FYI: 6th Cir Holds RICO Claims Generally Not Available to Creditors Following Corporate Default

The U.S. Court of Appeals for the Sixth Circuit recently affirmed the dismissal of a lender's RICO claims asserted in connection with a borrower's default on a $5 million dollar loan.

 

In so ruling, the Sixth circuit held that:

 

1-  The "fairly traceable" inquiry required for constitutional standing is jurisdictional, and distinct from the "proximate causation" element required to properly plead and prove a claim;

 

and

 

2-  RICO claims generally are not available to creditors following a corporate default, agreeing with several other federal appellate courts.

 

A copy of the opinion is available at:  Link to Opinion

 

A limited liability company ("lender") invested in startup company ("borrower") the purportedly had valuable intellectual property. The borrower was seeking to raise $26 million dollars to retire existing debt, cover future operating expenses, and take measures needed to begin production. Lender agreed to loan the borrower $5 million dollars. ("Loan") The loan was conditioned on the borrower securing the rest of the $26 million dollars and the loan would be secured by the borrower's intellectual property.

 

Prior to the lender and borrower closing on the loan, the lender learned that another entity ("third-party lender") already obtained an interest in the borrower's intellectual property. This posed a problem for the lender because the third-party lender's interest was secured by the intellectual property, and the third-party lender's interest was senior to the lender's.  Therefore, lender agreed to allow the borrower to pay $3.3 million to the third-party lender to pay off the third-party lender's loan and ensure that the lender had the first secured position on the borrower's intellectual property.

 

As time passed, the lender allegedly became wary of the borrower's business operations. The lender alleged that it learned the borrower actually only owed the creditor $2.2 million and that the shareholders of the borrower and the third-party lender were the same parties. Furthermore, according to the lender, the borrower did not disclose to the lender that the borrower licensed out their intellectual property to a separate entity and received no funds for the licensing agreement. Beyond the payoff to the third-party lender, the borrower also chose not to draw down the lender's line of credit to the borrow, and never purchased the equipment needed to begin production.

 

The lender alleged that the principal of the borrower owned a separate consulting company ("consulting company") and improperly diverted business opportunities to his consulting company for the principal's own personal benefit. A proxy war over control of the borrower and allegations of intellectual property theft further added to the turmoil of the borrower who at one point was losing $500,000.00 per month.

 

Eventually, the borrower defaulted on the loan. As a result, the lender filed various lawsuits in state and federal court.  In this case filed in federal court, the lender sued nine (9) defendants:  two shareholders of the borrower, two employees of the borrower, the consulting company, the creditor, and the principals of the creditor ("defendants").

 

The lender alleged the defendants' actions violated the federal Racketeer Influenced and Corrupt Organizations Act ("RICO") for engaging in a pattern of racketeering activity. The lender alleged that the defendants committed: two acts of bank fraud, one act of transactions involving money derived from that bank fraud, one act of trade secrets misappropriation, and one act of wire fraud.

 

Defendant moved to dismiss for failure to state a claim. The trial court granted defendants' motion to dismiss and this appeal followed.

 

STANDING

 

As an initial matter, the Sixth Circuit reviewed the lender's standing to sue. As you may recall, the U.S. Supreme Court requires a party standing in a lawsuit to satisfy the three elements: (1) an injury in fact that is (2) fairly traceable to the defendant's conduct and (3) likely to be redressed by judicial action. Spokeo, Inc. v. Robins, 578 U.S. 330, 337–38 (2016).

 

The defendants argued that the lender's allegations did not show injury that that "fairly traceable" to the defendants' alleged conduct, because the lender's alleged injuries were "merely the indirect result of defendants' alleged fraud, financial misconduct, and trade secrets misappropriation".  The argued that "courts have used the phrase 'RICO standing' when describing the requirement that a RICO plaintiff show a proximate connection between its injury and the defendant's conduct for purposes of pleading and proving a viable RICO claim."  See, e.g., Lerner v. Fleet Bank, N.A., 318 F.3d 113, 129 (2d Cir. 2003), abrogated on other grounds by Lexmark Int'l v. Static Control Components, Inc., 572 U.S. 118, 127 (2014).

