Appellate Court Declines Look at Subjective 'Good Faith' in Contract

The Supreme Court of Ohio recently held that a court cannot make a subjective inquiry into a gasoline distributor's motives in setting price levels where the prices were both commercially reasonable and nondiscriminatory, notwithstanding the plaintiffs' allegations that the prices were set at a level to try to force them out of business. See Casserlie et al. v. Shell Oil Co., et al. (2009), 121 Ohio St.3d 55, 902 N.E.2d 1.

In a dissent, one justice challenged whether Ohio law had created a safe harbor for gasoline distributors through the public posting of their prices to their dealers. The justice wrote “[a]fter this opinion becomes public, all franchisees in Ohio should watch their wallets very carefully because their franchisors will no longer be held to subjective good-faith standards.”

The Facts

The plaintiffs were a group of independent Shell lessee-dealers in the Cleveland area (the “Dealers”). The appellees were Shell Oil Company, its partners, and its successors (collectively, “Shell”).

According to the court, the Dealers operated as franchisee-leased gas stations. The Dealers' contracts required them to buy gasoline exclusively from Shell at a wholesale price Shell set on delivery, a kind of contract term known as an “Open Price” term. The price the Dealers paid is also referred to as the “dealer-tank-wagon” (“DTW”) price, since it included the delivery cost to the gas stations. The DTW price Shell charged the Dealers was based on market factors, including prices a competitor offered, as well as the street price in areas of Cleveland. Within each area of the city (price administration district or “PAD”), Shell charged all dealers the same DTW price.

In addition to sales to the Dealers, Shell also sold gasoline to “jobbers,” which are independent companies operating non'Shell-owned gas stations. Jobbers purchased gasoline at Shell's terminal and paid the “rack” price, which did not include delivery costs since it was purchased at the oil company's terminal.

The Dealers sued Shell, claiming it engaged in bad faith in setting the DTW price, among other claims. The plaintiffs claimed that the price the jobbers paid (the rack price) was often substantially below the price the Dealers paid (the DTW price). The pricing difference, the Dealers claimed, allowed jobbers to offer wholesale DTW prices that were substantially lower than the DTW price the Dealers were charged. The Dealers claimed that the pricing system was unreasonable and part of a marketing plan designed to drive them out of business so that Shell could take over operation of the gas stations and profit from all sales (including nonfuel sales) at the stations, and not merely the wholesale gasoline sales and rental income from the Dealers. The parties agreed to bifurcate the proceedings and to move forward only on the bad faith claim.

The trial court granted summary judgment in Shell's favor on the bad-faith claim, finding that Shell did not violate a requirement that a price be fixed in good faith, where the Dealers had not proven that Shell set the DTW price in a commercially unreasonable manner. The Ohio Court of Appeals affirmed, adopting an objective good faith standard based on the Sixth Circuit's decision in Tom-Lin Ents. v. Sunoco, Inc. (R&M), 349 F.3d 277 (6th Cir. 2009). The lower Ohio appellate court in Casserlie determined that the Dealers failed to show that Shell's prices were not commercially reasonable.

Ohio Supreme Court's Reasoning

In reviewing the case on discretionary appeal, the Ohio Supreme Court stated that the parties agreed that: 1) Shell has authority under the dealer agreements to set the price at delivery, and 2) the price is subject to Ohio Revised Code ' 1302.18, which requires the price to be “reasonable.” See Ohio Revised Code ' 1302.18(A). Under subsection (B) of that section, the price must be set “in good faith,” which the supreme court said is “defined generally as 'honesty in fact in the conduct or transaction concerned,'” (quoting Ohio Revised Code ' 1301.01(S)), but in the case of a merchant, “'good faith' ' means honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade.'” (quoting Ohio Revised Code ' 1302.01(A)(2)).

The Dealers' proposition of law on appeal was that the definition of “good faith” under the UCC, which incorporates an “honesty in fact” component, requires a subjective inquiry. Both the trial court and appellate court relied on Tom-Lin Ents., which involved a “nearly identical” agreement and concluded, based on Ohio law, that an inquiry into good faith required “an objective analysis of the merchant-seller's conduct,” according to the supreme court's opinion.

The Ohio Supreme Court noted that the parties did not dispute that “the observance of reasonable commercial standards of fair dealing in the trade” requires only an objective analysis, thus narrowing the issue to “whether there is room for a subjective inquiry within the honesty-in-fact analysis” in the circumstances. In searching for other authorities, the court noted that the UCC does not define the term “honesty in fact” and that courts and commentators have found that the meaning of “good faith” is not uniform throughout the UCC, making the case law defining good faith in other areas of the UCC “of somewhat limited value” in this case, and non-UCC cases defining good faith “of even less relevance.”

