Antitrust Law Daily Wrap Up, RICO—S.D.N.Y.: Default judgments vacated for failure to allege fraud with particularity, (Dec 9, 2013)

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

Default judgments against a Brazil-based business that allegedly conspired to purchase subscriptions to Elsevier scholarly journals at discount rates for resale at higher rates, in violation of federal RICO law, were set aside by the federal district court in New York City, based on assertions that Elsevier failed to assert fraud with sufficient particularity (Elsevier, Inc. v. Grossman, December 5, 2013, Failla, K.). However, Elsevier was granted leave to replead its complaint within 60 days.

Elsevier, a Delaware corporation with a principal place of business in New York, publishes scholarly books and journals relating to the natural and social sciences. Its journals consist primarily of peer-reviewed articles, written by scholars and often based on original research. Elsevier sells its journals through annual subscriptions, which are sold at two rates: a full-price rate for institutions and a discounted rate for individuals. The publisher does not allow individual subscribers to supply them to institutions. To that end, contracts with individual subscribers prohibit them from ordering on behalf of other undisclosed parties and from fulfilling an order for an institution. Elsevier would suffer financial injury if it received payment for institutional subscriptions at individual raters.

In its complaint, the publisher alleged that Pierre Grossman, IBIS Corp., and Publicacoes Tecnicas Internationais (PTI) conspired to purchase subscriptions to Elsevier journals at discounted rates and then to resell them to institutions at higher rates, thereby reaping substantial illegal profits while depriving Elsevier of revenue and customer information.

Specifically, Elsevier alleged that Grossman conspired with a group of co-conspirators who were relatives and/or business associates of PTI, IBIS, or Grossman. These subscribing defendants allegedly subscribed to journals individually, using false names and addresses; obtained journals through the mail and interstate wires; and caused PTI and IBIS to resell them to institutions at substantially higher rates. Grossman was also charged with reselling the journals to institutions at the institutional rate.

Elsevier filed the action on June 29, 2012. On October 29, 2012, the defendants executed a waiver of service, stating that their answer was to be due on November 19, 2012. However, they did not file an answer. On March 15, 2013, Elsevier filed the acknowledgement of service and requested that the clerk of court enter default against each defendant. The clerk entered a default on June 7, 2013. Elsevier filed an application for default judgment on June 30, 2013, and the court issued an order to show cause on July 30, 2013, requiring the defendants to show cause why a default judgment should not be entered. Defendants’ counsel filed a response on August 23, 2013.

At the show cause hearing held on August 30, 2013, the court heard extensive arguments. After the parties unsuccessfully attempted to negotiate a settlement, the parties asked the court to decide the pending motion to enter a default judgment. The defendants moved to set aside the clerk’s entries of default for good cause.

Three factors determine “good cause”: (1) whether the default was willful; (2) whether the adversary presented a meritorious defense; and (3) whether setting the default aside would prejudice the adversary.

Willfulness of default. Contrary to arguments of the defendants, the defendants’ default was knowing and willful, since they deliberately chose not to defend the action, the court found.

Meritorious defense. The defendants raised several defenses that would not constitute complete defenses at trial, including that Grossman and PTI were not subject to jurisdiction in New York and that the RICO claims were time-barred as to only some of the subscriptions at trial.

The defendants did, however, raise one meritorious defense that would constitute a complete defense at trial—that is, that Elsevier failed to assert its allegations of fraud with sufficient particularity under Federal Rule of Civil Procedure 9(b). “Because a deficiency in pleading of this type would dispose of the federal claims at issue, leaving the Court with discretion to exercise (or not exercise) pendent jurisdiction over Plaintiff’s state-law claims, this counsels in favor of allowing the Defendants to respond to the case on the merits.”

Prejudice. Elsevier failed to allege that lifting the entry of default would result in the loss of evidence, create increased difficulties in discovery, or provide greater opportunity for fraud and collusion. The fact that Elsevier’s potential recovery of Grossman’s alleged New York assets may be delayed or subordinated to other creditors was not sufficient to demonstrate legally cognizable prejudice, as was required.

Thus, the defendants’ motion to set aside the entries of default was granted.

Attorney fees. Because the defendants’ default was willful and egregious, the court found it appropriate to award costs Elsevier incurred in bringing this motion. The court found a sum of $5,000 would be reasonable to compensate Elsevier for the fees and costs associated with securing the defaults and pursuing this motion.

Issues with pleading RICO. The court found several defects in pleading, particularly as to the civil RICO claims upon which its jurisdiction was premised. First, Elsevier failed to allege facts sufficient to demonstrate the timeliness of any of its civil RICO claims. Elsevier brought this action in 2012, but failed to allege when it first discovered the subscription fraud. The subscriptions at issue were purchased between 2003 and 2011, with only some of them occurring within the four-year “window” of the statute of limitations. Regardless of when Elsevier discovered the claims, it may be compensated only for injuries discoverable after June 2008.

Moreover, the court found that Elsevier adequately alleged some, but not all, of the elements of a RICO violation. As such, it did not properly allege the claim. It did properly allege an enterprise between and among Grossmann, IBIS, PTI, and the John Doe defendants, but failed to allege a pattern of racketeering activity. A pattern requires at least two acts of racketeering activity, occurring within 10 years. Elsevier alleged mail and wire fraud by the defendants in the course of their alleged conspiracy. However, it did not allege the content, time, place, and manner of the alleged mail and wire transmission with sufficient particularity.

Elsevier also failed to plead related and continuous acts, but had properly alleged only one predicate act—Grossman’s 2011 subscription to the Archives of Physical Medicine and Rehabilitation. One predicate act cannot be related, continuous, or pose a threat of continuing.

Likewise, the RICO conspiracy was well pleaded, according to the court. Under Second Circuit precedent, a RICO plaintiff must provide (1) that the defendants agreed to form and associate themselves with a RICO enterprise; (2) that the defendants agreed to commit two predicate acts in furtherance of a pattern of racketeering; and (3) that the agreed-upon predicate acts would have constituted a pattern of racketeering activity if carried out. In this instance, Elsevier failed to allege two or more predicate acts. “By extension, it has failed to allege an agreement to conduct the affairs of the charged enterprise through two or more predicate acts.”

Finally, Elsevier failed to demonstrate entitlement to civil RICO damages. A RICO plaintiff must plead, at a minimum: (1) the defendant’s violation, (2) an injury to its business or property, and (3) causation of the injury.

Leave to replead. Although Elsevier failed to allege its civil RICO claims, the court found that it could allege a colorable claim if it pleaded the timeliness of its claims and stated its allegations with sufficient particularity. Thus, Elsevier was given 60 days to replead.

The case is No. 12 Civ. 5121 (KPF).

Attorneys: Jason Lee Jurkevich (Sills Cummis & Gross) for Elsevier Inc. Van Aaron Hughes (Dorsey & Whitney LLP) for Pierre Grossman and IBIS Corp.

Companies: Elsevier Inc.; IBIS Corp.

Cases: RICO NewYorkNews