Antitrust Law Daily Wrap Up, RICO—9th Cir.: Commercial property sales did not constitute a conspiracy to defraud property buyers, (May 8, 2014)

By Jody Coultas, J.D.

Commercial real estate buyers failed to state Racketeering Influenced and Corrupt Organizations Act (RICO) and RICO conspiracy claims in connection with an alleged real estate scheme to sell commercial properties at inflated prices based on a lack of allegations of intent to defraud, the U.S. Court of Appeals in San Francisco has held (Electric Properties East, LLC v. Marcus & Millichap Co., May 7, 2014, Gould, R.).

The defending real estate purchasers bought commercial real estate properties and added commercial leases for franchises on each property. After executing sale-leaseback transactions with the defending investment companies, the defending parties allegedly conspired to pay inflated rent payments so that the properties would appear far more valuable to third parties. The investment companies marketed the properties for sale to the public through the Marcus & Millichap Company, which allegedly used sham appraisals performed by the defending appraisal company to support the inflated property values. Electric Properties East, LLC (EPE) purchased all of the properties over three years for $30.3 million. The franchisees eventually failed to make their rent payments and each breached its lease. EPE then filed the RICO claims against the defendants alleging a conspiracy.

A district court dismissed the case under Federal Rule of Civil Procedure 12(b)(6) based on EPE’s failure to meet their burden under Rules 8(a) and 9(b) to plausibly allege a specific intent to defraud EPE.

Rule 8 requires a complaint to include “a short and plain statement of the claim showing that the pleader is entitled to relief.” Under the Twombly pleading standard, the factual allegations must be enough to raise a right to relief above a speculative level. Establishing the plausibility of a complaint’s allegations is a two-step process that is “context-specific” and “requires the reviewing court to draw on its judicial experience and common sense” under the Iqbal plausibility standard.

To state a RICO claim, EPE was required to show a specific intent to defraud the existence of a scheme, which was reasonably calculated to deceive persons of ordinary prudence and comprehension that would allow the court to infer a defendant’s specific intent to defraud. When companies engage in sale-leaseback transactions that are facially legitimate, pay rent and operate legitimate businesses for years thereafter, a significant level of factual specificity is required to allow a court to infer reasonably that such conduct is plausibly part of a fraudulent scheme.

EPE did not meet the pleading standards required by Twombly and Iqbal. One could not plausibly infer that the defendants specifically intended to defraud. Therefore EPE did not show a plausible entitlement to relief, according to the court. The allegation that the property at issue was worth $11.1 million but sold to EPE for $30.3 million was insufficient to show a conspiracy. Although the increase in price was consistent with fraudulent intent, it did not exclude other plausible explanation such as legitimate market forces and the national recession. EPE also failed to show that the properties’ “true fair market value” was actually $11.1 million, as there was no evidence submitted to support this amount. The fraud theory was not plausible when considered in light of the innocent explanations for the failure of franchise businesses in making rental payments, and their abandonment of leases. The facts established that the defendants paid out most of their alleged gains to EPE in rental payments and other operating expenses required to operate the fast food and auto maintenance businesses for up to four years.

The court could not infer a specific intent to defraud from the alleged concealment of the risky nature of the real estate investments. EPE’s allegations were based on the fact that the tenants had not been rated by credit agencies, which the defendants were aware of, and that the defendants described the investments as “safe and secure.” The statements about the relative security of the investments were mere puffery or related expressions of opinion that were not actionable. Also, EPE could not show “deceitful concealment of material facts,” as required. EPE did not request properties with credit-rated tenants, or information about whether the tenants on the properties they were being sold had been so rated.

The case is No. 12-16526.

Attorneys: Susan Katina Alexander (Robbins Geller Rudman & Dowd, LLP) for Eclectic Properties East, LLC; Risola Family LP II; CECA 3000, LP; Cheatham Properties, LLC; and VAS Enterprises I LLC. Daniel E. Jackson (Keker & Van Nest LLP) for Marcus & Millichap Co. Katherine Farkas (Scheper Kim & Harris LLP) for Marcus & Millichap Real Estate Investment Services Inc.; Marcus & Millichap Real Estate Investment Brokerage Co.; Sovereign Investment Co.; and Sovereign Scranton LLC.

Companies: Electric Properties East, LLC; Marcus & Millichap Co.

Cases: RICO FranchisingDistribution AlaskaNews ArizonaNews CaliforniaNews HawaiiNews IdahoNews MontanaNews NevadaNews OregonNews WashingtonNews