Congress has long resisted pleas from federal courts to circumscribe civil RICO to preclude a remedy for so-called “garden variety” business disputes. These courts, including the U.S. Court of Appeals for the Third Circuit, thought RICO should be unavailable in cases arising from contractual disputes between sophisticated business entities, but historically permitted such claims to proceed, believing they were bound to do so by the language of RICO and its statutorily mandated “broad application.”
However, the Third Circuit’s holding in Kolar v. Preferred Real Estate Investments, 2010 WL 104500, at *5 (3d Cir. 21010) (“not precedential”), may signal that going forward, it will take matters into its own hands and preclude, without congressional imprimatur, application of RICO to garden-variety business contract disputes, even where the technical elements of a RICO claim are satisfied. Interestingly, Kolar applied principles similar to Pennsylvania’s “gist of the action” doctrine to RICO, although the application of this doctrine to RICO had been rejected previously.
The RICO statute, 18 U.S.C. §1961 et seq., provides a private right of action for those injured in their business or property by reason of a violation of 18 U.S.C. §1962. The express pleading requirements of RICO are not onerous. Generally, Section 1962(a) prohibits those who receive income from a “pattern of racketeering activity” from using that income to acquire or operate an interstate enterprise. Section 1962(b) prohibits the acquisition of an interest in an interstate enterprise through a “pattern of racketeering activity.” Section 1962(c) prohibits employees or associates of an interstate enterprise from conducting the enterprise through a “pattern of racketeering activity.” Thus, a threshold requirement of RICO is that an injured party must demonstrate that the RICO defendants were engaged in a “pattern of racketeering activity.” “Racketeering activity” is defined through the enumeration of various predicate acts, including the federal mail and wire fraud statutes. Section 1961(5) provides that a pattern of racketeering activity requires “at least two acts of racketeering activity.”
In Tabas v. Tabas, 47 F.3d 1280 (3d Cir. 1995), the Third Circuit, like courts in other circuits, expressed distress over the application of RICO to so-called garden-variety business disputes. Tabas involved alleged improper diversion of partnership income away from the estate of a deceased partner, in derogation of obligations under a partnership agreement, where the estate claimed those diversions constituted RICO predicates sufficient to establish a pattern of racketeering activity. Tabas found that a RICO treble damages remedy was available in that garden-variety business dispute, but expressed concern over the statutorily mandated broad application of the statute, and the belief that RICO should be circumscribed by Congress to exclude garden-variety claims not involving a significant “societal threat.” Tabas noted RICO had been put to “extraordinary” uses resulting from the breadth of the predicate offenses available to establish a pattern of racketeering activity, and in particular the inclusion of wire and mail fraud. Tabas implied that these extraordinary uses were inconsistent with the true purpose of RICO: to address “long-term criminal conduct.” Indeed, as long as a RICO plaintiff could establish more than two predicate offenses by a RICO enterprise, establish that the acts were related and establish continuity, which was defined generally as either lasting for a substantial period of time (closed-ended continuity) or involving a threat of continued racketeering activity (open-ended continuity), a RICO claim could be made. This often permitted plaintiffs to transmute normal business disputes into federal statutory treble damages claims. In closing, Tabas stated that although it was bound to apply RICO in this context, it encouraged Congress to “decide whether to narrow the scope of RICO.” In dissent, Senior Judge Morton Greenberg noted that other circuits have ruled that RICO has “not federalized every state common-law cause of action available to remedy business deals gone sour,” and argued that the Third Circuit should follow suit.
Since Tabas, Congress has continued to refuse to circumscribe RICO to exclude garden-variety business contract disputes. Thus, in Kolar, an unpublished and nonbinding opinion, the Third Circuit took matters into its own hands, implicitly adopted Greenberg’s dissenting argument in Tabas, and ruled for the first time that RICO should not cover claims arising from contractual disputes between business entities, even if the technical pleading requirements of RICO were met. In the process, Kolar appears to have slipped a “societal threat” requirement, rejected in Tabas, in through the back door of RICO jurisprudence, and may also have injected a “gist of the action” test into RICO.
The plaintiff in Kolar, Erik E. Kolar,was the former president of a real estate investment company, PREI, and owned shares in various affiliate partnerships formed for the purpose of owning certain properties, including one named Island View. Kolar resigned as president and entered into a separation agreement where he would retain his interest in certain of the partnerships. After the separation, Kolar alleged that PREI diverted money owed to him by funneling profits to entities in which he had no interest. Kolar also alleged that PREI entered into a below-market lease for Island View, in exchange for the sale of a different property, Wheeler Way, to a PREI entity in which Kolar had no interest. When Wheeler Way was sold for a large profit, he alleged that he was cheated out of money to which he was entitled under the separation agreement. The RICO claims against PREI were based on these transactions.
