Civil RICO: A Blunt But Elusive Tool in Business Divorce Cases

March 22, 2021

What do business divorce litigants have in common with the frill-necked lizard? At the outset of confrontation, they both use in terrorem tactics in an attempt to force their adversary into rapid submission. The lizard spreads its frill to appear more threatening in what’s called a deimatic display. The business divorce litigant packs the initial pleading with the most aggressive legal claims available, designed to cause the adversary maximum fear of business and economic disruption, public embarrassment, and, of course, liability.

I’ve frequently preached that most business divorce litigation is tactical, meaning the lawsuit’s ultimate objective, whether styled as one for judicial dissolution and/or asserting direct and/or derivative claims, is to pressure the adverse business partner into a buyout or other agreement achieving a separation of business interests, without having to litigate to the bitter end.

On the pressure-spectrum of claims by and against business co-owners, starting with the least aggressive, there’s breach of the firm’s constitutive documents, i.e., articles of formation, by-laws, shareholder agreements, partnership agreements, LLC operating agreements, and the like. Taking it up a notch, there’s breach of fiduciary duty and a panoply of other fault-based business torts. Taking it up yet another notch, there’s fraud which, depending on the type of business, its customers and vendors, and its public or private reporting requirements, can threaten detrimental external consequences beyond the stigma of the fraudster label.

Then, at the far end of the spectrum, there’s RICO — the Racketeer Influenced and Corrupt Organization Act. Congress enacted RICO in 1970 primarily as a powerful prosecutorial weapon against mobsters and other criminal syndicates, targeting a broad range of activities and conspiracy in furtherance of an “ongoing criminal enterprise.” RICO defines racketeering activity to include a long list of independently illegal acts under federal and state law, called predicate acts, including not only crimes of violence, intimidation, and drug trafficking but also offenses traditionally less associated in the public mind with mob activity such as mail, wire, and securities fraud. Gambino crime family leader John Gotti received a life sentence following his RICO conviction in 1992. Financier Michael Milken, in the 1980’s known as the “king” of junk bonds, was indicted on RICO charges stemming largely from insider trading before pleading guilty to lesser charges and serving a prison term.

Civil RICO

As enacted, RICO also authorized a private right of civil action providing for recovery of treble damages and attorney’s fees by “any person injured in his business or property” against a person or business who engages in a “pattern of racketeering activity.” A New York Times article not too long ago described RICO as “contain[ing] a civil component that allows it to be used to turn ordinary business disputes that would be filed in state courts into federal cases.”

As with criminal cases, the plaintiff in a civil RICO case must prove at least two, related predicate acts as part of a continuous RICO “enterprise” defined to include “any individual, partnership, corporation, association, or other legal entity, and any union or group of individuals associated in fact although not a legal entity.” Unlike criminal cases in which the government must prove each element of the crime beyond a reasonable doubt, the plaintiff in a civil RICO action need only meet the lesser standard of proof based upon a preponderance of the evidence.

When I began practicing law in the 1980s, civil RICO seemed to be all the rage. The in terrorem effect of an award of treble damages and legal fees, plus the ease of alleging mail and/or wire fraud in connection with business operations and transactions, plus the relatively undeveloped state of the case law interpreting the statute’s nebulous terms, plus the ability to file the case in federal court as well as state court, was too good to pass up. In the ensuing decades, however, the federal courts, including the U.S. Supreme Court, perhaps in response to hyperactive civil RICO litigation, issued a series of major rulings tightening statutory definitions and pleading standards required to survive an early dismissal motion. As the NYT article observed, “[j]udges take a dim view of efforts to turn what look like ordinary state law claims into federal cases by claiming a RICO violation. For that reason, RICO cases often don’t survive the pleading stage.”

Civil RICO and Business Divorce Litigation

That observation is consistent not only with the apparent dearth of reported court decisions in business divorce litigation in New York and elsewhere, but also with the apparent dearth if not total absence of any reported decisions finding RICO liability in a business divorce setting. The following examples illustrate the hurdles to pleading a sustainable RICO claim in a business divorce setting:

