Antitrust Law Daily Wrap Up, RICO—NDIll: Former USA Baby Executive Fails to Plead RICO Claims Alleging Conspiracy Against the Company, (Jan 4, 2013)

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

A former executive of a franchisor of children’s products retailers has failed to state civil RICO claims against a range of former franchisees, shareholders, law firms, government officials and entities, and other entities and individuals, the federal district court in Chicago has ruled (Wallis v. Levine, January 2, 2013, Gottschall, J.).

The franchisor, USA Baby, Inc., sold children’s products through a chain of franchise stores, with Scott Wallis serving as one of its executives. By 2008, some franchises had gone out of business, and three franchisees and creditors filed an involuntary bankruptcy petition against USA Baby, resulting in an automatic bankruptcy stay. The bankruptcy court appointed a trustee for USA Baby, who converted the bankruptcy from Chapter 11 to Chapter 7, after determining reorganization was impossible. Wallis challenged the appointment of the trustee, and the trustee’s later decisions, but his motions were denied.

In May 2009, Commerce Capital, LP received relief from the stay to foreclose a lien on USA Baby’s assets, and in July 2009 Commerce Capital acquired the assets at a foreclosure sale through credit bidding. Commerce Capital subsequently brought and settled a number of lawsuits against USA Baby franchisees for trademark infringement and violations of franchise agreements.

Throughout the bankruptcy proceedings and prior to them, a range of lawsuits were filed against USA Baby and its executives, including Wallis. The Ohio Attorney General sued for violations of Ohio consumer protection laws. Two shareholders, Alan Levine and Barry Cohodes, sued for violations of a shareholder’s agreement. A former USA Baby employee filed a wage claim with the Illinois Department of Labor (IDOL), and the IDOL and the employee pursued claims in state court and administrative proceedings. Creditors, including Fifth Third Bank, American Chartered Bank, and the law firm Petti Murphy & Associates, filed suit to collect on their debts, according to Wallis all in violation of the bankruptcy stay. The U.S. Department of Labor brought suit to collect 401(k) and health insurance payments that USA Baby and its officers allegedly used to pay operating expenses rather than remitting them to participants in the plans, in violation of the Employee Retirement Income Security Act.

Wallis also alleged that some franchisees used USA Baby’s trademarks without authorization, and made false statements to the U.S. Patent and Trademark Office, resulting in the designation of the trademarks as dead. The franchisees allegedly established a new website in December 2008, with Cardservice International processing its credit card transactions.

Wallis filed suit, asserting a wide range of claims, including violations of the Racketeer Influenced and Corrupt Organizations Act (RICO). He claimed that a broad array of defendants, including USA Baby franchisees and law firms involved in the lawsuits against USA Baby, had conspired to “loot” USA Baby, with Levine and Cohodes “coordinat[ing] and mastermind[ing]” the effort and the franchisees promoting it through wire and mail communications. He also alleged that various government defendants “did not act to prevent” the looting, and that other individuals and entities assisted in it.

Specific RICO Claims

Wallis alleged both specific RICO claims against certain defendants, and general RICO claims against all defendants. The court first addressed a claim that the law firm Hinshaw & Culbertson, LLP committed mail fraud by mistakenly entering an appearance in a case filed by Wallis, finding that those allegations did “not support an inference that Hinshaw & Culbertson committed fraud or racketeering.” The court also found a claim against Travelers Insurance Company, for allegedly promising USA Baby that it would pay an insurance claim to a franchisee and then refusing to do so, to be barred by collateral estoppel. A previous court decision had dismissed Wallis’s claims against Traveler’s “as barred by the suit-limitation period in the insurance policy, as preempted by the Illinois Insurance Code, and for failure to state a claim.”

