contacts put forward two efficiency justifications for the restrictions: (i) avoidance of litigation costs though settlement and (ii) trade mark protection.  The FTC found that whilst these justifications were plausible, they were insufficient to outweigh the restrictions’ anti-competitive effects.  Further, the claimed pro-competitive benefits could have been achieved through less restrictive means.  In the agency’s analysis, “when an agreement limits truthful price advertising on the basis of trade mark protection, it must be narrowly tailored to protecting the asserted trade mark right”.  The settlement agreements in this case were not: they restricted advertising regardless of whether the ads were likely to cause consumer confusion (a key element of the test for trade mark infringement) and regardless of whether competitors actually used the trade mark term.

The FTC was also unimpressed by 1-800 Contacts’ argument that a trade mark settlement requiring non-use is immune from antitrust review because a prohibition on use is within a trade mark’s exclusionary potential.  Citing the US Supreme Court’s 2013 ruling in Actavis, the FTC emphasised the importance of considering “both antitrust and intellectual property policies”.  According to the agency, the “crux” of the Actavis decision was that there could be antitrust liability for settlement of litigation, regardless of whether the agreement’s anti-competitive effects fall within the scope of the exclusionary potential of the IP right in question.  1-800 Contacts’ argument “look[ed] only to half of the equation, i.e. trade mark policies, and did not withstand a thorough understanding of Actavis”.

Comment 

The decision sends a clear signal that the FTC takes a dim view of agreements between competitors that restrict online search advertising to the detriment of consumers.  Whilst agreements to limit advertising are not per se illegal in the US, it seems that such agreements will likely fall foul of the antitrust rules unless the parties can establish robust pro-competitive justifications for the restrictions.  The FTC’s position is clear: online search advertising plays a crucial role in the effective functioning of retail competition in the modern internet economy.

Competition authorities on this side of the Atlantic have also shown an interest in the links between online advertising and competition in recent years. The European Commission’s Final Report in the E-Commerce Sector Inquiry noted that almost one in ten retailers were contractually restricted from advertising online. The French competition authority published a report on the functioning of the online advertising sector in March this year.  And in the German Asics case, the Bundeskartellamt found that the sports equipment manufacturer’s prohibitions on the use of price comparison websites and Asics brand names in online advertisements amounted to a hardcore restriction of competition under the Vertical Agreements Block Exemption.  That decision was ultimately upheld by Germany’s highest court, the Federal Court of Justice.  Given the continuing growth of e-commerce, it would hardly be surprising to see further cases in this area in the future.

In a froth: Trademark licensing fails to disguise anti-competitive market sharing arrangement

The CMA has today issued a £1.71m fine against two laundry companies for market sharing.  Micronclean Limited was fined £510,118 and Berendsen Cleanroom Services Limited was liable for £1,197,956. The companies both specialise in laundering clothes worn in ‘cleanrooms’.  These are highly sterile environments, with meticulous rules on the cleanliness of equipment and clothing, which are vital in the manufacture of pharmaceuticals and medical devices.

The two companies had established a joint venture agreement in the 1980s where both traded under the ‘Micronclean’ brand.  However it was only in 2012 that they started the market sharing arrangement, attempting to mask it as a reciprocal trademark licence arrangement.

This arrangement had two problematic elements.  First an artificial line was drawn between London and Anglesey; customers south of that line were reserved for Berendsen, whilst those to the north were allocated to Micronclean.  Second, over and above the territorial restrictions, companies decided to reserve specific customers to themselves and agreed not to compete for them.

Geographic market sharing and customer allocation is illegal (other than where legitimate exclusivity arrangements are concluded as part of a broadly pro-competitive agreement such as technology licensing). In this instance, the CMA did consider whether the arrangement, when taken as part of the wider joint venture agreement, could be justified.  Unfortunately for Micronclean and Berendsen the CMA concluded that it could not.  In particular the CMA found that the companies were competitors and two of the biggest players on the market. This left customers, including the NHS, with few options in choosing service providers. 

