Rare Move By the U.S. Supreme Court

The U.S. Supreme Court rarely tackles commercial law issues, but has addressed an important franchise law issue this year. Recently, a franchise law case did raise a federal question involving the Petroleum Marketing Practices Act (Act). The Act is intended to protect service station dealers from unjust terminations and non-renewal, but did not address constructive termination or nonrenewal. On March 2, 2010, the Court unanimously held that a franchisee that stays in business cannot sue for constructive termination under the Act. The Court also decided that a franchisee waives its constructive nonrenewal claim when it actually enters into a renewal agreement.

These decisions by the Supreme Court are more than mere questions of whether the dealers can obtain a federal forum. Under the Act, not only are the dealers entitled to a federal forum, but in addition, they are granted a relaxed standard in order to obtain a preliminary injunction against termination or nonrenewal and enhanced recovery of damages in the form of counsel and expert fees.

Constructive Termination

In Mac's Shell Service Inc. v. Shell Oil Products Co. LLC, No. 08'240, March 2, 2010, service station franchisees sued their franchisor, Motiva Enterprises LLC (a joint venture of Shell Oil and two other companies), for withdrawing a volume-based rent subsidy. The withdrawal of the subsidy upon renewal escalated the franchisees' rent to a point which threatened viability. As each franchise agreement expired, Motiva offered new agreements that contained a new rent formula for calculating rent, which resulted in higher rent. The franchisees sued both for constructive termination and for constructive non-renewal while continuing in operation. The theme of the franchisees' case at trial was that the franchisor sought to drive the franchisees out of business for the purpose of taking over their service station locations. The jury found in favor of all the franchisees on both breach of contract claims and statutory claims under the Act. The compensatory damages for the contract breaches and the claims under the Act were identical; however, the Act allowed an additional award for counsel and expert fees. These additional fees totaled approximately $1 million, so the Supreme Court was cognizant that the issue in the case was not merely the availability of a federal forum for franchise contract breaches in service station cases.

The Court's Ruling

The Court held that a franchisee cannot recover for constructive termination under the Act if the allegedly wrongful conduct by the franchisor did not compel the franchisee to abandon the franchise. Mere attempts to cause the franchisee to close would be insufficient. In order to trigger the Act, the franchisor would literally be required to force the franchisee out of business.

The decision was based on the plain reading of the Act, bolstered by the analogous legal contexts of constructive termination in employment cases and constructive eviction in landlord-tenant law cases. The Court determined that the franchisees had adequate state law remedies to redress wrongful acts which did not put an end to their business and did not need to resort to federal jurisdiction under the Act.

The Court did not reach the issue whether a cause of action exists under the Act for constructive termination at all. It merely decided that constructive termination did not
exist in this case. For this reason, the decision will be very persuasive in evaluating whether franchisees are constructively terminated under state law.

Constructive Nonrenewal

The Court was also asked to decide whether a franchisee who is offered and signs a renewal agreement can nonetheless maintain a claim for “constructive nonrenewal” under the Act. For similar reasons, the Court decided that such a claim could not be maintained because the Act only covers the termination or cancellation of a franchise. In effect, the Court decided the franchisees did not have standing under the Act. A renewal, even under protest, defeats the argument that the franchise was not renewed. The Court suggested that where a franchisor would renew only under unlawful and coercive terms prohibited by the Act, the relaxed preliminary injunction standard under the Act would be available to resume the continuation of the franchise relationship during the litigation.

The Court chose to impose an easy-to-apply test for trial courts to determine whether federal subject matter jurisdiction exists in service station constructive termination and nonrenewal claims. By analogy, the Court's decision may provide persuasive precedent for claims under other state franchise relationship statutes. The Court's decision allows franchisors to have greater flexibility to modify the terms of their franchise agreements at the time of renewal because the franchisee may be required to elect between ceasing operation and accepting more stringent economic terms as a condition of renewal.

Common Law Remedies

The decision also discusses common law remedies for franchisees confronting potential constructive termination and nonrenewal claims. The case provides important lessons in critical thinking and strategy for all franchise termination and nonrenewal decisions.

Craig R. Tractenberg is a franchise, distribution, litigation and dispute resolution partner based in Nixon Peabody's New York City office. This article originally appeared in the New York Law Journal, an ALM sister publication of this newsletter.