The court then examined the full text of the Official Comment to UCC section 2-305 for guidance:

“[UCC section 2-305(2)], dealing with the situation where the price is to be fixed by one party rejects the uncommercial idea that an agreement that the seller may fix the price means that he may fix any price he may wish by the express qualification that the price so fixed must be fixed in good faith. Good faith includes observance of reasonable commercial standards of fair dealing in the trade if the party is a merchant. (Section 2-103 [R.C. 1302.01]). But in the normal case a 'posted price' or a future seller's or buyer's 'given price,' 'price in effect,' 'market price,' or the like satisfies the good faith requirement.” (Bracketed material in original.)

The court explained that while the second sentence in Comment 3 does not remove honesty in fact from the definition since the phrase “includes” is used, the last sentence “is not limited to part of the good-faith definition but rather provides a safe harbor where a 'posted price' satisfies good faith in its entirety.”

The Ohio Supreme Court examined cases from other jurisdictions that have relied on the “posted-price” language in the Comment, and in doing so, it discussed at length the Supreme Court of Texas decision in Shell Oil Co. v. HRN, Inc. , 144 S.W.3d 429 (Tex. 2004). There, the court held that Shell did not violate the duty of good faith because the posted price was both commercially reasonable and nondiscriminatory, and also noted that a subjective good-faith inquiry injects uncertainty into the law of contracts and undermines one of the UCC's primary goals of promoting certainty and predictability.

The court in Casserlie acknowledged that other cases (including a federal First Circuit Court of Appeals decision in 2008) have noted the posted-price comment, but concluded it does not provide a safe harbor where there is subjective bad faith. Some decisions contend that the Comment is limited to the “normal case,” which does not include a situation where there is a purposeful attempt to drive the buyer out of business. The Ohio Supreme Court nevertheless rejected that approach because it “would eviscerate the safe harbor in any action in which the plaintiff alleges circumstantial evidence of an improper motive, leading to drawn-out litigation even if the prices charged were within the range of those charged in the industry.” (Quotation omitted.)

The court further explained that “[a]ll of this is not to say that intent is necessarily irrelevant to an analysis of good faith under UCC section 2-305(2), but only that a subjective inquiry is not permitted when the posted-price safe harbor applies. By its language, the safe harbor does not apply when it is not the 'normal case' or when the price setter is not imposing a 'posted price,' 'given price,' 'price in effect,' 'market price,' or the like.”

In addition, the court explained that “[t]he touchstone of prices set through open-price-term contracts under UCC section 2-305 is reasonableness. A price that is nondiscriminatory among similarly situated buyers correspondingly qualifies as a 'posted price' or the like.” Thus, “a price that is both commercially reasonable and nondiscriminatory fits within the limits of the safe harbor and complies with the statute's good-faith requirement.” Because the court found that the safe harbor applies to the facts in the case, the court declined “to precisely define good faith as it is used in UCC section 2-305(2)” and offered no opinion on the role of subjective intent within the good-faith analysis beyond the safe harbor.

The court also explained that aside from the claim that the prices were set to drive the Dealers out of business, “the only evidence of bad faith was that the prices set were too high for dealers to remain profitable and compete with jobbers in the Cleveland area.” The court explained that “Shell is not required to sell gasoline at a price that is profitable for buyers.” Shell had submitted expert testimony establishing that the DTW prices were within the range set by competitors. The court also considered the variance in Shell's prices in the area because of PAD pricing, but found that it was reasonable for Shell to adjust DTW prices based on competition and found no evidence that Shell discriminated among similarly situated buyers, such as dealers within a PAD or dealers in similar PADs. The court also rejected the argument that there was discrimination in the prices charged to jobbers, because the jobbers and dealers are not similarly situated buyers, and, further, that jobbers perform other additional functions compared with dealers, such as bearing the risk of environmental liability.

In sum, the court found that the Dealers had not provided any evidence that the prices set were commercially unreasonable or discriminatory, and therefore found that the posted-price safe harbor applied, and a subjective inquiry into the motives of the price setter was not permitted. One justice concurred in the judgment only.

The Dissent

In dissent, one justice argued that the Ohio General Assembly has never adopted Official Comment 3 to section 2-305 and that the safe-harbor presumption is not part of Ohio law. The dissent wrote that a court's analysis of a merchant's good faith should be both subjective and objective and that the Dealers should be allowed to attempt to establish “that this is not a normal case” if the safe-harbor presumption otherwise applied.

Conclusion

Despite the dissent's admonition, franchisors in Ohio are still constrained by a reasonableness determination under the good faith inquiry, but this decision provides some guidance that if their actions fall under one of the safe harbors, such actions should not be second-guessed.