6th Cir. Holds RICO claims typically unavailable to creditors as a result of corporate default

The United States Court of Appeals for the Sixth Circuit recently upheld the dismissal of a lender’s RICO claims in connection with a borrower’s default on a $5 million loan.

In that decision, the Sixth Circuit held that: (1) the “fairly traceable” harm required for constitutional capacity is jurisdictional and distinct from the element of “immediate causation” required to properly plead and prove a claim; and (2) RICO claims are generally not available to creditors as a result of corporate default, consistent with several other federal appellate courts.

A copy of the notice in Grow Michigan, LLC vs. LT Lender, LLC is available at: Link to Opinion.

A limited company (“lender”) invested in a start-up (“borrower”) that allegedly owned valuable intellectual property “protecting the designs of a lightweight hybrid pallet used for cold food transportation.” The borrower was seeking to raise $26 million to repay existing debt, cover future operating expenses and take the necessary steps to begin production of pallets. The lender agreed to lend the borrower $5 million. The loan was conditional on the borrower obtaining the remainder of the $26 million and the loan would be secured by the borrower’s intellectual property.

Before the Lender and the Borrower entered into the Loan, the Lender became aware that another entity (“Third Party Lender”) had already obtained an interest in the Intellectual Property of the Borrower. This posed a problem for the lender because the interest of the third party lender was secured by the intellectual property and the interest of the third party lender was greater than that of the lender. Accordingly, the lender agreed to allow the borrower to pay $3.3 million to the third-party lender to repay the third-party lender’s loan and ensure that the lender had the first secured position in the intellectual property of the borrower.

Over time, the lender would have become suspicious of the borrower’s business operations. The lender alleged that it learned that the borrower actually only owed the creditor $2.2 million and that the shareholders of the borrower and the third-party lender were the same parties. Further, according to the lender, the borrower failed to disclose to the lender that it licensed its intellectual property to a separate entity and received no funds for the license agreement. Beyond the gain for the third-party lender, the borrower also chose not to draw on the lender’s line of credit to the borrower and never purchased the equipment needed to begin production.

The lender alleged that the borrower’s principal owned a separate consulting firm and improperly diverted business opportunities to its consulting firm for the principal’s personal benefit. A proxy war for control of the borrower and allegations of intellectual property theft further compounded the turmoil of the borrower, who at one point was losing $500,000 a month.

Eventually, the borrower defaulted on the loan. As a result, the lender filed various lawsuits in state and federal courts. In this case filed in federal court, the lender sued nine defendants: two stockholders of the borrower, two employees of the borrower, the consulting company, the creditor and the principals of the creditor (“defendants”).

The lender alleged that the defendants’ actions violated the federal Racketeering Influenced and Corrupt Organizations (RICO) Act for engaging in a pattern of racketeering activity. The lender alleged that the defendants committed: two acts of bank fraud, one act of transactions involving money derived from such bank fraud, one act of misappropriation of trade secrets and one act of wire fraud.

The defendants requested the dismissal for non-presentation of a request. The trial court granted the defendants’ motion to dismiss and this appeal followed.

UPRIGHT

First, the Sixth Circuit considered the lender’s ability to sue. As you may recall, the United States Supreme Court requires a party to a lawsuit to satisfy the following three elements: (1) factual harm that is (2) relatively attributable to the defendant’s conduct, and (3) capable of being repaired by judicial action. Spokeo, Inc. vs. Robins578 US 330, 337-38 (2016).

Defendants argued that the lender’s claims did not show “sufficiently attributable” harm to the defendants’ alleged conduct, as the lender’s alleged harms were “simply the indirect result of fraud, financial misconduct and embezzlement.” alleged trade secrets of the defendants”. Defendants argued that “courts have used the phrase ‘RICO standing’ to describe the requirement that a RICO plaintiff must show an immediate connection between his injury and the defendant’s conduct for the purposes of pleading and proving a viable RICO claim.” See, for example, Lerner vs. Fleet Bank, NA318 F.3d 113, 129 (2d Cir. 2003), abrogated for other reasons by Lexmark Int’l v Static Control Components, Inc.572 US 118, 127 (2014).