After the trial court dismissed the RICO claims, the Third Circuit affirmed. The court acknowledged that RICO was to be “read broadly,” and that generally speaking, RICO could consequently be applicable to garden-variety fraud cases. However, while Tabas, in similar circumstances, found this dispositive to permit the assertion of a RICO claim, Kolar found it inapplicable. Focusing first on the diverted payments, Kolar found that this alleged scheme had no “deceptive elements,” but instead, consisted only of a failure to pay money due under “purported claims of a contractual right.” The court in Kolar found that while Kolar attempted to characterize the conduct as “false” and “fraudulent,” the conduct, even if wrongful under “contract or other state law,” was not fraudulent, and could not form the basis of a RICO action. The court reiterated: “These allegations set forth disputes sounding in contract. Kolar cannot successfully transmute them into RICO claims by simply appending the terms ‘false’ and ‘fraudulent.’” The court also cited authorities from other jurisdictions to assert that it “will not lightly permit ordinary business contract or fraud disputes to be transformed into federal RICO claims,” and “the [mail fraud] statute does not reject all business practices that do not fulfill expectations, nor does it taint every breach of a business contract.” This analysis was similar to Greenberg’s dissent in Tabas.
Accordingly, the court in Kolar found that the diverted payments could not form the basis for a RICO action. The court then addressed the Wheeler Way transaction. It found that although that transaction may have included a fraud component, it was only a “single, finite transaction” insufficient to meet the “continuity” requirement under RICO.
Because Kolar is an unpublished opinion, it is not binding precedent. Thus, the impact of Kolar is far from clear. Notwithstanding, it could be a signal from the Third Circuit that it will, in the future, be hostile to civil RICO claims where the predicate acts alleged arise from duties contained in a contract — the most garden variety of garden-variety business disputes. Interestingly, the reasoning of Kolar is virtually identical to the “gist of the action” analysis articulated by many Pennsylvania courts with respect to state-law tort claims arising from the breach of contractual duties. These courts have held that the gist-of-the-action doctrine “precludes plaintiffs from recasting ordinary breach of contract claims into tort claims,” as in eToll v. Elias/Savion Advertising, 811 A.2d 10 (Pa.Super. 2002).
Importantly, three months prior to Kolar, in Knit With v. Knitting Fever, 2009 WL 3427054 (E.D.Pa. Oct. 20, 2009), the U.S. District Court for the Eastern District of Pennsylvania rejected the application of the gist-of-the-action doctrine to civil RICO, explaining: “Given the absence of any authority … together with the fact that a RICO cause of action based on tortious predicate acts does not implicate the fundamental premise of the gist-of-the-action doctrine, the court declines to dismiss plaintiff’s RICO claims.” Based on Kolar, which utilized an analysis similar to the gist of the action to dismiss a civil RICO claim, Pennsylvania courts could, in the future, be receptive to a request to dismiss a civil RICO claim under gist-of-the-action principles.
Kolar and Tabas both involved allegations that the failure to perform contractual duties, by diverting money due under contracts through the use of mails and wires, constituted RICO predicates sufficient to state a RICO claim. Tabas begrudgingly permitted the claim to go forward; Kolar did not. The rationale of the court in Kolar was that the failure to perform contractual duties cannot be a RICO predicate, even if one alleges that the conduct was fraudulent. Thus, although Kolar is not binding authority, it could be a clear signal from the Third Circuit of its intent going forward to deny garden-variety RICO claims arising from contractual disputes, even if the technical elements of civil RICO can be established. Assuming the Third Circuit continues to take this position, it will have effectively circumscribed civil RICO despite Congress’ refusal to do so. Because many business disputes arise (at least initially) from contractual relationships, this could dramatically reduce the number of civil RICO claims in the Third Circuit.
This principle, if adopted, would raise many questions. For example, in a business-tort context, generally, the gist-of-the-action doctrine precludes claims for “fraud in the performance” of a contract, but not for “fraud in the inducement.” (See, e.g., Sullivan v. Chartwell Inv. Partners, 873 A.2d 710 (Pa.Super. 2005).) Assuming that after Kolar, the Third Circuit precludes RICO claims arising from performance of contractual duties, one would question whether (and to what extent) it would likewise permit a RICO claim to go forward if the alleged RICO predicate involved fraud in the inducement to contract. Similarly, the gist-of-the-action doctrine applies only to parties in privity of contract, as in Knit With. One would also question whether, under Kolar, the Third Circuit’s preclusion on RICO claims arising out of contractual breaches would apply to claims made by those not in privity with a plaintiff, but intimately involved in the same transaction. Thus, assuming Kolar signals a sea change in the Third Circuit’s RICO jurisprudence, there would still be many questions left unanswered. •
Andrew J. DeFalco is a business litigation attorney with Spector, Gadon & Rosen. He has written extensively on business and corporate litigation issues. He can be reached at firstname.lastname@example.org.