In Daskal v Tyrnauer, 2012 NY Slip Op 52036(U) [Sup Ct Kings County 2012], the plaintiff brought direct and derivative claims against his co-owner in a realty holding LLC and others arising from a realty development project that ultimately led to the construction lender’s foreclosure on the LLC’s realty asset. The complaint’s gravamen was the plaintiff’s claim that his business partner defrauded him with the assistance of the lender’s loan officer in the diversion of the LLC’s assets. The complaint asserted civil RICO claims based on predicate acts of alleged mail fraud, wire fraud, bank fraud, and criminal bribery under state law. The defendants moved pre-answer to dismiss the RICO claims for failure to plead the existence of a racketeering “enterprise” and, specifically, failure to allege with the required particularity how the various associates of the alleged enterprise worked together as a unit to achieve the enterprise’s common purpose. The court agreed, finding that the complaint “is silent as to the internal workings or organization of the alleged enterprise, and fails to explain how such alleged organization was run or by whom it was run.” The court also based its dismissal of the RICO claims on the plaintiff’s failure to plead the existence of an enterprise “that is distinct from the alleged pattern of racketeering activity.” Rather, the court wrote, the plaintiff merely alleges that “the participants came together for the common purpose of defrauding him and the LLC’s by engaging in [the predicate acts].” Yet additional pleading defects, the court found, were the complaint’s failure to plead facts adequately showing enterprise continuity either of the open-ended or closed-ended variety, and the failure to allege that he or the LLC’s on whose behalf he sued suffered a non-speculative injury caused by the alleged racketeering activity.
In Weingarten v Kopelowitz, 2020 NY Slip Op 51260(U) [Sup Ct Kings County 2020], the plaintiff brought suit individually and derivatively on behalf of a Delaware LLC in which he held a one-third membership agreement after he was terminated as property manager of multi-unit rental properties in Tennessee owned indirectly by the LLC. The complaint included civil RICO claims alleging wire, mail, and bank fraud as predicate acts as part of a racketeering enterprise for the purpose of injuring plaintiff including loss of the LLC as an ongoing business, lost of investment, loss of personal credit, and reputational injury. The defendants moved to dismiss the RICO claims, arguing that the complaint failed to allege direct injury to himself or to the LLC resulting from the alleged predicate acts, and that any harm plaintiff suffered was derivative of any harm allegedly caused to the lending institutions to which the defendant member purportedly made misrepresentations. Applying the direct injury test for proximate causation established by U.S. Supreme Court decisional law, the court held that the plaintiff “does not even begin to approach the required showing” and that, at best, the plaintiff’s alleged injury resulted from his co-member’s “alleged retaliatory conduct against him personally after he told [the co-member] that he had learned of [the co-member’s] fraudulent activity.”
In Frank v D’Ambrosi, 4 F.3d 1378 [6th Cir. 1993], the plaintiff and defendant were 50/50 shareholders and co-directors in an Ohio steel processing company which was dissolved on consent in 1989 after the defendant, D’Ambrosi, sued for judicial dissolution. The plaintiff, Frank, subsequently filed a federal suit asserting RICO claims against D’Ambrosi and others claiming that they combined to form an association-in-fact enterprise through which they engaged in a pattern of racketeering activity including predicate acts of mail and securities fraud. The defendants moved to dismiss the complaint or, alternatively, for summary judgment which the District Court granted. On appeal to the Sixth Circuit, the court affirmed the dismissal of Frank’s RICO claims, finding that he lacked standing because the alleged wrongs and injuries were all directed at the corporation and that Frank “does not have standing to bring a RICO action for wrongs to [the corporation] in a direct suit as shareholder” or as an employee. The court also held that Frank did not adequately support his “absurd” allegation of mail fraud involving a letter sent by D’Ambrosi to Frank which “at most represents a fight for control of [the corporation].” The court likewise rejected Frank’s reliance on the corporation’s dissolution as a forced sale by him of securities, finding that “Frank owned then, and continues to own, 50% of [the corporation’s] stock, and 50% of its assets and liabilities — he cannot now seriously contend that the dissolution [pursuant to a consent decree] was a forced sale.”

The Takeaway. The RICO statute, enacted over 50 years ago, undoubtedly has had a major impact in the realm of criminal law enforcement, which was the main impetus for its enactment. Its popularity as a cudgel in civil litigation in the commercial realm has waxed and waned as the courts put their judicial gloss on the statute’s many requirements in an effort to put a damper on plaintiffs who, as one District Court wrote, in their zealous pursuit of RICO’s treble damages remedy and the stigma that may attach to RICO defendants, “have often been overzealous in pursuing RICO claims, flooding federal courts by dressing up run-of-the-mill fraud claims as RICO violations” requiring courts “to flush out frivolous RICO allegations at an early stage of the litigation.” As the above-discussed cases illustrate, the RICO statute and its case law present daunting and potentially insuperable challenges in suits between co-owners of closely held businesses who, in the end, may be better served by the causes of action and remedies available under state common and statutory law.