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Exxon's Zone Pricing Exerts Too Much Control over Franchisees

A recent case decided by the United States District Court for the District of New Jersey may breathe new life into the New Jersey Franchise Practices Act and the Robinson-Patman Act. South Gas, Inc. v. Exxonmobil Oil Corp., 2016 WL 816748 (D.N.J. February 29, 2016). The plaintiff franchisees’ claims in the case focused primarily on Exxon’s pricing practices, which pivoted off of a labyrinthine discriminatory pricing program known as zone pricing. In ruling for the Exxon franchisees, the Court was careful to point out that its ruling was preliminary, and as such, was limited to the question whether the plaintiff franchisees had alleged enough in the Complaint to meet their initial pleading obligation, not whether the franchisees had substantively proven their claims.

The plaintiff franchisees in this case were independent service station dealers that purchased refined gasoline directly from Exxon and other suppliers for resale to the public at retail service stations in New Jersey. Exxon’s zone pricing scheme divided New Jersey into approximately 100 zones and charged retail gas stations different wholesale prices for gas depending on the station’s zone placement. Because Exxon’s zone pricing scheme favored certain stations and disfavored other stations, including the plaintiffs, the franchisees claimed they were forced to charge higher retail prices to cover their operating expenses. Some of these wholesale price differences were so significant that they resulted in wholesale prices in some zones exceeding the retail prices in other contiguous zones.

Further exacerbating the financial plight of the franchisees was Exxon’s questionable calculation of rent. Under the prototypical lease, the plaintiffs that leased from Exxon were required to pay rent under a rent schedule determined in accordance with Exxon’s National Rent Guidelines, based heavily on a multiplier on the underlying property value, which was determined by appraisal. Although real estate values fell during the recession, the plaintiffs alleged that their renewed leases did not reflect that reduction in value, and in some cases, in fact, increased. The plaintiffs also alleged that Exxon engaged in other unfair practices such as refusing to credit rent offsets caused by tax increases, thereby refusing to pass these promised savings along to plaintiffs.

Similarly, the franchisees claimed that Exxon secretly planned to assign the dealers’ franchise agreements to a third party even though it had promised the franchisees it would not do so. In addition, the plaintiffs alleged that Exxon violated myriad other provisions of the franchise agreements, including: (1) refusing to pay for satellite lines, (2) withholding its approval of point of sale equipment, (3) charging plaintiffs higher credit card fees than plaintiffs would be charged by third party services, and (4) forcing the franchisees to purchase thousands of dollars of equipment associated with the “Speedpass” program, which Exxon then unjustifiably terminated without refunding plaintiffs for their expenditures.

Exxon’s Control Over its Franchisees Poses a Legal Problem in New Jersey

The Court began its analysis by examining the Robinson-Patman Act, which prohibits price discrimination that threatens to lessen competition or create a monopoly. The Robinson-Patman Act, unlike other federal antitrust laws, is not limited exclusively to market conduct that causes a loss to allocative economic efficiency. In this case, the franchisees alleged that Exxon’s zone pricing system caused secondary-line competitive injury to the discriminating seller’s customers (the dealer plaintiffs). Regarding the plaintiffs’ need to plead adequate competitive injury, the Court noted that the Robinson-Patman Act allows for a legal inference of such harm to be based upon the plaintiff’s showing that it competed with favored dealers to sell the product, and that the seller charged those competing dealers lower prices over an extended time.

Rejecting Exxon’s argument that the franchisees’ allegations of price differences did not suffice to prove wrongdoing, the Court pointed out that the inference of injurious price discrimination could be drawn in light of these additional allegations: (1) Exxon controlled the franchisees’ profit margins using the WAM calculation, by raising wholesale prices if plaintiffs raised retail prices or reduced other costs to increase their margins;  (2) Exxon forced the plaintiffs to lower their retail prices before Exxon would lower the wholesale prices; and (3) Exxon controlled other dealer costs that would be factored into retail prices, such as rent and technology costs.

As the Court concluded:

“With Exxon exerting this level of control over its dealers, a showing of extended disparities in retail prices among dealers makes an inference of price discrimination more reasonable.”

Exxon’s franchise lawyers also criticized the franchisees’ Robinson-Patman claims for failing “to allege that sales actually have been diverted away from any specific plaintiff to any specific ‘favored’ competitor.” The Court, however, refused to saddle the plaintiffs with such a rigorous burden to show competitive injury. According to the Court, plaintiffs met their burden, showing a reasonable inference of competitive injury, by alleging that “a favored competitor received a significant price reduction over a substantial period of time.”

