Mac's Shell Service, Inc. v. Shell Oil Products: Looking for the Practical Answer

Congress provided enhanced federal rights for dealers, which rights exist side by side with state law remedies for breach of contract. The Court was struggling with how to prevent garden-variety dealership issues from triggering the enhanced federal rights. In the case at bar, the difference between the state and federal remedies was attorney and expert fees totaling $1.2 million. The notion of constructive termination is not mentioned in the PMPA, yet it appears that Congress considered the dealers vulnerable, and the logical extension of the PMPA would seem to protect dealers against an implicit termination where the dealer loses one of the three elements of the franchise relationship. The franchising industry is eager to find out where the Justices decide to draw the line.

Editor's Note: Even though franchising represents a significant part of the commercial activity in the United States and the U.S. Supreme Court regularly considers legal issues pertaining to commerce, it's rare for the Court to hear a case that is directly related to franchising. But such a rarity took place on Jan. 19, 2010, in Mac's Shell Service Inc. v. Shell Oil Products Co. Craig R. Tractenberg, a partner at Nixon Peabody LLP, was in attendance, and he describes the oral argument.

The franchise issue before the Court was: When does a breach of a franchise agreement entitle a service station dealer to a federal forum with special federal remedies under the Petroleum Marketers Protection Act (the “PMPA”)? The PMPA prohibits the improper termination or nonrenewal of service station dealers. The PMPA grants dealers a federal forum for redress, grants a relaxed standard for obtaining an injunction against the franchisor, and grants an award of counsel fees and expert costs to the prevailing dealer.

In a Massachusetts federal district court, Shell Oil was accused of scheming to raise the rent and the wholesale price of gasoline to dealers for the purpose of driving the dealers out of business. The dealers argued that Shell intended to convert the dealer locations to company-owned service stations and capture the goodwill built by the dealers. The dealers never obtained an injunction in the district court, and most continued in business during the pendency of the trial. The jury awarded damages for a state law breach of the franchise agreement claim and identical damages for violation of the PMPA. In addition to the compensatory damages, the dealers were awarded under the PMPA counsel fees and expert fees totaling about $1 million. On appeal to the First Circuit, Shell won a reversal on the PMPA violation for nonrenewal, but not on the issue of “constructive termination.” Shell appealed on the issue of whether it violated the PMPA on the issue of constructive termination.

The facts are that Shell withdrew a rental subsidy and raised the price of gasoline to its dealers, but the dealers accepted the terms under protest and most stayed in business. Shell produced evidence that its gasoline-dealer price was actually lower than other competitors charged their dealers, but that argument did not carry the day. The dealers argued that Shell never affirmatively terminated their franchise agreements, but did so “constructively” by eliminating their ability to operate profitably. The PMPA does not explicitly prohibit “constructive” termination, so the first legal question for the Court was whether a “termination” occurs under the PMPA if the dealer stays in business. Shell's initial argument was that the concept of “constructive termination” is not an actual termination under the PMPA and that the franchisor must communicate the intent to terminate, by words or by action, if the PMPA is to be triggered.

The Justices' Questions

Chief Justice John G. Roberts asked whether the PMPA encompassed a situation where the franchisee was merely mitigating damages by staying in business. Justices Antonin Scalia, Ruth Bader Ginsburg, and Anthony Kennedy asked if this was not like a constructive eviction where the landlord fails to provide heat. Shell's counsel, Jeffrey A. Lamken, partner, Molo Lamken LLP, argued that, under the constructive eviction and employment termination cases, the victim must actually leave, whereas most of the Shell dealers stayed in possession and operated under protest. Shell's fallback position was that it was possible to have a constructive eviction when one of the three elements of the franchise has been terminated: 1) the lease, 2) the trademark, or 3) the supply of gasoline. Absent the franchisor terminating one of these elements, the PMPA was not triggered. Justices Samuel Alito and Scalia challenged this position, asking why the statute that addressed the franchisor refusing to deliver gas at any price is different from the franchisor that wants to charge $1,000 per gallon. Lambert replied that in this case, the price increase was less than the wholesale price in some cases charged by competitors and that the courts should not be put in the position of price regulators.

The Government's Middle Ground

In cases involving the federal statutes, the federal government is invited to participate. In this instance, the government took a middle ground. An assistant to the Solicitor General argued the government's position that the PMPA was intended to address constructive termination, but that the test would be the same as that in employment or tenant cases. The government suggested that the victim would need to leave the premises for the federal statute to be triggered. Justice Alito wanted to sharpen the distinction; he asked whether the application of the PMPA would be different for one dealer who was wealthy enough to continue operation but different for another dealer who could not afford to operate. The government responded that the test for the PMPA did not require leaving under those circumstances if “a reasonable franchisee in those circumstances would have no alternative but to do what this franchisee did and abandon the premises.”

Justice Stephen Breyer drilled deeper ” ' suppose the landlord here really wants the guy to clear out, so he puts thumb tacks on the ground and horrible-smelling things all over. And then the franchisee leaves, but the franchisor says:
'Hey, I didn't want you to leave; that's your problem.' I mean, is that constructive eviction or constructive termination?” The government agreed, which allowed Justice Breyer to exercise the law professor's prerogative to twist the facts, “Now suppose it's the same situation, but this person, the franchisee, being quite indefatigable and daring, finding a way of sneaking through the barbed wire that has been put up. And there is one pump they forgot, and there is a car that comes up and he serves that person. Now is it constructive eviction?” The government's answer was: “no,” because an objective standard is needed. Justice Breyer retorted, “Objective? You would say any sensible person would clear out immediately. There are lions and tigers roaming the gas station.” After the laughter subsided, the government stuck to its objective standard that the dealer must leave for the doctrine of constructive eviction to apply.

The Dealers' Arguments

The dealers' lawyer patiently watched the grilling from the justices. When it was time for his argument, he confidently argued that absent the doctrine of constructive termination, franchisors could circumvent the PMPA and terminate franchisees by increasing the burden of their operations. Seeking a practical answer, Judge Breyer immediately asked what test should be applied to trigger the PMPA when the dealer refuses to leave. When a bright-line solution was not offered, Justice Kennedy again asked for a proposed test so that lower courts could be instructed as to when the PMPA should apply. Counsel resisted a test requiring the dealer to leave the premises. Justice Sonia Sotomayor asked whether the solution was to have the franchisee withhold rent and elicit a termination notice from the franchisor in order to trigger the statute. She added that the franchisee could seek an injunction against eviction under the statute once the termination notice was issued and avoid eviction. Justice Breyer asked what was wrong with a clear line of requiring a dealer to leave the premises if it wanted a federal cause of action. Counsel responded that it was a bad choice because the PMPA granted rights, whereas that type of bright-line requirement would require the business to close before a federal remedy could be sought.

Congress provided enhanced federal rights for dealers, which rights exist side by side with state law remedies for breach of contract. The Court was struggling with how to prevent garden-variety dealership issues from triggering the enhanced federal rights. In the case at bar, the difference between the state and federal remedies was attorney and expert fees totaling $1.2 million. The notion of constructive termination is not mentioned in the PMPA, yet it appears that Congress considered the dealers vulnerable, and the logical extension of the PMPA would seem to protect dealers against an implicit termination where the dealer loses one of the three elements of the franchise relationship. The franchising industry is eager to find out where the Justices decide to draw the line.