When legal disputes between owners of closely held companies turn the corner past “Let’s resolve this issue without litigation” and head toward “See you in court,” the owners and their lawyers typically begin jockeying for the upper hand in a potential lawsuit. The most effective way to grab the upper hand is to be the party that files the lawsuit. That party gets to shape the lawsuit to their liking—both in terms of which court they decide to file the lawsuit in and the legal claims and supporting facts they include in the lawsuit.
These legal claims and supporting facts often signal what kind of legal battle the parties are looking at. The more incendiary the legal claims and supporting facts, the more contentious the lawsuit will be.
A lawsuit alleging a breach of a company’s operating agreement supported by straightforward factual allegations will have a much different feel than one alleging fraud and embezzlement supported by factual allegations seemingly ripped from a movie script.
And then there are civil RICO claims.
RICO stands for the Racketeer Influenced and Corrupt Organization Act signed into law by President Richard Nixon in 1970. RICO was part of the Organized Crime Control Act of 1970. Congress’s purpose in bringing the law was to:
seek the eradication of organized crime in the United States by strengthening the legal tools in the evidence-gathering process, by establishing new penal prohibitions, and by providing enhanced sanctions and new remedies to deal with the unlawful activities of those engaged in organized crime.
RICO was conceived as a new way to fight the mob and other illegal criminal enterprises by targeting the underlying activities that criminals took part in to keep their enterprises going. Through RICO, Congress defined racketeering activity broadly to include both violent crimes such as kidnapping, bribery, extortion, and counterfeiting, as well as white-collar crimes such as wire fraud and mail fraud.
In criminal RICO cases, prosecutors must prove beyond a reasonable doubt that a RICO “enterprise,” defined as “any individual, partnership, corporation, association, or other legal entity, and any union or group of individuals associated in fact although not a legal entity,” engaged in at least two related racketeering activities, known as “predicate acts,” in furtherance of that enterprise.
In addition to criminal RICO claims, Congress also created new civil RICO claims. Civil RICO claims can be brought in private litigation like litigation between owners of closely held companies. The winning party in a civil RICO case is entitled to treble (that is, 3x) damages and to have their adversary pay their attorneys’ fees.
A hammer in search of a nail?
When an owner of a closely held company lobs RICO allegations against their co-owner(s) in a lawsuit, they are throwing down the gauntlet as part of their jockeying for the upper hand. RICO allegations are the kind of legal claims that may arouse the interest of media outlets, get a company’s clients, vendors, employees, and shareholders buzzing (not in a good way), and cause significant reputational and business damage to closely held companies.
Thus, the thinking goes, if a party can allege RICO claims that survive multiple attempts to dismiss the lawsuit, those claims become strong leverage in settlement negotiations down the road. Knowing that your co-owner could have you dead to rights on a civil RICO claim will bring even the most stubborn co-owner to the settlement table given the treble damages and attorneys fees waiting for them on the other side of an unfavorable jury verdict.
But just how potent are civil RICO cases in the business divorce context in Pennsylvania?
Apparently, not very.
Few civil RICO cases in the business divorce context have been litigated in Pennsylvania. Of those that have, the plaintiffs have generally been unsuccessful with their claims. As you will see shortly, the nature of the events that tend to lead to business divorces do not fit nicely within the kind of factual allegations needed in a RICO case to survive judicial scrutiny.
Because of this, the parties against whom RICO claims are alleged in the business divorce context know their adversaries are going to have a tough time getting those RICO claims to survive attempts to dismiss them. With few successful civil RICO claims in the business divorce context, the claims’ effectiveness as a hammer used to jockey for position in a potential or newly filed lawsuit is greatly reduced.
The following four Pennsylvania cases show just how hard of a sell civil RICO claims are in the business divorce context.
In Domico v. Kontas, No. 3:12CV1449, 2013 WL 1248638 (M.D. Pa. Mar. 26, 2013), Dennis Domico, an investor in a corporation that operated the Hollywood Diner in Hazle Township, Pa., claimed he was tricked into investing $145,000 in the company for 50% ownership of it through his co-owner’s use of doctored bank statements, fraudulent invoices, and altered bank checks. While a state court business divorce lawsuit was pending between Domico and his co-owner, he brought a federal civil RICO case against the co-owner and a number of the co-owner’s business associates, alleging both a civil RICO claim and a conspiracy to commit civil RICO claim. The relevant predicate acts were wire, mail, and bank fraud.
Unfortunately for Domico, the court determined the predicate acts actually formed the basis of a claim for securities fraud because they all related to his investment in the corporation that operated the diner. This was a problem because the Private Securities Litigation Reform Act of 1995 eliminated securities fraud as a predicate act for a civil RICO claim. The court ruled that all of the defendants’ actions were part of a single fraudulent scheme to trick Domico into purchasing securities in the corporation that owned the diner. As a result, the court dismissed both civil RICO claims.