 

The Sixth Circuit disagreed, holding that "[w]hile proximate causation is an element of a RICO plaintiff's cause of action, ... it is not a jurisdictional requirement."

 

Thus, the Sixth Circuit ruled the lender had standing to sue all but one defendant because the complaint properly alleged that the defendants made misrepresentations in acquiring the loans and then engaged in financial misconduct and trade secret misappropriation, which resulted in borrower's default and harmed the lender's standing as a creditor. As a result, the allegations in lender's complaint were sufficient to show a traceable connection between conduct and injury as to most of the defendants.

 

However, the Sixth Circuit held that the lender did not have standing to sue the consulting company because the lender's lawsuit did not allege that the consulting company's actions reduced the borrower's capitalization or ability to repay the lender.

 

RICO ISSUES

 

RICO creates a private cause of action for civil litigants when "[a]ny person injured in his business or property by reason of a violation of section 1962" may sue for treble damages and attorney's fees. 18 U.S.C. § 1964(c). Section 1962 lists the prohibited activities that may ultimately violate the statute.  18 U.S.C. § 1962.

 

To properly plead a violation of the RICO statute a plaintiff must allege: (1) two or more predicate racketeering offenses, (2) the existence of an enterprise affecting interstate commerce, (3) a connection between the racketeering offenses and the enterprise, and (4) injury by reason of the above. See Moon v. Harrison Piping Supply, 465 F.3d 719, 723 (6th Cir. 2006); Frank v. D'Ambrosi, 4 F.3d 1378, 1385 (6th Cir. 1993).

 

The RICO plaintiff must be able to plead at least two of those five predicate acts, and, from the foundation of those two acts, the remaining elements of a RICO claim. If these facts are properly pled, a plaintiff can meet its burden to state a RICO claim. See 18 U.S.C. §§ 1961(5), 1962.

 

The Sith Circuit also recited that "proximate cause, as an aspect of RICO's "by reason of" standard, has been understood to require a RICO plaintiff to show that the defendant's racketeering offense 'led directly to the plaintiff's injuries", and that "RICO's directness requirement elevates a plaintiff's burden by requiring more than a showing of mere foreseeability, the crux of common law causation principles."  In addition, the Sixth Circuit noted, the "'by reason of' standard precludes recovery where a plaintiff's injuries are merely the 'derivative or passed-on' result of the alleged racketeering activity."

 

The lender alleged that the defendants committed five (5) separate predicate racketeering offenses: two acts of fraud against a financial institution, transactions using money derived from that fraud, trade secrets misappropriation and wire fraud.

 

However, the Sixth Circuit pointed out that the lender only alleged that it "incurred injuries due to a cascading series of wrongful acts committed by defendants to harm" the borrower, which was not enough to meet the "by reason" of causation standard for RICO claims.

 

More importantly, the Appellate Court noted, "the injury a creditor suffers due to a corporation's default caused by another party's actions is considered derivative, not direct, for purposes of RICO causation. In that scenario, the acts of racketeering target the corporation, not the creditor."  Thus, the Sixth Circuit continued, a "RICO claim is customarily unavailable to creditors following a corporate default."

 

Explaining its ruling, the Sixth Circuit stated that, "[if there is any proper plaintiff to assert claims for the wrongdoing alleged by [lender], RICO's causation principles suggest that it is [borrower]. After all, [borrower], as the 'immediate victim[]" of defendants' alleged violations, 'can be expected to vindicate the laws by pursuing [its] own claims", and that "[h]olding otherwise, it bears noting, would dramatically expand RICO's scope."

