Commercial Litigation and Arbitration

RICO — Direct vs. Derivative Injury — Shareholder in Close Corporation

From Siddle v. Crants, 2009 U.S. Dist. LEXIS 52997 (M.D. Tenn. June 18, 2009):

From October 2001 thru October 2006, defendant Crants, Jr. was the Chairman, CEO and majority shareholder of Homeland Security Corporation (HSC). In 2003, his son, defendant Crants, III, acquired five percent ownership of HSC. During this time period, Crants, Jr. and Crants, III owned and controlled various other entities ("Related Parties"), such as Pharos Homeland and Pharos Homeland Financial, which carried on business with HSC.


On December 1, 2001, HSC entered into a joint venture with PPCT Management Systems (a plaintiff in this case). Plaintiff Bruce Siddle ran PPCT at this time, apparently as the sole or majority shareholder. The joint venture was formed to compete for a $106,000,000 TSA contract, which was awarded to the joint venture on April 20, 2002.... [A]fter the contract was awarded, the joint venture dissolved when Mr. Siddle transferred his interest in PPCT to HSC in exchange for Crants, Jr.’s promise of 25 percent ownership in HSC and cash.... Through this transaction, Mr. Siddle became, along with Crants, Jr., a member of the HSC Board of Directors....

The plaintiffs allege that, from October 2001 to October 2006, both Crants, Jr. and Crants, III were operating an elaborate scheme that was designed to, and did, defraud the plaintiffs by taking their business and property interests under false pretenses. While the Amended Complaint alleges numerous manifestations of this broad plan, three devices are particularly prominent in the allegations. First is the "demand note" scheme, through which, in one manifestation, the plaintiffs contend that Crants, Jr. and Crants, III agreed to misrepresent to the public, the Siddles, and various banks that HSC had issued a $5,000,000 promissory note to one of the Pharos entitles controlled by Crants, III, when, in fact, no such note had been issued. The plaintiffs allege that this misrepresentation (and those connected to similar fraudulent demand notes) allowed Crants, Jr and Crants, III to deem HSC cash transactions with them or a Related Party a payment on the note, which allowed them to maintain control over HSC's cash and avoid various reporting requirements. When "due diligence" investigations were conducted with HSC and the relevant notes were requested, the plaintiffs allege that Crants, Jr. and Crants, III simply agreed to draw up a fraudulent note.

Second is the "stock redemption" scheme, by which the plaintiffs allege that Crants, Jr. repeatedly (on four specific occasions) redeemed his HSC common stock with HSC for $60 per share, which was the value that Crants, Jr claimed the stock had. The plaintiffs allege that Crants, Jr. told HSC that he needed the cash to repay "loans," when, in fact, no loans existed. The plaintiffs contend that the stock redemption technique was Crants, Jr.'s way of paying himself (but not the plaintiffs or any other HSC shareholder) a dividend and his way of simply taking cash from HSC, without approval from the Board of Directors, including Mr. Siddle.

Third is the "Fraudulent Factoring for Hidden Related Party Payments Device," by which Crants, Jr. (without consultation with others at HSC) caused HSC to enter into a high interest rate factoring agreement with a financial institution. Through the factoring agreement, the financial institution paid HSC (through Crants, Jr.) a cash advance in exchange for a high interest rate and a security interest in HSC's accounts receivable. The plaintiffs allege that Crants, Jr. kept the advance payment for himself (or funneled it to a Related Party directed by Crants, III) and left HSC with the problem of paying back the high interest rate loan, which further drained HSC of cash. In sum, the plaintiffs allege that Crants, Jr. (often assisted by his son) used all three of these schemes to enhance his personal wealth, while draining HSC of cash, and, further, that Crants, Jr. and Crants, III covered up and lied about their schemes to employees of HSC, the plaintiffs, and entities such as the IRS.


B. Standing


RICO's civil suit provision grants "[a]ny person injured in his business or property by reason of a violation of" RICO's substantive provisions the right to "sue [ ] in any appropriate United States district court" and to "recover threefold the damages he sustains and the cost of the suit, including a reasonable attorney's fee." 18 U.S.C. § 1964(c). There is no question, however, that, if the plaintiff in a RICO suit asserts an injury that is purely derivative of a corporate injury, that plaintiff would not have standing to sue under RICO for that injury. Trollinger v. Tyson Foods, Inc., 370 F.3d 602, 612 (6th Cir. 2004); Warren v. Manuf. Nat'l Bank of Detroit, 759 F.2d 542, 544-45 (6th Cir. 1985)(finding that, where the injuries were "apparently inflicted upon the corporation," the corporation's sole shareholder did not have the right to sue in an individual capacity under RICO for business losses and loss of employment); Gaff v. FDIC, 814 F.2d 311, 317 (6th Cir. 1987) ("We find that in Warren this Circuit conclusively adopted the general rule that a shareholder does not have standing to bring a direct cause of action under federal law when the only damage alleged is the diminution in the value of corporate shares.")

The Crants defendants argue that, because the Amended Complaint repeatedly alleges that the defendants drained cash from HSC and caused HSC certain damages, the plaintiffs' alleged injuries must be purely derivative of those suffered by HSC, and, therefore, the plaintiffs lack standing.... The defendants point out that the sum total of the damages that the plaintiffs seek in this case is almost exactly triple the amount that the plaintiffs have alleged that the defendants took from HSC ($41,761,464) in the course of their scheme, which, because RICO permits a treble damages recovery, would indicate that the plaintiffs did not suffer any damages on their own.... That argument is not entirely correct, because, among other things, the plaintiffs' RICO Case Statement says that the "fraudulent and coercive schemes" caused harm "in excess" of that $41,761,464 amount....

The question, therefore, is whether, at this stage, taking the plaintiffs' Complaint allegations as true, the plaintiffs have sufficiently alleged that they suffered injuries independent of HSC.***

While the plaintiffs do repeatedly mention injuries suffered by HSC, the Complaint and the plaintiffs' RICO Case Statement contain enough support for the proposition that the plaintiffs suffered injuries independent from HSC (personal, direct injury) such that the court, at this stage, cannot dismiss the RICO claims for lack of standing. For instance, in their Complaint and RICO Case Statement, the plaintiffs state that, among other things, the defendants' RICO violations cost them "business clients and business opportunities, security clearances, and past performance credentials," and also damaged their "financial accounts and credit" and "copyrights, patents, and trademarks."...

It is certainly reasonable to assume, in light of the allegations in the Complaint, that the scheme alleged could have directly injured individuals closely associated with the scheme and HSC in these respects. That is, among other things, such a scheme could have discredited individuals associated with HSC in certain circles to such an extent that the plaintiffs lost their "business clients and business opportunities, security clearances, and past performance credentials." ... It appears that it is this type of injury, amongst others, that the plaintiffs are alleging here. This injury strikes the court as significantly more direct than the derivative injuries discussed in the Sixth Circuit case law noted above.


Only further discovery can reveal whether the plaintiffs will be able to show any damages separate and apart from those suffered by HSC, and the court certainly will not foreclose the defendants from reasserting this standing argument at a later stage in the proceeding. Therefore, the court will not dismiss the Complaint against either defendant based on lack of standing, and the court now turns to the additional arguments made by Crants, III in support of his motion to dismiss.

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