Antitrust Law Daily Wrap Up, RICO—D. Del.: Priority creditors could not pursue RICO claims against bankruptcy creditors seeking equitable subordination, (Sep 7, 2016)

By Mark Engstrom, J.D.

Two companies that became the majority shareholders of Allied Systems Holdings after Allied emerged from bankruptcy failed to plead a concrete financial loss and a pattern of racketeering in their RICO claims against individuals and entities that sought to recover a "substantial multiple" on their original investment in Allied—by forcing the company into bankruptcy a second time and by seeking the equitable subordination of the plaintiffs’ first lien claims, the federal district court in Wilmington, Delaware, has ruled. Because the plaintiffs failed to state a viable RICO claim, the defendants’ motion to dismiss was granted (Yucaipa American Alliance Fund I, L.P. v. Erlich, September 2, 2016, Robinson, S.).

Plaintiffs Yucaipa American Alliance Fund I and Yucaipa American Alliance (Parallel) Fund I sued BDCM Opportunity Fund II, Black Diamond CLO 2005-1, Spectrum Investment Partners, and four members of Allied’s board of directors for RICO violations, fraud, and tortious interference with business relations.

According to the plaintiffs, the defendants’ goal was to force Allied into involuntary bankruptcy—and to equitably subordinate the plaintiffs’ priority lien claims—as part of a scheme to recover a substantial multiple on their original investment in Allied. To implement that scheme, Spectrum and Black Diamond allegedly encouraged the plaintiffs to acquire Allied’s first-lien debts. Thereafter, Black Diamond forced Allied into involuntary bankruptcy and filed an equitable subordination claim against the plaintiffs. The equitable subordination claim remained pending in the bankruptcy court.

Standing. The plaintiffs’ injury—the equitable subordination of their priority lien claims in Allied’s bankruptcy proceedings—had not yet occurred and was wholly contingent on the outcome of the bankruptcy proceedings, the court noted. Any RICO injury from the equitable subordination of their lien claims was therefore speculative. Because the asserted injury included a significant amount of factual speculation, and because the plaintiffs failed to plead a concrete financial loss that was specific and quantifiable, their injury was insufficient to support a RICO cause of action, according to the court.

The plaintiffs argued that their loss of millions of dollars in attorneys’ fees and costs was a concrete financial loss, but the court disagreed. The court noted that the Third Circuit had not formally addressed the issue of whether prior legal fees were sufficient injuries under RICO, and it further noted that other authorities were split on issue.

Nevertheless, the plaintiffs’ legal fees were still pending in Allied’s bankruptcy proceedings. Because recovery on the plaintiffs’ reimbursement claims in the bankruptcy proceedings was still unclear, the plaintiffs’ legal fees did not confer RICO standing. The RICO claim was therefore dismissed.

Pattern of racketeering. The court noted that a pattern of racketeering required multiple predicate acts that: (1) were related and (2) amounted to or posed a threat of continued criminal activity.

With respect to the relationship element, the plaintiffs had alleged that the asserted predicate acts were related to each other and to defendants’ purpose of subordinating their first lien claims by forcing Allied into an involuntary bankruptcy. In the court’s view, those allegations satisfied the requirement that the asserted predicate acts were related.

With respect to the threat of continued criminal activity, the court noted that the plaintiffs could meet that requirement through open-ended or closed ended continuity.

Closed-ended continuity. Because the plaintiffs failed to identify predicate acts that extended over a substantial period of time, they failed to allege close-ended continuity, according to the court. Significantly, the Third Circuit had consistently held that a pattern lasting less than a year did not, as a matter of law, constitute a "substantial" period of time.

In this case, the plaintiffs alleged that the defendants’ racketeering scheme had run "from at least in 2009 and continues today." However, the duration of a pattern of racketeering began on the date of the earliest predicate act, the court explained, and not on the date that the defendants began to contemplate their scheme.

According to the court, the earliest predicate act was committed in September of 2011, when the defendants sent emails that allegedly violated the federal wire fraud statute by facilitating the solicitation of Allied debtholders, who were urged to "join the involuntary petition[s] and [d]efendants’ illegal claims trading."

However, even if the court accepted those emails as acts of wire fraud, the alleged pattern still fell short of the one-year threshold. Because the involuntary bankruptcy petitions that were filed against Allied, and which allegedly constituted mail fraud and bankruptcy fraud, were filed in May of 2012, the pattern of racketeering activity was not more than nine months in duration.

The plaintiffs argued that the predicate acts did not end with the bankruptcy filings in May 2012 because their complaint alleged that the defendants continued to obstruct justice. However, the Third Circuit had decided that obstruction of justice was a viable predicate act only when the alleged obstruction involved witness intimidation. In this case, however, the plaintiffs had alleged that the defendants’ involuntary bankruptcy petitions were supported by false affidavits. In the court’s view, the filing of those affidavits was not a RICO predicate act.

Having pleaded a pattern of racketeering activity that lasted "at most" only nine months, the plaintiffs did not allege close-ended continuity as a matter of law.

Open-ended continuity. The plaintiffs alleged that the defendants’ scheme would continue until the defendants achieved their objective of equitably subordinating the plaintiffs’ debt holdings in Allied. However, the court noted that the Third Circuit had often found that a single scheme involving a single injury to a single victim within a short period of time did not constitute a pattern of racketeering.

The court acknowledged that the Supreme Court had rejected the theory that a RICO pattern required proof of multiple schemes, but it also acknowledged that, when a single fraudulent scheme was short-lived and directed at a limited number of people, the Third Circuit required further indication that the defendant’s fraudulent activities were likely to continue.

In this case, the final goal of the defendants’ scheme was clearly defined identified as the equitable subordination of the plaintiffs’ claims. In the court’s view, however, the scheme had a finite duration and thus did not satisfy open-ended continuity. Significantly, a threat of long-term criminal activity was not present if the predicate acts focused on a clearly defined, discrete, and finite goal.

Because related predicate acts that continued for less than a year and did not threaten future criminal conduct could not satisfy RICO’s continuity requirement, the plaintiffs failed to allege a pattern of racketeering. Dismissal of their RICO claim was therefore warranted.

The case is No. 15-373 (SLR).

Attorneys: John T. Dorsey (Young, Conaway, Stargatt & Taylor, LLP) for Yucaipa American Alliance Fund I LP and Yucaipa American Alliance [Parallel] Fund I LP. Kerri King Mumford (Landis, Rath & Cobb, LLP) for Richard A. Ehrlich, BDCM Opportunity Fund II LP, and Spectrum Investment Partners LP. David M. Hillman (Schulte, Roth & Zabel, LLP) for Black Diamond CLO 2005-1 Ltd.

Companies: Yucaipa American Alliance Fund I, LP; Yucaipa American Alliance [Parallel] Fund I, LP

Cases: RICO DelawareNews