Antitrust Law Daily Wrap Up, RICO—W.D. Ky.: RICO claims based on allegedly fraudulently induced building purchase dismissed, (Nov 22, 2013)

By Peter Reap, J.D., LL.M.

The RICO claims brought by two companies that purchased a commercial property in Addison, Illinois, and seven individuals who invested in those companies, against Steven Berg, Lawrence A. Shapin, and First Federal Savings Bank of Elizabethtown were without merit, the federal district court in Louisville has decided (Miller v. First Federal Savings Bank of Elizabethtown, Inc., November 19, 2013, McKinley, J.). The individual plaintiffs lacked standing to assert RICO claims and the plaintiff companies failed to describe the predicate acts required for a RICO claim with particularity. Because the RICO claims were the only federal claims brought by the plaintiffs, the court declined to exercise supplemental jurisdiction over their state law claims, granting the defendants’ motion to dismiss.

Background. According to the individual plaintiffs, defendant Shapin learned of the Addison property, a multi-office dental building owned by Dr. Husam Aldairi, in early 2007. Dr. Aldairi listed the property for sale in a sale-leaseback deal for $3.9 million.

In April of 2007, Shapin started approaching potential investors and allegedly stated that investors could get a 16.1 percent return on their investment in the property. Additionally, Shapin told the individual plaintiffs that “the guarantor, Aldairi, was creditworthy and had a net worth of $17 to $21 million.” Shapin, along with Berg, allegedly “promised due diligence to be conducted on behalf of the investors.”

Based on the alleged representations made by Berg and Shapin concerning the Addison property, the individual plaintiffs decided to purchase membership interests in Addent, LLC and Forwin, LLC, the companies that would purchase the property. Prior to closing on the property, Shapin acquired financing in the form of a $3,315,000 loan from First Federal. First Federal secured the loan with a mortgage on the Addison property, and required each member of the two LLCs to personally guarantee the loan.

Problems with the investment arose two years after its purchase, when, in September of 2009, Dr. Aldairi fell behind on his lease payments for the first time. According to the plaintiffs, Dr. Aldairi completely stopped making payments on the lease in January of 2011. On June 28, 2011, Dr. Aldairi filed for protection from his creditors under Chapter 7 of the Bankruptcy Code. The companies repossessed the property in August and attempted to resell it, but the best offer they received on the property was only for $1.2 million.

Both the individual plaintiffs and the two LLCs asserted multiple claims against the defendants based on representations made by Berg and Shapin prior to the investment in the LLCs and subsequent dealings with First Federal in obtaining financing. The central issue to the defendants’ motions to dismiss was the plaintiffs’ claims under the Racketeer Influenced and Corrupt Organizations Act (“RICO”), 18 U.S.C. § 1964, because it provided the sole basis for federal jurisdiction.

Claims of the individual plaintiffs. The defendants argued that the claims of the individual plaintiffs should be dismissed because they lacked a right to sue as individuals under RICO. The plaintiffs did not dispute the general proposition that shareholders could not recover where the only damage alleged was diminution in the value of stock or where damages were based solely on damage to a corporate entity. However, the individual plaintiffs argued that they suffered a separate injury from that of the LLCs based on representations about the investment made by Shapin and the individual guarantees made to First Federal, the court noted.

As to the claim against Shapin, the plaintiffs contended that they suffered a separate harm because “Defendant Shapin approached the individual Plaintiffs as potential investors. He did not pitch his proposal to Addent or Forwin.” The defendants relied on Warren v. Mfrs. Nat’l. Bank of Detroit, 759 F.2d 542, 544 (6^th Cir. 1985), which adopted the rule as to individual shareholder suits in antitrust cases and applied it to civil suits under RICO. In Warren, the Sixth Circuit held that an action to redress injuries to a corporation could not be maintained by a shareholder in his own name. Based on Warren, the individual plaintiffs lacked the right to individually recover in this case, the court ruled.

A recovery by the individual plaintiffs in this case would simply be the recovery of the value of their membership interests. By preventing the individual plaintiffs from suing the defendants under RICO, the court avoided the possibility of double recovery for an injury to the LLCs.

The individual plaintiffs sought to overcome the general rule by pointing to the fact that Berg made fraudulent representations prior to the purchase of membership interests in Addent, LLC. However, this argument still missed the mark because it failed to address the issue of a distinct injury from that of the LLCs, according to the court.

The individual plaintiffs also asserted a theory of specific injury resulting from their signing of personal guarantees with First Federal. The fact that the individual plaintiffs signed personal guarantees with First Federal did not create a unique injury because direct dealing was not the same as direct injury, the court held. The alleged injuries by First Federal arose out of misrepresentations made to the LLCs, not the individual plaintiffs. This was the only logical result because the individual plaintiffs signed these personal guarantees to secure the loans made to Addent, LLC and Forwin, LLC.

Claims of Addent, LLC and Forwin, LLC. The defendants did not contest that the LLCs were the proper parties to bring a cause of action under RICO, but they argued that the LLCs failed to alleged sufficient facts in the complaint to meet the necessary pleading standards.

The defendants contended that the plaintiff LLCs failed to even allege the facts necessary to describe one predicate act necessary to plead a pattern of racketeering. The complaint stated that “[t]he pattern of racketeering engaged in by Defendants involved fraudulent acts in support of the above scheme constituting mail fraud (18 U.S.C. § 1341), wire fraud (18 U.S.C. § 1343), and financial institution fraud (18 U.S.C. § 1346) ….” Even after having an opportunity to file an amended complaint, the plaintiffs declined to describe with more particularity the predicate acts necessary for a RICO claim. Additionally, at least one alleged predicate act, financial institution fraud, was impossible because it only occurred when someone defrauds the bank, not vice versa, the court reasoned.

In addition to RICO claims, the LLCs stated that “Defendants and other unnamed coconspirators knowingly and willfully conspired to violated [sic] 18 U.S.C. §§ 1962(a), (b), and (c) ….” This statement as to a RICO conspiracy claim not only failed to meet the Iqbal pleading standards but also omitted essential allegations detailing an agreement to jointly undertake specific actions rendered illegal by RICO. As such, the plaintiffs’ RICO conspiracy claims failed as a matter of law.

Therefore, the defendants’ motions to dismiss the RICO and RICO conspiracy claims of Addent, LLC and Forwin, LLC were granted.

The case is No. 3:13CV-206-JHM.

Attorneys: D. Brian Rattliff (Kruger & Schwartz) for William P. Miller. Robert Wendell Dibert (Frost Brown Todd LLC) for First Federal Savings Bank of Elizabethtown, Inc. Gregory S. Berman (Wyatt, Tarrant & Combs LLP) for Lawrence A. Shapin. Edward H. Stopher (Boehl Stopher & Graves, LLP) for Steven R. Berg.

Companies: First Federal Savings Bank of Elizabethtown, Inc.; Addent, LLC; Forwin, LLC

Cases: RICO KentuckyNews