The existence of the trade mark agreement did nothing to change that fundamental position. Trade mark licences do not generally fall within the scope of the Technology Transfer Block Exemption.  In any event, the EU Commission’s Guidelines on Technology Transfer, which provides broad guidance on the analytical approach to the competitive effects of IP licensing, make clear that sales restrictions agreed between competitors in a licensing arrangement are likely to be regarded as market sharing, particularly where the licence is a cross licence (or “reciprocal” in the language of the block exemption) – and so it proved here.

This case serves as a reminder that anti-competitive practices which take place under the guise of an IP licence will not avoid scrutiny by the competition authorities.  In this instance the arrangement came to light in the context of two related merger reviews in the industry undertaken by the CMA – also a reminder of the importance of due diligence and early review of competition issues in the context of corporate transactions. As Ann Pope, Senior Director at the CMA added to the press release: “Companies must regularly check their trading arrangements, including long-running joint ventures and collaborative agreements, to make sure they’re not breaking the law.

Sticky switching opens the way to over-stickering

Lord Justice Floyd has had occasion recently to remind us of the re-packaging/re-labelling rules in a recent Court of Appeal judgment in European Pharma Ltd and Doncaster Pharmaceuticals Group Ltd and Madaus GmbH. The Court of Appeal, overturning the first instance judgment, held that it was legal for a parallel importer (Doncaster) to export pharma products containing the active ingredient Trospium Chloride from France and Germany where they were marketed under the trade mark Céris and UriVesc respectively and import them into the UK by affixing the products with the UK trade mark ‘REGURIN’.
 Article 7(1) Trade Mark Directive provides for EU-wide exhaustion where the parallel importer uses a trade mark from the country of export and re-affixes it onto a product to be imported to another Member State. However, this case was different. Here the parallel importer was re-labelling a product with the trademark of the country of import. In this instance, re-affirming previous case law in Pharmacia & Upjohn v Paranova, the court determined that trade mark owners may take steps to prevent such over-stickering unless doing so creates an impediment to free movement of goods between Member States. That would be the case where over-stickering is necessary to obtain effective access to the market and is not simply for the importer’s commercial advantage.

Trade mark holders will be concerned that in this case the very points evidencing the success of the REGURIN brand were those relied upon as showing that it was necessary for the parallel trader to over-sticker. The strength of the UK brand therefore prevented the trademark owner from exercising its UK trademark rights to stop what is, on its face, an infringement.  The facts relied on as evidence of “necessity” were the fact that doctors and pharmacists were resistant to switching away from prescribing by reference to 'REGURIN' rather than the generic INN and the impracticability for Doncaster to set up a new brand and persuade doctors to prescribe to it. This is because parallel importers are dependent on purchases from third parties and therefore cannot guarantee supply. As a result of this resistance to using non-branded products, the court found that it was indeed necessary to over-sticker the products entering the UK with the UK TM REGURIN in order for Doncaster to be able to compete effectively. An attempt to prevent this would be an impediment to the free movement rules. Furthermore, Doncaster did not obtain a commercial advantage from over-stickering as it would never be able to sell more cheaply than a generic. 

This case will STICK in the minds of trade mark holders who, as a result of this judgment may find their ability to benefit from their trade marks curtailed after expiry of the patent. However trade mark holders may find some solace in the fact that before using their trademarks, parallel importers will still have to prove that over-stickering is necessary to gain effective access to the market and will have to comply with the five conditions protecting the guarantee of origin of the trade mark owner’s mark as set out in Bristol Myers Squibb v Paranova.

Nespresso finalises its competition commitments in France – but at what price for innovation?

I wrote on this blog (here) about commitments offered by Nespresso to the French Competition Authority (FCA) a few months back.  The FCA has now reported that the commitments have been finalised.

