When is a franchise contract terminated or not renewed?

Below is a preview of Mac’s Shell Service v. Shell Oil Products Co. (08-240; 08-372), a case that will be argued tomorrow, by Stanford Law School student Shira Liu.  For updates on the case later, check the Mac’s Shell Service page on SCOTUSwiki.

Retail gasoline stations bearing the name of an oil company like Shell or Texaco are frequently operated by franchisees, which typically contract to buy the oil company’s gasoline, license its trademark, and lease its retail premises.  There are about 75,000 such franchisees in the United States.  The 1976 Petroleum Marketers Protection Act (PMPA) partially governs this franchise relationship by, for example, outlining the conditions in which a franchisor may terminate a franchise and requiring it to renew franchise agreements when they expire.  The PMPA allows the franchisor to change some terms in the renewed contract if it does so in good faith and without an improper purpose of coercing franchisees to give up their franchises.  Finally, the PMPA also provides notification requirements for franchisor termination and nonrenewal, relatively lenient guidelines for courts to grant punitive damages, and litigation costs.

The case arose when Shell Oil and Texaco formed a joint venture, which they named Motiva Enterprises LLC, to handle their domestic marketing operations.  Shell assigned its franchisor responsibilities to Motiva, which subsequently phased out a rent subsidy program and offered franchisees whose contracts were expiring new agreements with more onerous terms.

A group of franchisees (which were later winnowed to a representative eight) filed suit against Shell and Motiva in federal district court under the PMPA and state law, seeking a preliminary injunction to stop termination of their franchises and asking for damages for the constructive termination and nonrenewal of their franchises.  Seven of the eight franchisees had signed new franchise agreements “under protest,” and the eighth had exited the industry without renewing its contract but did not directly allege that the renewal terms caused its exit.  Concluding that too much time had passed, the district court declined to issue the preliminary injunction.  However, it allowed the franchisees’ suit for damages to go to the jury, which awarded the eight franchisees $3.3 million.  In the jury’s view, Shell and Motiva had violated the PMPA by constructively terminating and failing to renew the franchise agreements.  On appeal, the U.S. Court of Appeals for the First Circuit affirmed in part and reversed in part.  It agreed that Shell and Motiva had constructively terminated the franchisees’ agreement, but it reversed the jury’s finding that the companies were liable for the constructive non-renewal of the franchise agreement on the ground that the franchisees had signed new franchise agreements.

Petitions for Certiorari

Both sides sought Supreme Court review.  In No. 08-372, Shell and Motiva argued that certiorari was warranted on the question whether a franchisee that continues to operate can claim constructive termination, citing a two-to-four split among the circuits.  In No. 08-240, the franchisees sought certiorari on their constructive nonrenewal theory, citing a one-to-one circuit split.  Shell and Motiva agreed with the franchisees that their petition should be granted, but asked the Court to affirm the judgment below in that respect.  The Court called for the views of the Solicitor General on both petitions; the United States recommended that certiorari be granted on both questions.  The Court granted certiorari in both cases on June 15, 2009.

In their opening brief, Shell and Motiva agree that PMPA was enacted to protect franchisees, but they argue that PMPA is limited to actual terminations and non-renewals initiated by the franchisor.  With regard to the constructive termination claim, Shell and Motiva contend that both the plain and technical meanings of the PMPA apply only if a franchisor terminates a franchise agreement.  Allowing constructive terminations, by contrast, would violate the PMPA’s federal-state balance by preempting state contract law for breach of contract claims.  Finally, they argue that even if the PMPA does allow constructive terminations, the Court should not find one when the relationship is ongoing.

In their brief, the franchisees attempt to draw an analogy between a termination claim brought by franchisees who are still operating and an injunctive suit brought by franchisees in response to a notice of nonrenewal – the latter of which is authorized by the PMPA.  The franchisees emphasize that the statute was intended to give courts equitable power and should be read liberally to protect franchisees. Thus, a prohibited termination occurs when an assignment of a franchise is either invalid under state law or leads to a breach of one of the three statutory elements: the fuel supply contract, the trademark license, or the lease of the premises.

The Solicitor General’s brief supports Shell and Motiva in this case but provides future franchisees with a stronger theory of constructive termination.  In the Solicitor General’s view, a franchisee has a cause of action for constructive termination when the franchisor creates conditions that are so intolerable that a franchisee terminates the franchise.  Such a rule would ignore the assignment condition, but it would also require that the relationship be actually severed; otherwise, the rule would essentially provide a federal remedy for a mere breach of a franchise agreement.

In their supplemental brief, the franchisees attack the Solicitor General’s argument that a claim for constructive termination is sustainable only if the relationship is actually severed.  It would be illogical, they argue, for Congress to require a franchisee to either obtain injunctive relief or wait for the business to actually fail, but for it to exclude the middle ground that franchisees followed in this case:  proceeding to a claim for damages after failing to obtain injunctive relief.

Turning to the constructive non-renewal claim, Shell and Motiva argue that the plain language of the PMPA prevents a franchisee from claiming that its contract was constructively not renewed when it has signed a new agreement, whether “under protest” or otherwise. The PMPA allows good-faith changes to the franchise relationship in new contracts, and nonrenewal is limited by definition to “a failure to reinstate . . . the franchise relationship.”  Franchisees are sufficiently protected by both the PMPA’s requirement that a franchisor give a franchisee notice of nonrenewal and the lenient standards for a preliminary injunction.  These provisions would be unnecessary if a franchisee could sign a franchise agreement and then sue for nonrenewal.

The franchisees counter that these provisions do not protect franchisees from a franchisor offering a contract with bad-faith changes, because a franchisor that inserts such changes into a contract would not provide a notice of non-renewal.  Requiring a franchisee in this situation to refuse to sign a contract, wait for a notice of termination, go out of business, and only then bring suit allows franchisors to coerce franchisees to sign contracts presented in bad faith.

On this point too the Solicitor General seeks a middle ground.  She argues that although the PMPA allows a claim for constructive nonrenewal, a franchisee cannot claim nonrenewal after it has signed a new contract.