 

The lender tried to raise two additional arguments on appeal. First, the lender argued that since the lender's security interest in the borrower's intellectual property vested, the misappropriation of the trade-secrets led to a direct injury. Second, the lender argued that they properly alleged multiple acts of wire fraud and together these acts established a pattern of racketeering activity.

 

However, the lender did not properly raise these issues at the trial court, and therefore the Court of Appeals did not consider these issues on appeal.

 

Therefore, the Sixth Circuit affirmed the trial court's dismissal of the lender's RICO claims.

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 6^th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

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FYI: 2nd Cir Holds NY's Interest-on-Escrow Law Preempted as to National Banks

The U.S. Court of Appeals for the Second Circuit recently held that:

 

(1) New York's interest-on-escrow law is preempted by the National Bank Act of 1864 ("NBA") under the "ordinary legal principles of pre-emption," Barnett Bank of Marion Cnty., N.A. v. Nelson, 517 U.S. 25, 37 (1996), and

 

(2) the amendments to the NBA in the Dodd Frank Wall Street Reform and Consumer Protection Act ("Dodd Frank Act") did not change this analysis.

 

A copy of the opinion is available at:  Link to Opinion

 

The plaintiff borrowers in two putative class actions took out home mortgage loans from a national bank, one before and the other after the effective date of certain provisions of the Dodd Frank Act. The loan agreements, which were governed by the laws of New York and by federal law, required the borrowers to deposit money in escrow accounts for property taxes and insurance payments for each mortgaged property.

 

When the bank paid no interest on the escrowed amounts, the borrowers sued for breach of contract, claiming that they were entitled to interest under New York General Obligations Law Section 5-601 ("GOL Section 5-601"), which sets a minimum 2% interest rate on mortgage escrow accounts.

 

The bank moved to dismiss on the ground that GOL Section 5-601 does not apply to mortgage loans made by national banks because, as applied to such banks, it is preempted by the NBA. The trial court disagreed and denied the motion. The bank timely appealed.

 

As you recall, the Supremacy Clause of the United States Constitution provides: "the Laws of the United States" made "in Pursuance" of the Constitution "shall be the supreme Law of the Land . . . [the] Laws of any State to the Contrary notwithstanding." U.S. Const. art. VI, cl. 2.         

                                                                                                                   

Under "ordinary legal principles of pre-emption," a court asks whether the federal and state provisions are in "irreconcilable conflict." Barnett Bank of Marion Cnty., N.A. v. Nelson, 517 U.S. 25, 31, 37 (1996). In that regard, the Second Circuit noted that, when the NBA grants "powers" to national banks, "both enumerated and incidental," those powers are "not normally limited by, but rather ordinarily pre-empt[], contrary state law." Id. at 32.  

 

The borrowers here argued that state laws are preempted by the NBA only if they "prevent the exercise of a national bank's power [or] come close to doing so." And to make that determination, the borrowers urged the Second Circuit to look to the "degree of interference," which they claimed was "minimal" because the law requires payment of only a "modest amount of interest." Id. at 34–35.

 

However, the Second Circuit made it clear that the question is not how much a state law impacts a national bank, but rather whether it purports to "control" the exercise of its powers. McCulloch v. Maryland, 17 U.S. (4 Wheat.) 316, 431 (1819); see also United States v. Washington, 142 S. Ct. 1976, 1984 (2022); Farmers' & Mechs.' Nat'l Bank v. Dearing, 91 U.S. 29, 34 (1875); Watters v. Wachovia Bank, N.A., 550 U.S. 1, 11 (2007); Easton v. Iowa, 188 U.S. 220, 230 (1903).

 

Additionally, the Court held that control is not a question of the "degree" of the state law's effects on national banks, but rather of the kind of intrusion on the banking powers granted by the federal government. McCulloch, 17 U.S. at 430–31.

 

In light of the foregoing, the Second Circuit concluded that GOL § 5-601 was preempted.

