Deconstructing Franchisee Claims for "Constructive" Termination and Nonrenewal - Implications of Supreme Court Petroleum Marketing Decision for Distribution and Franchise Generally

Earlier this month, the Supreme Court issued its long-awaited decision in the case of Mac’s Shell Service, Inc. v. Shell Oil Products Co., 559 U.S. ______ (2010). Apart from its holding, the decision is noteworthy in at least two other important respects. First, it represents one of the rare occasions when the high court has spoken on an issue of distribution and franchise law. Second, the decision — authored by Justice Alito — was unanimous.

The Mac’s Shell Service decision involved the interpretation of the Petroleum Marketing Practices Act, 15 U.S.C. § 2801 et seq. (PMPA), a federal statute that establishes uniform federal grounds and procedures for termination and nonrenewal of motor fuel franchises. In terms of precedential value, the holding of Mac’s Shell Service is therefore limited to claims against suppliers brought by retail outlets of branded motor fuel. However, the issue before the Supreme Court in Mac’s Shell Service — whether changes to contract terms can be tantamount to constructive termination and constructive nonrenewal of a franchise or dealership — is one that is litigated frequently under various state statutes. These state statutes include franchise “relationship” laws of general applicability as well as industry-specific statutes that provide certain protections to franchisees and dealers of products that include motor vehicles, boats, ATVs, construction equipment, agricultural equipment, forestry equipment, industrial equipment, and — of course — motor fuel. Courts interpreting these statutes may find the Supreme Court’s Mac Shell Service decision instructive in deciding whether to allow plaintiffs to pursue claims for constructive termination or nonrenewal of franchises, dealerships, or distributorships.

This issue arises frequently when a manufacturer, franchisor, or other supplier proposes — or imposes — substantial changes to the terms and conditions of the franchise, dealership, or distributorship agreement. To address this situation, many state statutes require the same “good cause” for a “substantial change in competitive circumstances” or an “amendment” that they require for a termination or nonrenewal.¹ Because many state statutes require good cause only for termination and nonrenewal, creative and aggressive plaintiffs’ lawyers often allege that changes to contract terms or to the relationship are tantamount to a constructive termination or nonrenewal. In various states — including Connecticut,² Arkansas,³ and New Jersey,⁴ among others — such efforts have been successful.

In Mac’s Shell Service, the plaintiffs alleged that franchisor changes to their rent subsidy were so material that they constituted a constructive termination or nonrenewal. Following a jury verdict and district court judgment in favor of the franchisees, the First Circuit affirmed in part and reversed in part. With respect to constructive termination, the First Circuit held that the PMPA permits a franchisee to recover for constructive termination even without actual abandonment of the franchise if the alleged breach of contract resulted in “such a material change that it effectively ended the lease, even though the [franchisee] continued to operate [its franchise].” See 524 F.3d at 45-47. If the franchisee agreed to renew the franchise on the disputed terms, however, it could not maintain an action for constructive nonrenewal, the First Circuit held.

The Supreme Court found that neither cause of action — constructive termination or constructive nonrenewal — was actionable. In so holding, the Supreme Court relied upon the statutory definition of “franchise,” which includes:

any contract … under which a refiner or distributor (as the case may be) authorizes or permits a retailer or distributor to use, in connection with the sale, consignment, or distribution of motor fuel, a trademark which is owned or controlled by such refiner or by a refiner which supplies motor fuel to the distributor which authorizes or permits such use.

15 U.S.C. § 2801(1) (emphasis added). Absent outright termination or nonrenewal of the trademark license and other essential elements of a franchise, the Supreme Court held, a claim for termination or nonrenewal — constructive or otherwise — is not actionable.

Although the PMPA’s definition of franchise is somewhat unique, most if not all of the other federal and state statutes that govern the franchise relationship define the protected franchise, dealership, or distributorship in terms of a trademark license.⁵ Indeed, it was on this very basis that the Seventh Circuit — in a landmark “market withdrawal” decision this time last year — held that a manufacturer had the requisite good cause for termination of a franchise under the Maine Franchise Law.⁶ If other courts — following the lead of the Supreme Court and the Seventh Circuit — are similarly true to the language of franchise and dealer protection statutes, claims for constructive termination and nonrenewal may be relegated to where Mac’s Shell Service says they belong: at best, a claim for breach of contract. 

¹ For example, the Wisconsin Fair Dealership Law (WFDL) requires good cause to “substantially change the competitive circumstances of a dealership agreement” (Wis. Stat. §  135.03) (emphasis added) along with 90-days prior notice to the dealer of any “substantial change in competitive circumstances.” Wis. Stat. §  135.04. The notice must “state all the reasons for … substantial change in competitive circumstances” and “provide that the dealer has 60 days in which to rectify any claimed deficiency.” Id. As interpreted by the Wisconsin Supreme Court, the notice requirements of Section § 135.04 apply to any “substantial change in competitive circumstances” of the dealership rather than the dealership agreement. See Jungbluth v. Hometown Oil, Inc., 201 Wis. 2d 320, 330, 548 N.W.2d 519, 523 (1996).

² Petereit v. S.B. Thomas, Inc., 63 F.3d 1169, 1183 (2d Cir. 1995).

³ Capital Equipment, Inc. v. CNH America LLC, 471 F. Supp. 2d 951, 959-60 (E.D. Ark. 2006).

⁴ Maintainco, Inc. v. Mitsubishi Caterpillar Forklift America, Inc., 408 N.J. Super. 461 (App. Div.), cert. denied, 200 N.J. 502, 983 A.2d 1110 (2009).

⁵ For example, under the FTC Franchise Rule, the mere possibility that a “distributor,” “dealer,” “licensee,” “VAR,” “sales representative,” or “sales agent” could use the manufacturer’s trademark suffices to establish a trademark license for purposes of the definition of “franchise.” Informal FTC Staff Advisory Opinion to U.S. Marble, Inc., Bus. Franchise Guide (CCH) ¶ 6424 (Oct. 9, 1980). With respect to the trademark element of the definition, the Amended Franchise Rule Compliance Guide states that “a supplier can avoid Rule coverage of a particular distribution arrangement by expressly prohibiting the distributor from using its mark.”

⁶ See March 27, 2009 Legal News Alert — Seventh Circuit Decision in Landmark “Market Withdrawal” Case Eases Burden on Manufacturers and Franchisors Seeking to Consolidate Branded Distribution Systems (http://www.foley.com/publications/pub_detail.aspx?pubid=5890). 

Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues. If you have any questions about this update or would like to discuss this topic further, please contact your Foley attorney or the following:

Michael J. Lockerby
Washington, D.C.
202.945.6079
mlockerby@foley.com