Turning next to the New Jersey Franchise Practices Act (“NJFPA”) claim, the Court pronounced that since the NJFPA was enacted to remedy the effects of unequal bargaining power, it must generally be “construed broadly.” The franchisees’ specific franchise act claim was that Exxon violated Section 56:10-7(e) of the NJFPA, which makes it a violation for a franchisor “to impose unreasonable standards of performance upon a franchisee.”

The Court noted straightaway that its legal analysis would be handicapped to some extent given that neither the NJFPA nor prior courts provided a working definition of “unreasonable standards of performance.” In the face of this legal vacuum, the Court relied upon a preliminary and earlier ruling made by a prior judge in the case.  In this regard, the Court stated that “Judge Chesler appeared disinclined to accommodate plaintiffs and extend the NJFPA beyond his holding in King that ‘arbitrariness, bad intent or economic ruin appear to be the hallmarks of an ‘unreasonable standard of performance’ under the NJFPA.” However, the Exxon Court then pointed out that a prior New Jersey case found that it was an unreasonable standard of performance for a franchisee to be required to lose eleven million dollars or forty percent of sales. (Beilowitz v. Gen. Motors Corp., 233 F. Supp. 2d 631, 643-44 (D.N.J. 2002).

 

Exxon’s Zone Pricing Program Could Violate New Jersey Law

After determining that the service station dealers had met their burden, the Exxon Court added some flavorsome additional meat to the ‘unreasonable standards of performance’ bone by observing that many of the prior cases on Section 56:10-7(e) “were decided based upon reviewing evidence in aggregate and deciding whether compliance with the standards of performance was unreasonable.” See e.g., Dunkin’ Donuts Inc. v. Dough Boy Mgmt., Inc., No. CIV 02-243 (JLL), 2006 WL 20521, at *11 (D.N.J. Jan. 3, 2006) (“Defendants provide a litany of examples as to how Plaintiffs set them up for failure….”); Carlo C. Gelardi Corp. v. Miller Brewing Co., 502 F. Supp. 637, 653 (D.N.J. 1980) (“While any given action of franchisor may not have violated this statutory prohibition the cumulative effect amounted to imposing an unreasonable standard of performance….”); Cent. Jersey Freightliner, Inc. v. Freightliner Corp., 987 F. Supp. 289, 295-96 (D.N.J. 1997) (requiring stores stay open twenty four hours a day, seven days a week, as well as specific inventory levels, sales quotas, and financing was not sufficient for a preliminary injunction).

In ruling for the Exxon franchisees on their NJFPA claim, the Court also rejected the argument of Exxon’s franchise attorneys that the franchisees’ allegations failed to meet a “minimum level of specificity.” The Court determined that the plaintiffs’ allegations sufficiently identified specific infractions that involved “standards” under the plain meaning of the NJFPA. In this regard, the Court pointed to two items in the Complaint that it believed were “standards of performance”, including inventory and volume requirements. The Court bolstered its decision on this issue by stating that “additionally, plaintiffs proffer a list of other complaints that could contribute to a finding of a § 56:10-7(e) violation, including price discrimination.”

Piercing the outer layer of negativity associated with Exxon’s esoteric zone pricing scheme reveals the underlying source of the franchisees’ legal action — the battle for overall operational and managerial control at the dealership level. In this regard, the franchisees were convinced of the following two facts: (1) that they possessed prolific clearly articulated rights under their franchise agreements to control many aspects of their day-to-day businesses; and (2) that Exxon usurped these rights by exercising command over their businesses in copious ways.

The Complaint, if taken as true, showed that Exxon exercised pervasive control over the dealers – Exxon set the rent, established wholesale gas prices, instituted hours of operation, charged for connection to satellite systems and credit card fees, and dictated product deliveries and inventory levels. Indeed, the only vital aspect of retail operations that did not appear to be explicitly controlled by Exxon through the franchise agreement was the dealers’ retail pricing. However, given Exxon’s manipulation of almost every cost incurred by the dealers, a good argument can be made that, in effect, Exxon controls and directs its dealers’ retail gas prices. And, since the Court has already ruled that it will use an “aggregate impact” test for a violation of the NJFPA, Exxon’s pervasive control over its dealers’ financial fortunes cannot bode well for a final ruling in its favor on the merits of this claim.

 

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