The Sixth Circuit disagreed, finding that “[w]Although immediate causation is an element of a RICO plaintiff’s cause of action, … it is not a jurisdictional requirement.

Thus, the Sixth Circuit ruled that the lender had standing to sue all but one of the defendants because the suit correctly alleged that the defendants made misrepresentations when acquiring the loans and then engaged in a financial misconduct and misappropriation of trade secrets, which led to default by the borrower and damage to the lender. quality of creditor. Accordingly, the allegations in the lender’s complaint were sufficient to show a traceable link between the conduct and the harm for most of the defendants.

However, the Sixth Circuit ruled that the lender lacked standing to sue the consulting firm because the lender’s lawsuit does not allege that the consulting firm’s actions reduced the borrower’s capitalization or ability. to repay the lender.

RICO PROBLEMS

RICO creates a private cause of action for civil litigants when “[a]Anyone injured in their business or property due to a violation of Section 1962” may sue for treble damages and attorneys’ fees. 18 USC § 1964(c). Section 1962 lists prohibited activities that may ultimately violate the law. 18 USC § 1962.

To properly plead a violation of the RICO Act, a plaintiff must allege: (1) two or more predicate racketeering offences, (2) the existence of an enterprise affecting interstate commerce, (3) a nexus between the racketeering and business, and (4) injury due to the foregoing. See Moon Piping Supply c. Harrison465 F.3d 719, 723 (6th Cir. 2006); Frank v. D’Ambrosi4 F.3d 1378, 1385 (6th Cir. 1993).

The RICO claimant must be able to rely on at least two of these five underlying acts and, from the basis of these two acts, the remaining elements of a RICO claim. If these facts are properly pleaded, a plaintiff may discharge his or her obligation to file a RICO claim. See 18 USC §§ 1961(5), 1962.

The Sixth Circuit also clarified that “proximate cause, as an aspect of RICO’s ‘due to’ standard, has been understood to require a RICO plaintiff to show that the racketeering offense of the Defendant’s “directly led to Plaintiff’s injury” and that “RICO’s immediacy requirement increases the plaintiff’s burden by requiring more than mere proof of foreseeability, central to common law principles of causation.” Further, the Sixth Circuit noted that “the ‘due to’ standard precludes recovery where a plaintiff’s injuries are merely the ‘derived or transmitted’ result of the alleged racketeering activity.”

The lender alleged that the defendants committed five separate predicate offenses of racketeering: two acts of fraud against a financial institution, transactions using money derived from that fraud, misappropriation of trade secrets, and wire fraud.

However, the Sixth Circuit pointed out that the lender only alleged that he “suffered injuries due to a cascading series of wrongful acts committed by defendants to harm” the borrower, which was not not sufficient to meet RICO’s “due to” causation standard. complaints.

More importantly, the Court of Appeal noted that “damage suffered by a creditor as a result of a company’s default caused by the actions of another party is considered derivative, not direct, for purposes of causation. RICO. In this scenario, the acts of racketeering target the company, not the creditor. Thus, the Sixth Circuit continued, a “RICO claim is generally not available to creditors following a corporate default.”

Explaining its decision, the Sixth Circuit said that “[if there is any proper plaintiff to assert claims for the wrongdoing alleged by [lender]RICO’s principles of causation suggest that it is [borrower]. After all, [borrower]as “immediate victim[]’ alleged violations by the defendants, ‘ they can be expected to uphold the laws by prosecuting [its] own complaints'” and that “[h]otherwise, it should be noted, would greatly expand RICO’s reach.

The lender attempted to raise two additional arguments on appeal. First, the lender argued that since the lender’s security interest in the borrower’s intellectual property was vested, the misappropriation of trade secrets resulted in direct harm. Second, the lender argued that it correctly alleged multiple acts of wire fraud and that together these acts established a pattern of racketeering activity.

However, the lender did not properly raise these issues in the trial court and therefore the Court of Appeal did not consider these issues on appeal.

Consequently, the Sixth Circuit upheld the trial court’s dismissal of the lender’s RICO claims.

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