In Gintowt v. TL Ventures, 226. F. Supp. 2d 672 (E.D. Pa. 2002), Kristoff Gintowt, a co-owner of a successful staffing company claimed that after his company was merged into a new company, Broadreach, his equity in it was wiped out due to fraud and misrepresentations by the defendants who were corporate executives of, and entities affiliated with, Broadreach. Gintowt brought civil RICO claims against the defendants, alleging that the defendants committed various predicate acts of mail fraud and wire fraud, such as when they assured Gintowt that he and his co-owners would have a seat on the board of Broadreach and when the company made misleading statements about its business to potential buyers.
The court dismissed Gintowt’s complaint. While noting that Gintowt adequately alleged the existence of an enterprise (Broadreach) and damages in support of his RICO claim, the court held that Gintowt failed to do so when it came to how the alleged fraudulent acts committed against him furthered the scheme to defraud him or were related to an essential part of that scheme. According to the court, because Gintowt did not tie the alleged fraudulent acts together, he did not properly allege that the acts constituted “a pattern of racketeering activity” required by RICO (which is often properly alleged by claiming those acts are part of an ongoing entity’s regular way of doing business).
In Bardsley v. Powell, Trachtman, Logan, Carrle & Bowman, P.C. et al., 916 F. Supp. 458, 463 (E.D. Pa.), aff’d, 106 F.3d 384 (3d Cir. 1996), Norman Bardsley, a shareholder and director of Inofast, a manufacturer and distributor of fasteners, claimed that a number of Inofast’s minority shareholders—including his twin brother and father!—concocted a scheme involving a number of improper and fraudulent transactions to divest him of his majority shareholder status. The scheme was allegedly hatched to thwart Bardsley’s attempts to replace Inofast’s management after the company found itself in financial trouble. As was the situation in the Domico case I discussed above, while a state court business divorce lawsuit was pending between Bardsley and a number of Inofast shareholders, two of their outside lawyers, and their law firm, he brought a federal securities fraud and civil RICO case against those defendants.
The court dismissed the securities fraud claim on the basis that Bardsley did not bring his claim within the required period of time under the federal securities laws. The court also dismissed Bardsley’s civil RICO claim. The court held that Bardsley did not show that the defendants’ alleged fraudulent scheme included a pattern of racketeering activity as required by RICO. Specifically, he did not allege that the defendants’ scheme was continuous. According to the court, he alleged the scheme lasted seven or eight months, was directed only toward him, and was implemented for a single purpose. The court determined that the defendants’ alleged misconduct fell short of RICO’s “continuity” requirement.
(Note that this case was decided soon after the Private Securities Litigation Reform Act of 1995 was passed. Though the PSLRA was not mentioned, it would not have changed the ultimate result.)
Finally, in Ferdinand Drexel Inv. Co. v. Alibert, 723 F. Supp. 313, 326 (E.D. Pa. 1989), aff’d, 904 F.2d 694 (3d Cir. 1990), Vernon Alibert, the co-owner of a number of family-owned companies, claimed he was fraudulently divested of his ownership in them thanks to their majority shareholders (who were his family members). Alibert brought securities fraud claims against the majority shareholders, as well as a civil RICO claim with predicate acts of securities fraud and of mail fraud.
The judge dismissed the securities fraud claims, in part because Alibert could not have relied on allegedly false statements in certain documents because he refused to accept those documents when the United States Postal Service delivered them to him. Regarding the RICO claims, the judge dismissed them as well, focusing on the mail fraud claim because he had already dismissed the securities fraud claim. He held that even if the notices mailed to the plaintiff were fraudulent, there were only two of them and they were sent within the same month. This fell short of RICO’s “continuity” and “pattern” requirements for predicate acts. In addition, the judge held that Alibert could not have been injured as a result of the shareholders’ alleged racketeering scheme because he did not detrimentally rely on the alleged fraudulent mailed notices because (as was the case with his securities fraud claim) he never read them.
(Note that this case was decided six years before the PSLRA was passed. As with the Bardsley case I mentioned above, the PSLRA would not have changed the ultimate result.)
No go, RICO
There have not been many civil RICO cases in Pennsylvania arising in the business divorce context to begin with, let alone ones where the plaintiff has prevailed. That civil RICO cases are so few and far between suggests to me that lawyers and their clients involved in business divorces understand that civil RICO claims are tough hills to climb in that context.
Given the lackluster track record of previous plaintiffs in civil RICO cases in the business divorce context, would-be plaintiffs likely do not want to spend the required time and money for their lawyers to draft the kinds of detailed legal complaints necessary to properly allege RICO claims—assuming the facts of a particular business divorce support such claims—only to stand a good chance of those complaints being dismissed early in the litigation process. Thus, fewer civil RICO cases in the business divorce context are being filed.
Perhaps there are those rare business divorces that provide the factual and legal basis for a dead-to-rights civil RICO claim. But short of that, I do not expect many co-owners of closely held companies in Pennsylvania to raise civil RICO claims in Pennsylvania federal courts to complement, or in place of, bread-and-butter business divorce lawsuits in Pennsylvania state courts. The chances of winning a civil RICO case are simply too low to justify the likely expense of mounting one.
For these reasons, when co-owners of closely held companies and their lawyers begin jockeying for the upper hand in a potential lawsuit regarding a business divorce, it seems a civil RICO claim will almost certainly be a hammer without a nail.