 

The Second Circuit explained that the banking power at issue here was the power to create and fund escrow accounts, and the Court determined that GOL § 5-601 would target, curtail, and hinder a power granted to national banks by the federal government. By requiring a bank to pay its customers in order to exercise a banking power granted by the federal government, the law would exert control over banks' exercise of that power.

 

Thus, the Court concluded that no interest was due to the borrowers under federal law and the law of New York State and the borrowers failed to state a claim for breach of contract.

 

Furthermore, the Dodd Frank Act provides that "State consumer financial laws" are preempted in three circumstances: (A) if they have a "discriminatory effect on national banks" as opposed to state-chartered banks; (B) if "in accordance with the legal standard for preemption in the decision of the Supreme Court of the United States in [Barnett Bank]," the law "prevents or significantly interferes with the exercise by the national bank of its powers"; or (C) if the law "is preempted by a provision of Federal law other than title 62 of the Revised Statutes." 12 U.S.C. § 25b(b)(1).

 

The borrowers admitted that the Dodd Frank Act codified Barnett Bank, but they nonetheless urged a close textual analysis of the phrase "significantly interferes"— language from the Dodd-Frank Act mirroring the Court's opinion in Barnett Bank. See 12 U.S.C. § 25b(b)(1)(B); Barnett Bank, 517 U.S. at 33.

 

However, the Second Circuit reasoned that, when Congress "ha[s] before it the meaning" a case gave "to the words it selected…, [the court] give[s] the language found...the meaning ascribed [to] it" by that case. Slack v. McDaniel, 529 U.S. 473, 483 (2000). In turn, the Court held that the borrowers' focus on the words "significantly interferes" in isolation was misguided because Barnett Bank was explicit that it was applying the "ordinary legal principles of pre-emption," not announcing a new standard. 517 U.S. at 37.

 

However, even under the borrowers' interpretive approach, the Second Circuit was unpersuaded by their arguments.

 

The borrowers' assumed that "significantly" must mean of high "degree." But although "significant" can mean "[f]airly large in amount or quantity," the Court concluded that it can also mean "important" or "meaningful"— as in, interference is significant if it is important in relation to the banking power at issue. Significant, American Heritage Dictionary of the English Language (4th ed. 2000).

 

In short, the Court held, the Dodd Frank Act amendments did not change the analysis applicable to this case.

 

Accordingly, the Second Circuit reversed the trial court's order and remanded for further proceedings consistent with its opinion.

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 6^th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

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FYI: Ill App Ct (5th Dist) Holds Release of Mortgage May Be Obtained by Citation to Recover in Probate

The Illinois Court of Appeals, Fifth District, affirmed a trial court's judgment granting the release of a mortgage and vacated the trial court's order denying an award of attorney's fees.

 

In so ruling, the Appellate Court held that a citation to recover under section 16-1 of the Illinois Probate Act is a proper vehicle to be used to obtain a release of mortgage.

 

A copy of to the opinion is available at:  Link to Opinion

 

The borrower (Decedent) died in August of 2016. After Decedent's death, a financial institution (Lender) filed a claim against the Decedent's estate (Estate) regarding two promissory notes personally guaranteed by the decedent.

 

The first promissory note (First Note) was secured by a mortgage on four separate parcels of real property along with the leases and rents associated with the properties.  The second promissory note (Second Note) refinanced a separate parcel of real estate and was secured by a mortgage along with the leases and rents associated with the property. The Decedent personally guaranteed the First and Second Note, and Decedent's limited liability company (LLC) owned the real estate.

 

After Decedent's death, Lender sued the Estate in Jackson County. Count I of the Lender's lawsuit was a foreclosure proceeding against the LLC that owned the properties secured by the First and Second Notes. Count II was an action on the guaranties against the Estate.  The trial court in the Lender's lawsuit entered judgment of foreclosure, approved the report of sale, and issued a deficiency judgment against LLC and Estate. The trial court in Jackson County also awarded the Lender possession of the properties and required the Estate to transfer all security deposits to the Lender.

