A vehicle system controller (20) is presented for a LSR parallel hybrid electric vehicle having an engine (10), a motor (12), wheels (14), a transmission (16) and a battery (18). The vehicle system controller (20) has a state machine having a plurality of predefined states (22-32) that represent operating modes for the vehicle. A set of rules is defined for controlling the transition between any two states in the state machine. The states (22-32) are prioritized according to driver demands, energy management concerns and system fault occurrences. The vehicle system controller (20) controls the transitions from a lower priority state to a higher priority state based on the set of rules. In addition, the vehicle system controller (20) will control a transition to a lower state from a higher state when the conditions no longer warrant staying in the current state. A unique set of output commands is defined for each state for the purpose of controlling lower level subsystem controllers. These commands serve to achieve the desire vehicle functionality within each state and insure smooth transitions between states.