The U.S. Supreme Court rarely tackles commercial law issues, but has addressed an important franchise law issue this year. Recently, a franchise law case did raise a federal question involving the Petroleum Marketing Practices Act (Act). The Act is intended to protect service station dealers from unjust terminations and non-renewal, but did not address constructive termination or nonrenewal. On March 2, 2010, the Court unanimously held that a franchisee that stays in business cannot sue for constructive termination under the Act. The Court also decided that a franchisee waives its constructive nonrenewal claim when it actually enters into a renewal agreement.

These decisions by the Supreme Court are more than mere questions of whether the dealers can obtain a federal forum. Under the Act, not only are the dealers entitled to a federal forum, but in addition, they are granted a relaxed standard in order to obtain a preliminary injunction against termination or nonrenewal and enhanced recovery of damages in the form of counsel and expert fees.

Constructive Termination

In Mac's Shell Service Inc. v. Shell Oil Products Co. LLC, No. 08'240, March 2, 2010, service station franchisees sued their franchisor, Motiva Enterprises LLC (a joint venture of Shell Oil and two other companies), for withdrawing a volume-based rent subsidy. The withdrawal of the subsidy upon renewal escalated the franchisees' rent to a point which threatened viability. As each franchise agreement expired, Motiva offered new agreements that contained a new rent formula for calculating rent, which resulted in higher rent. The franchisees sued both for constructive termination and for constructive non-renewal while continuing in operation. The theme of the franchisees' case at trial was that the franchisor sought to drive the franchisees out of business for the purpose of taking over their service station locations. The jury found in favor of all the franchisees on both breach of contract claims and statutory claims under the Act. The compensatory damages for the contract breaches and the claims under the Act were identical; however, the Act allowed an additional award for counsel and expert fees. These additional fees totaled approximately $1 million, so the Supreme Court was cognizant that the issue in the case was not merely the availability of a federal forum for franchise contract breaches in service station cases.

The Court's Ruling

The Court held that a franchisee cannot recover for constructive termination under the Act if the allegedly wrongful conduct by the franchisor did not compel the franchisee to abandon the franchise. Mere attempts to cause the franchisee to close would be insufficient. In order to trigger the Act, the franchisor would literally be required to force the franchisee out of business.

The decision was based on the plain reading of the Act, bolstered by the analogous legal contexts of constructive termination in employment cases and constructive eviction in landlord-tenant law cases. The Court determined that the franchisees had adequate state law remedies to redress wrongful acts which did not put an end to their business and did not need to resort to federal jurisdiction under the Act.

The Court did not reach the issue whether a cause of action exists under the Act for constructive termination at all. It merely decided that constructive termination did not
exist in this case. For this reason, the decision will be very persuasive in evaluating whether franchisees are constructively terminated under state law.

Constructive Nonrenewal

The Court was also asked to decide whether a franchisee who is offered and signs a renewal agreement can nonetheless maintain a claim for “constructive nonrenewal” under the Act. For similar reasons, the Court decided that such a claim could not be maintained because the Act only covers the termination or cancellation of a franchise. In effect, the Court decided the franchisees did not have standing under the Act. A renewal, even under protest, defeats the argument that the franchise was not renewed. The Court suggested that where a franchisor would renew only under unlawful and coercive terms prohibited by the Act, the relaxed preliminary injunction standard under the Act would be available to resume the continuation of the franchise relationship during the litigation.

The Court chose to impose an easy-to-apply test for trial courts to determine whether federal subject matter jurisdiction exists in service station constructive termination and nonrenewal claims. By analogy, the Court's decision may provide persuasive precedent for claims under other state franchise relationship statutes. The Court's decision allows franchisors to have greater flexibility to modify the terms of their franchise agreements at the time of renewal because the franchisee may be required to elect between ceasing operation and accepting more stringent economic terms as a condition of renewal.

Common Law Remedies

The decision also discusses common law remedies for franchisees confronting potential constructive termination and nonrenewal claims. The case provides important lessons in critical thinking and strategy for all franchise termination and nonrenewal decisions.

Craig R. Tractenberg is a franchise, distribution, litigation and dispute resolution partner based in Nixon Peabody's New York City office. This article originally appeared in the New York Law Journal, an ALM sister publication of this newsletter.