Antitrust Law Daily Wrap Up, RICO—EDIll: Mortgage Lender’s RICO Claims Against Real Estate Developers and Former Employees Dismissed, (Dec 13, 2012)

By Tobias J. Gillett, J.D., LLM.

A mortgage company has failed to allege Racketeer Influenced and Corrupt Organizations Act claims against real estate developers, associated entities and individuals, and some of its own employees, the federal district court in Chicago has ruled (Guaranteed Rate, Inc. v. Barr, December 12, 2012, Kendall, V.). The claims failed because the mortgage company did not demonstrate that the RICO defendants had participated in the alleged RICO enterprise’s affairs, rather than pursuing their own individual benefit, and because the mortgage company failed to plead a sufficiently continuous pattern of racketeering activity.

The mortgage company, Guaranteed Rate, Inc., alleged that a seller of condominium units, 13th & State, LLC, owned a condominium complex with many unsold units. With those units unsold, Guaranteed Rate claimed, the guarantors of the loan used to build the complex would stand to lose millions of dollars. Accordingly, the guarantors, their counsel, and another individual concocted a scheme, under which straw buyers would purchase the units at inflated prices, funding the purchases with loans obtained from Guaranteed Rate and other lenders, Guaranteed Rate alleged.

According to Guaranteed Rate’s description of the scheme, Guaranteed Rate’s Vice President of Mortgage Lending assisted in the scheme by collecting false information from the straw buyers and by originating the loans to them. The vice president also retained an appraiser who agreed to prepare false appraisals of the condominium units that would reflect values as high or higher than the purchase prices. A Guaranteed Rate mortgage consultant also allegedly participated in the scheme by certifying that the vice president’s information was accurate.

Excess funds obtained through this scheme were allegedly funneled to another company, Aslam Group, which used them to provide illegal incentives to the straw buyers, including paying the buyers’ down payments, mortgage payments, and homeowner’s association assessments. The defendants intentionally concealed their payment of funds to Aslam Group, and the failure of the straw buyers to pay the earnest money required in their contracts, from Guaranteed Rate.

The same straw buyers who bought units with loans from Guaranteed Rate allegedly also purchased other units in the complex, with loans from other lenders. Despite signing statements claiming that they would employ the units purchased through Guaranteed Rate as their primary residences, the buyers never did so, nor did they provide a 10% down payment at closing. Instead, an attorney for the buyers paid the down payments with checks from Aslam Group. Moreover, the vice president allegedly knew their statements were false, and submitted them to Guaranteed Rate anyway.

The units purchased through Guaranteed Rate were later foreclosed upon. Guaranteed Rate filed a complaint alleging violations of the RICO Act, along with various state law claims.

RICO Statute of Limitations

As the court noted, RICO does not have an express statute of limitation for civil actions, but the Supreme Court has applied the four-year statute of limitations for claims under the Clayton Act to RICO claims. The statute of limitations is an affirmative defense that the plaintiff does not have to address in its complaint, so the complaint could only be dismissed at that stage for failing to comply with the statute of limitations if the plaintiff “plead itself out of court” by alleging facts such that the plaintiff had essentially admitted that the limitations period had expired.

The court observed that the statute of limitations for a RICO claim “begins to accrue when both a ‘pattern of racketeering’—i.e. two predicate acts—has occurred, and when the plaintiff knows or should know he or she was injured.” Guaranteed Rate had alleged predicate acts committed between December 9, 2007 and May 2, 2008. Barring any intervening rule, such as equitable tolling, Guaranteed Rate’s complaint, filed July 9, 2012, would have exceeded the statute of limitations.

However, the court found that Guaranteed Rate could not have known of its injury until after the closing dates for the units, the last predicate acts alleged. Although the vice president and the mortgage consultant knew that the mortgage applications contained false information, their knowledge could not be imputed to Guaranteed Rate due to the common law principle treating a principal as ignorant of facts known to an agent acting adversely to the principal, and in its own interest. While the defendants might still be able to prove their affirmative defense, the court found that Guaranteed Rate had at least not “pled itself out of court” on the statute of limitations issue.

Particularity of RICO Claims

The court moved on to address Federal Rule of Civil Procedure 9(b), which mandates higher pleading requirements for fraud claims, with regard to the RICO claims filed against 13th& State’s counsel. Under Rule 9(b), RICO plaintiffs must “describe two predicate acts of fraud by each RICO defendant with some specificity and state the time, place, and content of the alleged communications perpetrating the fraud, the method by which the misrepresentations were communicated, and the identities of the parties to those misrepresentations.”

