Federal Court Considers Ban On "Formula" Businesses

Winter 2009
News & Publications
CCN Retail Perspectives

This article examines a pair of cases challenging a zoning ordinance restricting “formula” retail stores and restaurants in Islamorada, Florida, an incorporated village comprised of four islands in the Florida Keys.  The U.S. Court of Appeals for the 11th Circuit (the “Court” or the “11th Circuit”; the 11th Circuit covers Florida, Georgia and Alabama) invalidated the portions of the ordinance that restrict development of chain retail stores as an unconstitutional violation of the Dormant Commerce Clause, and remanded the ban on chain restaurants to the lower court for further proceedings under an elevated standard of review.

A.  Dormant Commerce Clause

The Dormant Commerce Clause is a legal doctrine inferred from the Commerce Clause contained in Article I, Section 8 of the U.S. Constitution.  The Commerce Clause grants to Congress the express power to regulate interstate commerce.  Over the years, courts have interpreted this grant of power as evidence of the intent of the drafters of the U.S. Constitution to prevent local legislation that unfairly burdens or discriminates against interstate commerce, such as regulatory measures designed to benefit in-state businesses by burdening out-of-state competitors.

Courts apply two standards of review to determine whether a regulation violates the Dormant Commerce Clause.  If a regulation is discriminatory on its face or has the effect of favoring in-state interests, a higher level of scrutiny is applied.  Such a regulation will be struck down unless it advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives.  If a regulation has only indirect effects on interstate commerce, then a lower level of scrutiny is applied.  Such a regulation will be upheld if the local interest is legitimate and if the burden on interstate commerce does not exceed the local benefits.

B.  Formula Retail

In the first case, Island Silver & Spice, Inc., et al. v. Islamorada, et al. (11th Cir., No. 07-11418, filed September 8, 2008), the 11th Circuit found that the restrictions on formula retail are an unconstitutional violation of the Dormant Commerce Clause.

In 2002, Islamorada enacted a zoning ordinance which limited “formula retail” establishments to 2,000 square feet or 50 feet of frontage.  The ordinance defined “formula retail” as retail sales establishments that are contractually required to maintain standardized features across locations, such as uniforms, services, merchandise, trademark, decor, architecture or layout.

When the ordinance was passed, plaintiff Island Silver owned and operated an independent retail store in Islamorada.  Six months later, Island Silver entered into a purchase and sale agreement with a buyer seeking to develop a Walgreen’s drug store within the same footprint of plaintiff’s existing mixed-retail store building.  After learning that use as a typical Walgreen’s would be prohibited by the Islamorada ordinance, the prospective buyer challenged the formula retail restrictions through the local administrative process.  When the buyer did not prevail, it terminated the purchase agreement.

Island Silver then sued Islamorada to invalidate the formula retail restrictions and to recover damages.  The District Court granted injunctive and monetary relief in favor of the plaintiff.  The District Court also invalidated the formula retail provisions of the zoning ordinance by finding that the provisions violated the Dormant Commerce Clause because they had a discriminatory impact on interstate commerce unsupported by a legitimate state purpose.  Islamorada appealed the ruling of the District Court, but the 11th Circuit affirmed the District Court’s ruling.

The Court found that while the Islamorada ordinance did not facially discriminate against interstate commerce, the ordinance had the effect of favoring in-state interests.  The Court based this determination on stipulations by the parties that the ordinance effectively prevented the establishment of new chain retail stores because premises limited to no more than 2,000 square feet or 50 feet of frontage cannot accommodate the minimum requirements of most nationally and regionally branded retail stores.  Since the ordinance would have the practical effect of discriminating against interstate commerce by effectively eliminating any new interstate chain retailers, the Court applied the elevated scrutiny test.

The 11th Circuit affirmed the District Court’s holding that Islamorada failed to advance a legitimate local purpose for the ordinance.  The ordinance’s stated purpose is the preservation of “unique and natural” “smalltown” community characteristics, encouragement of “small scale uses, water-oriented uses, [and] a nationally significant natural environment,” and avoidance of increased “traffic congestion . . . [and] litter, garbage and rubbish offsite.”