The final commitments package is very similar to Nespresso’s original proposal, subject to a few additional concessions.  For those interested in the interplay of competition law, IP rights and innovation, the FCA’s decision makes for interesting reading – as much for what it omits as what it includes.  At the heart of the abuse of dominance identified in the preliminary assessment is the ‘technological tie’ between Nespresso’s coffee machines (dominant on the market for espresso machines) and the compatible Nespresso-branded capsules (which was inevitably limited to Nespresso’s machines – Nespresso was again obviously dominant on that consumables market also).  The identified abuse encompasses in particular four changes to the design of Nespresso’s coffee machines and/or the capsules used with the machines which, it is said, rendered it more difficult for ‘generic’ competitors to access and remain on the market.  (The resonances with the pharma market are deeper than terminology alone – the alleged abuse has considerable similarity to a product-hopping type allegation as seen in AstraZeneca and Reckitt (UK), and there are also allegations of denigration of the competitors products, as with recent FCA abuse of dominance cases in the pharmaceutical sector – an issue which seems to concern the French in particular.)  

It is common to hear competition lawyers complaining about the explosion of commitments decisions at national and, in particular, EU level over the past few years.  While these are sometimes good for the companies concerned, they typically leave much to be desired in terms of legal reasoning, and thus legal certainty for third parties (and their advisors).   The frustrating part in this case is the lack of any assessment of the potential defensive elements, including as to possible objective justifications, that could have been available to Nespresso. Despite a mention (in para. 20) of the patents covering the machines and capsules, there is no discussion of whether patents could have legitimately excluded the generic competitors or the role played by trademarks where competitors seek to introduce compatible products.  While it is possible that there was no plausible case on these facts for any patent applying to Nespresso’s past technological developments, Nespresso’s commitment to make details of future changes available to competitors has the potential to cover patented inventions in future – yet it is far from clear that Nespresso’s conduct would pass the “exceptional circumstances” test required for a compulsory licence to be granted, still less that the competitors producing generic capsules would pass the new product test.  There is a mention (para. 117) of Nespresso having made the technical changes in order to remedy malfunctions (presumably of the products), but commentary on this in the decision is limited to a statement that the existence of such malfunctions is not conclusively demonstrated by the case file.  Equally, only minimal evidence is presented to suggest that the re-designs were motivated by a sustained corporate strategy to exclude competitors. The lack of any in depth consideration of these elements means that the final decision comes to look like a per se rule on product redesigns by dominant companies where there is any prospect of third parties wishing to interface with the dominant product.

Nevertheless, the FCA appears to have taken a pragmatic view to finalising the commitments, noting the existence of a “double asymmetry” on the market – first, where Nespresso makes changes to its machines, these will usually be designed to have the minimum impact on its own capsules, whereas competitors will have to modify their capsules to make them compatible with the new machines –  the time needed for competitors to make this adaptation may be longer than that needed by Nespresso; and secondly, the various competitors on the consumables market will be affected in different ways by each change. According to the FCA, these factors meant that it was impossible to achieve absolute neutrality between Nespresso and its competitors as to the impact of technological changes.  Only excessively extending the prior notice period for Nespresso to advertise technical changes to its competitors could potentially achieve such neutrality, but the decision rightly notes that a period of adaptation is entirely normal in a competitive market.  The FCA also exhibits an awareness of the need to maintain possibilities for competition between the ‘generic’ capsule manufacturers.  For these reasons, the changes to the commitments compared to the original draft are relatively limited, with Nespresso notably having agreed to give an additional month’s notice of appreciable technical changes (extending the period to four months, but not the 18 months requested by some competitors), and to place a larger number of prototype machines at the disposal of the competitors.

This decision relieves Nespresso of the need to fight a competition action, at least in France, gives its downstream competitors a leg-up in the capsules market, and doubtless lays the ground for increased price competition at the consumables level.  But there is no discussion in the decision as to the impact on companies’ incentives to innovate and to improve product design, and the decision certainly does not heed the approach of US antitrust law which, in the words of the Court in Allied Orthopedic v. Tyco (US Court of Appeals, 9th Circuit, 2010), has noted that: "to weigh the benefits of an improved product design against the resulting injuries to competitors is not just unwise, it is unadministrable".  The FCA, perhaps unsurprisingly, evidently does not agree.