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Your client, a Silicon Alley technology company, is negotiating its acquisition by a larger competitor. It shares information, but the deal falls apart. Suddenly, your client’s key employees leave to join the competitor, taking business with them. Your client is small, and its records of profits limited, so the damages awarded in traditional lawsuits for breach of contract or fraud might not justify the expense of asserting a claim. Does RICO [FOOTNOTE 1], with its provision for treble damages, provide a viable cause of action? Despite much noted judicial antagonism to the use of RICO in private lawsuits, the courts have left an opening for plaintiffs who are injured by the wrongful actions of a direct competitor. [FOOTNOTE 2] That opening has been widened by a recent decision of the 2nd U.S. Circuit Court of Appeals in Commercial Cleaning Services, L.L.C. v. Colin Service Systems, Inc. [FOOTNOTE 3] Although the facts of Commercial Cleaning are unusual, the holding has applications for businesses of all sizes, whether they are engaged in a head-to-head bidding war with defendants or simply trying to protect their employee know-how and client lists from a raiding corporation. USE OF RICO IN CIVIL SUITS Understanding the full impact of Commercial Cleaning, however, requires knowledge of the barriers that previously blocked the use of RICO in many civil suits. RICO allows recovery to private plaintiffs who can prove injury “by reason of” any of four separate violations enumerated in � 1962. [FOOTNOTE 4] Private businesses frequently allege injury by reason of a violation of subsection (a): the “investment” of income derived from a pattern of racketeering activity to acquire an interest in an enterprise [FOOTNOTE 5] , or subsection (b), the “acquisition” of an interest in an enterprise through a pattern of racketeering activity. [FOOTNOTE 6] Statutory and judicial limitations often render the remaining two subsections less useful. Subsection (c), for example, prohibits persons associated with an enterprise from conducting its affairs through a pattern of racketeering activity. [FOOTNOTE 7] Under this section the defendant “person” cannot be the same as the “enterprise.” [FOOTNOTE 8] Fraud and other racketeering activity, however, cannot always be traced beyond the enterprise to a controlling person, and a controlling person is often a judgment-proof defendant. [FOOTNOTE 9] In order to seek relief under subsections (a) and (b) of � 1962, however, it is insufficient to allege mere participation in predicate acts; potential plaintiffs must allege injury by reason of a defendant’s “investment” of income from the predicate act [FOOTNOTE 10] or injury resulting from the defendant’s “acquisition” of an enterprise. [FOOTNOTE 11] In other words, the investment or the acquisition, not the predicate act itself, must be the proximate cause of harm to the plaintiff. This is the “investment injury” rule, which is among the most difficult barriers for plaintiffs to circumvent in bringing a civil RICO action. [FOOTNOTE 12] Under the investment injury rule, for example, a plaintiff defrauded in the purchase or sale of a stock through the defendant’s pattern of repeated fraudulent representations has no standing under RICO, unless the plaintiff can also show that proceeds of the purchase or sale were then invested in some way that also harmed the plaintiff. [FOOTNOTE 13] More often than not, a specific showing of precisely how the proceeds were distributed is impossible. In addition, some courts have imposed a “no reinvestment” extension of the investment injury rule, holding that allegations that racketeering income was invested in the same racketeering enterprise that generated the income cannot satisfy the investment injury rule. [FOOTNOTE 14] These courts have found an insufficient causal nexus between general investment in an ongoing enterprise, on the one hand, and specific injury to the plaintiff on the other. [FOOTNOTE 15] Notably, however, in few of the cases alleging a reinvestment injury was the plaintiff a competitor of the defendant. [FOOTNOTE 16] A competitor is the one type of plaintiff whose injury is a direct result of the mere continuation or operation of a competing enterprise. If that continuation results from the reinvestment of income obtained through racketeering activity, a civil RICO action should lie, even if some of the enterprise’s activity is legitimate, because the correct causal nexus between the investment and the injury exists. [FOOTNOTE 17] SMALL TECH FIRMS Small technology companies that depend on easily transferrable assets, such as employee know-how and client lists, are the companies most likely to have injuries stemming from a competitor’s continuity and performance, and the ones most at risk for wrongful loss of their assets to a competitor. They are also the companies with the shortest history of profits and least-adequate legal and accounting systems to establish a traditional claim for damages. Small technology companies, therefore, could benefit the most from the application of RICO to suits against competitors. Support for the common-sense principle that businesses suffer direct injury when their competitor’s economic power is illegally enhanced can be garnered from Commercial Cleaning, even though the facts of that case are distinguishable from the typical business conflicts affecting technology companies and even though it dealt with alleged violations of � 1962(c). In Commercial Cleaning, the plaintiff was defeated in a bid for lucrative contracts by the defendant, a direct competitor. [FOOTNOTE 18] The plaintiff alleged that the defendant was able to underbid it only because it hired workers in violation of � 274 of the Immigration and Nationality Act (INA) and paid them less than legally hired workers. [FOOTNOTE 19] The alleged INA violations became the predicate acts for a RICO suit. [FOOTNOTE 20] THE SECOND CIRCUIT Vacating and remanding the decision of the Connecticut District Court dismissing the complaint, the 2nd Circuit found that the plaintiff’s complaint adequately stated a direct proximate relationship between its injury and the pattern of racketeering activity. [FOOTNOTE 21] The 2nd Circuit stated: “[T]he plaintiffs may well show that they lost contracts directly because of the cost savings defendant realized through its scheme to employ illegal workers.” [FOOTNOTE 22] The causal relationship anticipated by the court in Commercial Cleaners looks past the fact that the illegal hiring itself was not precisely what caused the plaintiff’s losses. The illegal hiring resulted in cost savings, and the reinvestment of those savings enhanced the economic bidding power of the defendant. Under the 2nd Circuit’s reasoning, wrongful activity leading to reinvestment can lead to a RICO injury if the defendant is a direct competitor. This reasoning has multiple applications for “investment injury” cases. For example, if a company shares confidential information in failed merger negotiations and can show that the bidder later repeatedly misused that information to hire employees or lure clients, that company could have standing under RICO. While at least two decisions in the Southern District of New York, NRB and Galerie Furstenberg, [FOOTNOTE 23] have applied the no reinvestment extension of the investment injury rule to block certain RICO claims by a competitor, Commercial Cleaning leaves other potential plaintiffs with plenty of ammunition to challenge the correctness of those decisions. It is possible that with more specific factual allegations, including allegations of a pattern of fraud that results in the recruitment of specific employees and specific clients, the outcome in NRB would have been different. More importantly, however, the written decisions in NRB and Galerie Furstenberg do not fully address the ongoing injury that results to competitors of an enterprise from maintenance of that enterprise using the proceeds of fraudulently obtained information. They apply the no reinvestment extension of the investment injury rule without this analysis. CONCLUSION To the extent the no reinvestment extension of the investment injury rule permits a self-investing corporate racketeer to perpetuate the pattern of racketeering against its original victim, NRB and Galerie Furstenberg might not represent the best rule. In light of the 2nd Circuit’s decision in Commercial Cleaners, and particularly in light of recent expansion and contraction in technology companies, the time is right for re-examination of application of the investment injury rule to RICO disputes among corporate competitors. Raymond L. Vandenberg is a partner at Vandenberg & Feliu. Lisa M. Napoletano is of counsel at Vandenberg & Feliu.

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