 

The Estate responded by filing a petition in Marion County for citation to recover release of mortgage (Petition) as to the portion of the collateral property located in Marion County. The Petition alleged that Decedent paid off the loans associated with the Marion County property and the Lender wrongfully foreclosed on the property.

 

The Estate requested a release of the mortgage and penalties and legal fees under the Illinois Mortgage Certificate of Release Act and section 16-1(d) of the Illinois Probate Act of 1975  which provides an Illinois trial court authority to "determine all questions of title, claims of adverse title and the right of property and may enter such orders and judgment as the case requires." 755 ILCS 5/16-1.

 

The trial court in the Estate's action in Marion County held an evidentiary hearing and ultimately found that both of the loans were paid in full before Decedent's death. As a result, the First and Second Notes for the loans were no longer secured by the Marion County mortgage. The trial court further held that promissory notes regarding the LLC and personal guaranties of the Decedent were merged into the judgment from the Lender's lawsuit in Jackson County and the Lender's deficiency judgment in Jackson County was not a debt secured by the Marion County mortgage. The trail court ordered the Lender to execute and deliver releases of the mortgages under Section 2 of the Illinois Mortgage Act, 765 ILCS 905/2. The trial court also allowed the Estate to file a petition for its attorney's fees and costs, which the trial court later denied.

 

The Lender and Estate both appealed.

 

On appeal, the Lender argued that a release of mortgage is not "property subject to a citation to recover" under the Illinois Probate Act. Second, the Lender argued that the mortgage secures the debt which remained outstanding from Decedent and Decedent's estate.

 

The Appellate Court disagreed, holding that a citation to release the mortgage is a proper remedy under section 16-1 of the Illinois Probate Act. The Lender argued it was improper because a release of mortgage was not a document already in existence and therefore section 16-1 did not apply. However, the Appellate Court noted that the trial court determined that the existing loans secured by the mortgages were satisfied. As a result, the trial court had jurisdiction to issue an order requiring the release of the lien under section 16-2(d) of the Illinois Probate Act.

 

The Lender also argued that the deficiency judgment obtained in the Lender's lawsuit in Jackson County should be considered a debt that is ultimately secured by the mortgage on the property in Marion County. However, the Appellate Court noted that the plain language of the mortgage required the Lender to provide the borrower with notice of the right of recission if the Lender alleged the security instrument secured any other debt. Because there was no proof in the record that the Lender complied with this provision, the Appellate Court affirmed the release of the Marion County mortgage.

 

The Estate's cross appeal raised one issue: Whether the trial court erred in denying the Estates motion for attorney's fees and costs. The Estate sought attorney fees under the Section 4 of the Illinois Mortgage Act, which states in relevant part:

 

If any mortgagee or trustee, in a deed in a mortgage, of real property, or his or her executor or administrator, heirs or assigns, knowing the same to be paid, shall not, within 30 days after the payment of the debt secured by such mortgage or trust deed, comply with the requirements of section 2 of this Act, he or she shall, for every such offense, be liable for and pay to the party aggrieved $200 which may be recovered by the party aggrieved in a civil action, with reasonable attorney's fees.

 

765 ILCS 905/4.

 

Because the probate court's order granted the Estate's petition for citation under section 4 of the Illinois Mortgage Act, the Appellate Court held that the probate court improperly denied the Estate's petition for attorney's fees.

 

As a result, the Appellate Court vacated the probate court's denial of the Estate's request for legal fees. In addition, the Appellate Court vacated the probate court's award of costs to the Estate because section 4 of the Illinois Mortgage Act does not include an award of costs to the prevailing party.

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 6^th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

Alabama   |   California   |   Florida   |   Illinois   |   Massachusetts   |   New Jersey   |   New York   |   Ohio   |   Pennsylvania   |   Tennessee   |   Texas   |   Washington, DC

 

 

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