Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—DSC: Franchisee Customers’ RICO Claims Against President of Tax Preparation Franchisor Proceed, (Mar 28, 2013)

By John W. Arden, J.D., LL.M.

Customers of Liberty Tax franchisees stated a federal RICO claim against the president of the franchisor for instructing franchisees and their employees to sell unnecessary forms and schedules when completing tax returns, so that the franchisees could charge higher fees, the federal district court in Charleston, South Carolina has ruled (Martin v. JTH Tax, Inc., March 27, 2013, Norton, D.).

While the customers’ RICO claims against the president survived a motion for summary judgment, their RICO claims against a marketing officer of the franchisor did not. The officers also were granted summary judgment on the customers’ unjust enrichment claims.

Background. Kenneth Martin and other customers brought suit against JTH Tax, Inc., d/b/a Liberty Tax Services, the president and CEO John Hewitt, and marketing vice president Danny Hewitt for violation of the federal RICO law (against the Hewitts), breach of contract (against Liberty Tax), breach of fiduciary duties (against Liberty Tax), and unjust enrichment (against all defendants).

In 2009, Kenneth and Myra Martin sued Liberty Tax and South Carolina franchisee Annie Fuller in state court, claiming that their tax returns had been improperly prepared pursuant to the same fraudulent scheme asserted in this case. According to the complaint in this case, Liberty Tax refused to defend Fuller, portraying her as a “rogue franchisee” and ultimately terminating her franchise agreements. Liberty and its officers contend that Fuller made a deal with plaintiffs’ counsel to provide recorded statements regarding the franchise system in return for dismissal of the state court claims against her.

The plaintiffs alleged that Fuller admitted to teaching improper tax preparation methods to franchisees at the direction of the Hewitts. Specifically, she instructed franchisees on how to increase the cost of tax returns and the amount of refunds due to customers by decreasing the customers’ tax liability through the preparation of false and fraudulent forms and schedules, claiming improper deductions and credits. Plaintiffs further alleged that John Hewitt taught tax preparers not to be concerned about the truthfulness of information given by customers.

Four sets of plaintiffs (the Martins, the Goodwines, the Allens, and the Reids) alleged that they employed South Carolina Liberty Tax offices to prepare federal and state tax returns, that the franchisees’ tax agents filed returns with nondeductible business expenses, that the plaintiffs were audited by state or federal tax authorities, and that they were ordered to pay back taxes, penalties, and interest.

John and Danny Hewitt moved for summary judgment on the RICO and unjust enrichment claims, arguing that the plaintiffs had only the transcript of an interview with Fuller to support an allegation of a unified system-wide fraudulent scheme.

Federal RICO

To prevail in a RICO claim brought under §1962(c), a plaintiff must show (1) the defendant’s employment by of association with (2) an “enterprise” (3) engaged in or affecting interstate commerce, (4) the affairs of which the defendant conducts or participates in through a pattern of racketeering activity. The enterprise must be distinct from the persons alleged to have violated §1962(c).

To state a claims for a RICO conspiracy pursuant to §1962(d), plaintiffs must allege that there was (1) an agreement to further or facilitate (2) an act this is independently wrongful under RICO.

Pattern of racketeering activity. The defendants argued that the plaintiffs failed to show that the Hewitts participated in the enterprise through a pattern of racketeering activity. The plaintiffs relied on a statement of Annie Fuller as evidence of racketeering activity, despite the fact that she later recanted many of the allegations of wrongdoing during her deposition.

They also offered the deposition testimony of Trisha Grabert, a Liberty franchisee who was terminated in April 2012. Grabert stated that she was trained by Annie Fuller to (1) increase her average net fee for tax returns by using unnecessary forms that contained false or inflated data solicited from customers and (2) probe customers and let them make up false or inflated information to be entered into the Liberty computer system. According to Grabert, Fuller was “under the direction of John Hewitt to do this training” and John Hewitt watched Fuller do the training for him.

Viewed in the light most favorable to the plaintiffs, the court found genuine issues of material facts as to whether John Hewitt conducted or participated in a pattern of racketeering activity.

“If believed, Grabert’s testimony would create an inference that John Hewitt spearheaded or at least sanctioned a scheme to electronically file thousands of fraudulent tax returns, which would satisfy the ‘pattern of racketeering activity’ requirement,” the court concluded.

However, the plaintiffs produced no evidence to implicate Danny Hewitt in the alleged fraudulent scheme, the court found. In fact, Grabert admitted in her testimony that Danny Hewitt was not involved in any training regarding tax preparation issues. Thus, summary judgment was entered in favor of Danny Hewitt on the RICO claims.

Causation. The Hewitts further argued that the plaintiffs failed to meet RICO’s causation requirement, which mandates that private plaintiffs show that they have been injured in their business or property by reason of a violation of §1962. The causation requirement has been framed as an issue of standing. To have standing to bring a private cause of action, a plaintiff must show that a RICO predicate offense was the proximate cause of the injury.

The Hewitts contended that plaintiffs could not establish causation because there was no evidence that the plaintiffs were exposed—directly or indirectly—to any of the unlawful tax preparation methods allegedly conducted by John Hewitt, Danny Hewitt, or Annie Fuller. The plaintiffs countered that each of them had tax returns prepared by a Liberty Tax-trained agent working for a franchise owned by Annie Fuller or her business partner.

There was some evidence that the scheme allegedly sanctioned by John Hewitt and taught by Annie Fuller was put in action in South Carolina. From this, it could be inferred that the audits experienced by the plaintiffs occurred as a result of the alleged illegal tax preparation scheme, the court noted. Thus, the court found that the plaintiffs established genuine issues of fact on the causation element.

Accordingly, the court granted summary judgment to Danny Hewitt on the RICO claims but denied summary judgment to John Hewitt on the claims.

Unjust Enrichment

The plaintiffs also brought an unjust enrichment claim, alleging that they had conferred a financial benefit upon Liberty Tax, John Hewitt, and Danny Hewitt by paying for tax preparation services. To recover for unjust enrichment in South Carolina, a plaintiff must show (1) that he or she conferred a non-gratuitous benefit on the defendant, (2) that the defendant realized some value from the benefit, and (3) that it would be inequitable for the defendant to retain the benefit without paying the plaintiff for its value.

The Hewitts contended that the plaintiffs could not satisfy the first element—that they conferred a benefit on them—since any benefit the Hewitts received was from Liberty Tax in the form of royalties and marketing fees from the franchisees. The court agreed, finding that plaintiffs failed to concretely allege or show that they directly conferred any benefit on the individual defendants. Thus, the court granted summary judgment rejecting the unjust enrichment claims against the Hewitts.

The case is No. 9:10-cv-03016-DCN.

Attorneys: Graham Lee Newman (Richard A. Harpootlian PA) for Kenneth Martin. Paul T. Collins (Nelson Mullins Riley and Scarborough) for JTH Tax, Inc.

Companies: JTH Tax, Inc.; Liberty Tax Service

Cases: FranchisingDistribution RICO SouthCarolinaNews