The Court found that although preserving small town community is a legitimate purpose, Islamorada could not demonstrate “that it has any small town character to preserve,” as there are a number of pre-existing formula retail establishments and there is no historic district nor any historic buildings in the vicinity of plaintiff’s property.  The 11th Circuit also agreed with the District Court’s assessment that the ordinance does not effectively serve its stated purpose to preserve Islamorada’s small town character, because the ordinance does not restrict formula retail stores smaller than 2,000 square feet or with less than 50 feet of frontage, or large non-chain businesses.

The 11th Circuit also affirmed the finding of the District Court that the ordinance’s stated purpose of encouraging small-scale and natural uses is not a legitimate state interest because Islamorada failed to prove that it is “uniquely relaxed or natural,” and that there is a “pre-dominance of natural conditions and characteristics over human intrusions.”  Finally, the 11th Circuit agreed with the District Court’s finding that existing regulations could adequately address the ordinance’s stated purpose to limit traffic and garbage.

Since the Court determined that the Islamorada ordinance does not provide a legitimate local purpose, the Court did not reach the third prong of the elevated scrutiny test (whether or not Islamorada can show that no adequate, non-discriminatory methods are available).  Accordingly, the 11th Circuit struck down the restrictions on chain retail stores as an unconstitutional violation of the Dormant Commerce Clause.

C.  Formula Restaurants

In the second case, Joseph Cachia v. Islamorada (11th Cir., No. 06-16606, filed September 8, 2008), the 11th Circuit considered the ban on formula restaurants contained within the same Islamorada zoning ordinance.  Plaintiff Joseph Cachia entered a letter of intent to sell his property to a corporation planning to convert the property into a Starbucks coffee shop.  When the prospective buyer learned that such use would be prohibited by the Islamorada zoning ordinance, the buyer terminated.

Cachia sued to, among other things, invalidate the ordinance as a violation of the Dormant Commerce Clause.  The District Court found that the prohibition on formula restaurants has only an indirect effect on interstate commerce, because it does not bar all out-of-state restaurants, just those restaurants that operate multiple locations sharing common characteristics such as name, trademark, menu or style.  Accordingly, the District Court applied the lower level of scrutiny to the zoning ordinance, and found that the Islamorada ordinance is supported by a legitimate state interest (the economic protection of small, locally-owned businesses) and the burden on interstate commerce does not exceed the local benefits.  The District Court found that Cachia failed to state a valid claim under the Dormant Commerce Clause because the ban on formula restaurants survives the lower standard of review.

The 11th Circuit disagreed with the District Court.  In particular, the 11th Circuit determined that the ban on formula restaurants has more than an indirect effect on interstate commerce.  The 11th Circuit ruled that although the ordinance does not facially discriminate against out-of-state business, the ban on restaurants operating under the same name, trademark, menu or style effectively prohibits interstate restaurants from operating locally.  Accordingly, the 11th Circuit held that the elevated scrutiny test should apply and remanded the case back to the District Court for further proceedings under this higher level of review.

D.  Relevance to California

While the 11th Circuit’s decisions in Island Silver and Cachia are currently binding only on Florida, Georgia and Alabama, it may have relevance to California, as they address a similar issue as was presented in Wal-Mart Stores Inc. v. City of Turlock, a California 5th District Court of Appeal case in April 2006 (which was reported on in Retail Perspectives in the fall of 2006) – the power of a municipality to control and organize development in its boundaries as a means of serving the general welfare.  In Wal-Mart, the court held that a central California town’s ban on discount superstores in excess of 100,000 square feet devoting at least 5% of sales floor area to non-taxable items (such as groceries) was a valid exercise of such power because it reasonably implemented a legitimate policy choice of preferring neighborhood shopping centers equally dispersed throughout the city over big-box megastores.  The reason these decisions may have relevance to California is that Wal-Mart was a state court decision, whereas the 11th Circuit opinions were based on the U.S. Constitution and the Dormant Commerce Clause, which were not at issue in Wal-Mart.  Wal-Mart had also filed in federal court alleging several constitutional violations, but after the California 5th Circuit’s decision, Wal-Mart did not appeal to the California Supreme Court and did not continue with federal case, so it is not clear what might have transpired if Wal-Mart had gone further in federal court, and there is now some authority that could be relied on that might support Wal-Mart, or another big box retailer, if such an ordinance were to be challenged again.

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