In the court’s view, one of Guaranteed Rate’s RICO counts against the counsel were pled with the requisite particularity, in that it specified that he appeared at the closings on behalf of 13th& State and executed the buyers’ HUD forms knowing they did not reveal the funds paid to Aslam Group. However, the other counts did not articulate claims in sufficient detail against the counsel in particular, relying instead on general claims that the defendants as a group had committed various acts. This method of pleading did not satisfy the requirement that RICO claims must “plead sufficient facts to notify each defendant of his alleged participation in the scheme.”

RICO Enterprise

The court identified three elements that an association must possess in order to constitute an enterprise for RICO purposes: “a purpose, relationships among those associated with the enterprise, and longevity sufficient to permit these associate to continue to pursue the enterprise’s purpose.”

The court determined that Guaranteed Rate had failed to demonstrate both that the alleged enterprise had a common purpose and that the defendants had the requisite relationship. Although Guaranteed Rate had asserted that the purpose of the enterprise was to eliminate the liability of the guarantors under the loans used to purchase the condominium complex, it failed to plead facts showing that the defendants “had any interest in the outcome of the alleged scheme beyond their own individual interests.” Each alleged participant entity merely conducted its own affairs for its own benefit.

Moreover, the complaint failed to allege any relationship between the alleged participants beyond that necessary to commit the predicate acts, in the court’s view. Although perhaps sufficient to constitute common law fraud, a RICO enterprise requires more. With regard to the counsel specifically, the court found that the complaint alleged no more that the counsel had performed as a “hireling” for the alleged enterprise. To have liability under RICO, a defendant “must participate in the operation or management of the operation itself, which means having some part in directing those affairs,” facts not alleged here.

Pattern of Racketeering Activity

The court also concluded that Guaranteed Rate had failed to adequately allege a pattern of racketeering activity. A plaintiff pleading a RICO claim must establish at least two predicate acts of racketeering occurring within a ten-year period, and that those acts “extended over a substantial period of time” (closed-ended continuity) or “by their very nature project into the future with a threat of repetition” (open-ended continuity).

The court identified five factors courts use in evaluating closed-ended continuity: “(1) the number and variety of predicate acts; (2) the length of time over which they were committed; (3) the number of victims; (4) the presence of separate schemes; and (5) the occurrence of distinct injuries,” with the duration factor the most important, although not dispositive.

Guaranteed Rate had alleged a six-month scheme, running from formation of the plan to the final closing. The court found that case precedent in the Seventh Circuit indicated that this period did not generally satisfy the duration requirement. Moreover, Guaranteed Rate had only alleged a “single scheme with a single point of completion,” facts that the court found weighed “against a finding of closed-ended continuity.”

Furthermore, the court found that Guaranteed Rate had identified only a single victim of the scheme, itself, and, since courts treat “repeated economic injuries based on a single scheme to defraud” as indistinct from each other, that Guaranteed Rate had only shown one injury. The court therefore found that those factors also weighed against a finding of closed-ended continuity.

Although Guaranteed Rate attempted to get the court to recognize additional units sold through loans provided by other lenders through judicial notice, the court found judicial notice inappropriate for that purpose. The court also found that case precedent cited by Guaranteed Rate that predated the Supreme Court’s 1989 decision in H.J. Inc. v. Northwestern Bell Telephone Co. (492 U.S. 229) had been “at least partially abrogated” by that decision, and that “an overwhelming number” of Seventh Circuit decisions after Northwestern Bell had concluded that “one type of injury resulting from a single scheme lasting less than two years” did not establish closed-ended continuity.

The court identified three methods of establishing open-ended continuity: “(1) a ‘specific threat of repetition’; (2) that the ‘predicate acts or offenses are part of an ongoing entity’s regular way of doing business; or (3) that defendants operate a ‘long term association that exists for criminal purposes.’” The court found none of those methods applicable here, as “the alleged scheme has come to its natural end.”

Although Guaranteed Rate argued that the scheme was capable of being used again to sell real estate, the court found that it had not shown “what natural feature of the alleged scheme renders it so uniquely susceptible to repetition so as to warrant a finding of open-ended continuity.” Moreover, the court found nothing in the complaint that showed that the defendants regularly conducted business in that manner, or operated a long term association for criminal purposes. Therefore, the court found no open-ended continuity.

Having reached these conclusions, the court dismissed Guaranteed Rate’s RICO claims. As the court had dismissed the RICO claims, the sole basis for federal jurisdiction in the case, the court chose not to exercise its supplemental jurisdiction over the remaining state law claims.

The case is No. 12 C 5362.

Clayton E. Hutchinson for Guaranteed Rate, Inc. Joseph Thomas Gentleman for Warren Barr.

Cases: RICO IllinoisNews