I was playing a game recently, and during the game the Happy Days are Here Again environment card was in play(the Terror Level cannot increase with this environment card).

While it was in play I drew A Corrupting Influence from the Legacy of the Pharaohs exhibit. This card says that you MUST discard an ally card or raise the Terror Level by one and draw an exhibit item. With Happy Days are Here Again in play I cannot raise the Terror Level. What happens if I have no allies in this situation? Do I just get a free exhibit item? If I did have an ally could I opt to "raise the Terror Level" and then just not actually raise it because of the environment and take an exhibit item? Would I just not get an exhibit item because I could not do either action that I must do in order to get the item?

During the game I was using Charlie Kane, so I did have an ally(two in fact). I decided since I could discard an ally card I would do so and take the exhibit item.

I'll start by saying "can't"s trump "must"s. I'm not making that a solid rule because there could be a good exception but I don't know any off the top of my head, and Happy Days is the best-known example. So the terror level simply can't increase.

Anyway, here's the text of the encounter:

You must either return one of your Ally cards to the box or raise the terror level by one. Then gain an Exhibit Item.

I'll be honest—I'm confused on the wording here. I'm not sure if you're allowed to pick the "terror level" option if it can't increase. I'm inclined to say "no" but I'm starting to confuse this game's rulings with Eldritch's so I'm not 100% on that.

BUT. In any case, no matter which thing you chose, you get the Exhibit item. That occurs after everything else does.

Well, I think if you have an Ally, it would have to be returned. Otherwise, nothing happens.

As a general rule of thumb, you cannot choose an option you're not able to fulfill. If for instance you're given the option to discard an Ally or lose all your clues, you cannot choose the Ally if you don't have one, and you cannot choose the clues if you don't have any.

So, first of all you should check the requisites. If you have an Ally in the case you quoted, you must discard it. If you don't have the Ally, then you choose the Terror and the Mythos card will work as a safety bag.