When we hear the word “franchise,” most of us probably think of a fast food restaurant. As we have discussed in previous posts, franchising is an enormous component of the American consumer marketplace and franchises are common in all segments of the market including the sale of gasoline. Most franchises here in San Diego and elsewhere in California are governed by the statutory scheme established under the California Franchise Relations Act and the California Franchise Investment Act. See Cal. Bus. & Prof. Code, § 20000 et seq. and Cal. Corp. Code, §31000 et seq.

However, sometimes Congress passes a federal law that preempts the application of local and state laws. One example involves gas station franchises, which are covered by the federal Petroleum Marketing Practices Act. See 15 U.S.C. § 2805. Like its California statutory “cousins,” the Act is intended to protect franchisees from arbitrary actions taken by the franchisor. Franchisees spend large sums of money and time building up their franchises and, often, the business is the sole source of family income. Having the franchise terminated can have life-altering consequences.

A recent decision issued by the federal Court in San Francisco gives a good illustration of how the Act is applied. See S.A. Mission Corp. v. BP Westcoast Products, LLC, Case No. C 18-03456 WHA (January 3, 2019). In that decision, the court issued a temporary restraining order preventing the franchisor, British Petroleum Westcoast, from terminating its franchise agreement with the franchisee, S.A. Mission Corporation. The case is interesting for a number of reasons including the fact that the court took a very close look at the various alleged violations of the franchise agreements.

The case involved operation of a gas station and mini-mart located in San Francisco under the franchise brand ARCO. There were actually two franchise agreements — one for selling and running the gas station and an agreement covering the mini-mart. Both agreements contained nearly identical provisions related to what was termed the “image standards.” Under these provisions, the franchisee agreed to maintain the premises in good repair and to operate the mini-mart in accordance with the franchisor’s cleanliness, neatness, state of repair, and other standards set forth in the relevant store systems manuals. The franchisor was allowed under the agreements to conduct periodic inspections and the franchise agreements could be terminated for repeated failure of the inspections.

The inspections took place randomly, but at least once every three months. The inspections resulted in a quarterly report in which a grade was given. Any grade under 70% was considered a failing grade. The franchisee’s station and mini-mart received six failing grades in a row and the franchisor terminated the franchise agreements. The franchisee sued, claiming that the inspections and scoring was in violation of the franchise agreements and that the franchisor was violating the Act by manipulating the inspection regime to force franchisees to sell their stations to the franchisor “at a bargain” so that the franchisor could expand its number of company-owned stations.

As noted, the court held in favor of the franchisee, at least at this early stage of the case. The court looked closely at the franchise agreements, at the quarterly inspection reports and at the evidence — such as photos — contained therein. The court agreed with the franchisor that some violations were indeed shown and seemed properly marked down in the quarterly reports. But, the court also held that other “violations” were not consistent with what the franchisor’s system manuals required. As one example, the systems manual required that an area of the mini-mart called the Fruit Merchandiser “… must be available and stocked.” However, the manual only required “fruit” and did not specify any particular type of fruit. Despite this, in one quarterly report, the franchisor assessed zero points for the alleged failure to keep the Fruit Merchandiser stocked because there were no bananas. However, apples and oranges were available for purchase. The court held that the franchisor had overreached and imposed arbitrary standards that were not listed in the manual.

The court cited several other examples of similar overreaching. As a result, the court issued a temporary injunction preventing the franchisor from terminating the franchise agreements. The case will continue to be litigated, but, for now, the franchisee can continue operating.

Several legal lessons can be seen here. First, courts take the franchise system manuals seriously. Second, if the franchisor wants to impose new and different standards, then the manuals must be updated.

Contact San Diego Corporate Law Today

For more information, contact attorney Michael Leonard, Esq. of San Diego Corporate Law by email or by calling (858) 483-9200. Mr. Leonard has extensive experience with California and federal franchise laws and can draft or review your franchise agreements, help with the purchase (or sale) of a San Diego franchise and/or assist with any other business-related matter. Like us on Facebook.

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