The U.S. Supreme Court recently decided Mac’s Shell Service, Inc. v. Shell Oil Products Co. LLC et al. 130 S.Ct. 1251 (March 2, 2010). The Court strictly limited the context in which claims can be asserted for constructive termination and constructive nonrenewal of franchise agreements under the Petroleum Marketing Practices Act (PMPA). The Court held that there is no basis for a constructive termination claim under the PMPA when the franchisee did not, in fact, cease operations and abandon the franchise. Furthermore, the Court held that there is no basis for a constructive nonrenewal claim under the PMPA when the franchisee signed a renewal agreement, even if it is signed "under protest."

Background. In 1998, Shell Oil Company joined two other oil companies to create Motiva Enterprises, LLC, which combined the petroleum marketing operations of all three companies in the Eastern United States. Effective January 1, 2000, Motiva took two steps that resulted in numerous franchisees filing a lawsuit.

First, Motiva ended rent subsidies to franchisees based upon sales volume, resulting in higher rent for most franchisees. These rent subsidies had been in place for many years, although they were renewed annually and could be terminated on 30 days' notice. Second, Motiva offered franchise renewals upon the natural expiration of existing franchise agreements that contained a new formula for calculating rent, again resulting in higher rent for most franchisees.

A group of 63 Shell franchisees sued Shell and Motiva, alleging certain claims under state law and two claims under the PMPA, namely that Shell and Motiva had (1) constructively terminated their franchises in violation of the PMPA by eliminating the rent subsidies and (2) "constructively non-renewed" their franchise agreements by pressing franchisees into renewal agreements on less favorable economic terms.

Justice Alito's Decision. Writing for a unanimous Court, Justice Samuel Alito held that a necessary element of a prima facie constructive termination claim under the PMPA is that the alleged wrongful conduct forced an end to the franchisee's use of the franchisor’s trademark, purchase of the franchisor's fuel, or occupation of the franchisor's service station. In other words, business must halt and the franchise be abandoned in order to maintain a prima facie case for constructive termination.

The Court's decision specifically reserves the issue of whether a claim for constructive termination exists at all under the PMPA. While not deciding the issue, Justice Alito's decision contains language that seriously questions the viability of such a claim.

First, the opinion notes that the PMPA is to be read as strictly limiting the reach of federal law into a domain traditionally reserved for the states. An overarching concern about federalism, combined with a strict statutory interpretation standard, led Justice Alito to suggest that allowing the PMPA to address claims that would otherwise be deemed a breach of contract under applicable state law would expand federal jurisdiction under the PMPA beyond what Congress intended. Second, the opinion notes that any standard to be used to determine whether there was a "constructive termination" when an actual termination of the franchise agreement does not exist would be "indeterminate and unworkable."

Reversal of the Appeals Court. In reversing the First Circuit Court of Appeals, the Court criticized the test established by the lower court?that a constructive termination occurs when there is a material change that effectively ends a franchise, even though the franchisee continues to operate. Justice Alito rejected this standard as circular in nature and as simply restating the relevant question.

As a practical matter, Justice Alito noted that any attempt to formulate a standard for "constructive termination" would provide courts with no firm standard to determine when a breach is serious enough to effectively end a franchise when the franchisee continues to operate. Furthermore, the opinion notes that the concept of "constructive termination" does not allow the franchisor to know in advance what breaches a court might later determine to be so serious as to create liability for a wrongful termination. Thus, although not deciding the issue, the language in the decision seriously calls into question whether a subsequent case alleging constructive termination under the PMPA would be successful.

The Issue of Nonrenewal. On the nonrenewal issue, the Court upheld the First Circuit ruling that there can be no claim for constructive nonrenewal when a renewal agreement has been signed. In short, no cause of action exists unless the franchisee does not sign a renewal agreement.

Furthermore, regarding cases in which a renewal agreement has been offered and there is a refusal to sign based on a claim of onerous terms, the opinion questions whether a claim for constructive nonrenewal can be asserted. The decision notes that the PMPA contemplates that franchisors are free to respond to market demands by proposing new and different terms upon renewal.

Practical Implications. The practical implications of Mac's Shell Service are several:

  • The PMPA is to be read strictly and consistent with the goal of limiting federal interference in state court contract law and relationship statutes governing franchises.
  • The scope of preemption under the PMPA is limited to the specific provisions of the statute, which are to be narrowly construed.
  • Claims for constructive termination or constructive nonrenewal under the PMPA may be in jeopardy.
  • Limiting the reach of the PMPA to situations where there is an actual cessation of business operations and removing "constructive" claims decrease the incentive to bring actions under the PMPA created by its attorneys fees and punitive damages provisions.

Language in the decision questioning the nature of constructive termination and constructive nonrenewal claims may be useful in other cases to argue that courts should carefully examine such claims by a franchisee when, in fact, the franchisee remains open for business.