The court next addressed a claim that Commerce Capital committed fraud in seeking relief from the automatic bankruptcy stay. Wallis had not provided any evidence to support his allegations of conspiracy and conflicts of interest regarding the trustee’s failure to oppose Commerce Capital’s request for relief from the stay. In addition, the foreclosure had not been commercially unreasonable, and even if it had been, it “would not establish a predicate act for a RICO claim.” Moreover, an Illinois Appellate Court decision that another executive had notice of the sale precluded Wallis’s argument that he did not have proper notice. The fact that he objected to the sale showed that he did have actual notice of it.

General RICO Claims

The court began its discussion of Wallis’s general RICO claims by explaining that, to state a claim under RICO, “a plaintiff must allege that (1) the defendants were employed by or associated with an ‘enterprise’ that was engaged in activities that affect interstate commerce, and (2) the defendants conducted or participated in the conduct of the enterprise through a ‘pattern of racketeering activity.’” The court first observed that Wallis had not shown that the defendants had engaged in a joint enterprise and that “the court has no idea what the ‘structure’ of an enterprise comprised of a country, two states, three counties, and hundreds of other businesses and law firms might be.”

Moreover, the court found that Wallis had not adequately alleged a pattern of racketeering activity, explaining that such a pattern requires predicate acts that are “related to one another (the relationship prong) and pose a threat of continued criminal activity (the continuity prong).” The court found that Wallis had not satisfied either prong, as the defendants were not related to each other, and as his allegations described “a routine commercial dispute” rather than “organized, longterm, habitual criminal activity.” Furthermore, the conduct posed no threat of future criminal activity, as the alleged enterprise only targeted USA Baby.

Finally, the court found that Wallis had not established the requisite predicate acts for a RICO violation. Wallis had alleged that the franchisees, law firms, and government officials had interfered with interstate commerce by failing to pay royalties, by restricting UBA Baby “from offering, or fulfilling, its services,” and by stopping USA Baby’s sales. The franchisees allegedly trafficked in counterfeit goods by illegally using USA Baby’s trademarks, with the shareholders, law firms, and credit card processor aiding them. The franchisees and law firms allegedly committed copyright infringement, by using USA Baby’s materials to promote their businesses. The franchisees, the law firms, and the credit card processor allegedly conspired to commit wire, mail, and bank fraud by carrying out transactions knowing the use of USA Baby’s trademarks was illegal.

The court found that none of these allegations were sufficient to serve as a predicate act for RICO purposes. 18 U.S.C. § 1951, prohibiting interference with commerce by robbery or extortion, did not apply, since no such robbery or extortion by actual or threatened force, violence, fear of injury, or color of official right had occurred. The use of USA Baby’s trademarks did not violate 18 U.S.C. § 2320, since it did not constitute trafficking in counterfeit goods. Even if the franchisees had committed copyright infringement, the infringement could not establish a “threat of continuity,” since Commerce Capital had settled its claims against the franchisees over USA Baby’s intellectual property, and since the alleged copyright infringement did not occur over a substantial period of time or involve multiple victims.

Moreover, Wallis did not allege his claims of mail and wire fraud with sufficient particularity, as he did not specify what communications he considered to be fraudulent, or how each defendant participated in the fraud. His allegations of bank fraud also failed “because none of the actions alleged were intended to defraud a bank.”

The court also noted that his RICO claims as they pertained to the state governments were “barred by the Eleventh Amendment,” and as they pertained to the state judges were “barred by judicial immunity.” The court therefore dismissed the two counts of his complaint that alleged RICO claims.

The court also dismissed the other thirty-eight counts in his complaint, including a range of claims revolving around various alleged breaches of the bankruptcy stay, claims that various judicial and administrative officers and governments exceeded their authority or failed in their duties, claims of intellectual property violations, claims that defendants made false statements to the U.S. Patent and Trademark Office, claims alleging equal protection and due process violations and conspiracy to deprive him of equal protection, and claims concerning violations of the Supremacy Clause of the U.S. Constitution.

The case is No. 12 C 5285.

Scott Wallis, pro se. John Scott Monical (Lawrence, Kamin, Saunders & Uhlenhop) for Alan Levine.

Cases: RICO IllinoisNews