Rico and the Prime: Taking a Bite Out of Crime?
| Publication year | 1991 |
| Pages | 7 |
Kenneth R. Wallentine, J.
Introduction
Two of the trial attorney's darlings are more frequently crossing paths these days as lender liability plaintiffs add RICO[1] claims to their complaints. RICO entices plaintiffs with the benefits of potential attorney fees, [2] treble damages, [3] generous venue provisions, [4] nationwide service of process, [5] broad injunctive relief, [6] and the coercive weapon of gangster stigmatization, a label that strikes fear in the heart of banks' marketing gurus. While federal courts have generally taken a hostile approach to aggressive RICO actions, many pitfalls await the careless lender. RICO reform legislation has been considered in the past few Congresses, particularly aimed at eliminating treble damages;[7] however, business interests have made little headway in achieving their agendas.
RICO suits brought against financial institutions have been far-reaching and varied. One major type of RICO suits brought against lenders is based on "prime rate fraud, " where a lender promises to extend credit to a customer at the prime rate and the customer later discovers that "below-prime" loans have been extended to other borrowers.[8]At least one federal court has found that prime rate fraud claims may be certified as class actions, perhaps opening the door to colossal damage awards.[9] This category of RICO claim is obviously unique to lenders and provides the focus of the remainder of this article.
Other RICO actions against lenders are styled as complaints of unlawful efforts to collect or protect security on existing debts.[10] Plaintiffs may allege that the lender misrepresented assets, inducing a third party to purchase a borrower's business, [11] or that the lender wrongfully converted funds to satisfy a guarantee.[12]Claims may also arise in the context of failure to fulfill loan commitments.[13]A lender may be alleged to be a facilitating participant in a fraudulent investment scheme, leading to RICO liability.[14]
Lenders occasionally fall prey to RICO as innocent third party victims when the government brings a complaint under RICO's criminal forfeiture provisions against a bank customer.[15] Any property derived from racketeering activity is subject to forfeiture. Title vests in the government at the time the predicate act[16] is committed.[17] When the lender has a perfected security interest in the debtor's property, the interest may be destroyed through relation-back of the title vesting provisions. While various constitutional and equitable defenses may be raised against forfeiture, the forfeiture statute is tightly worded to give every advantage to the government.[18] The Supreme Court has recently demonstrated its willingness to strictly apply criminal forfeitures, even in light of sound fifth and sixth amendment challenges.[19]
Part I of this article presents an synopsis of the complicated RICO statute and the requisite elements of a RICO offense. Part II discusses application of these elements to prime rate fraud actions. Part III examines potential defenses to prime rate fraud allegations. Finally, the Conclusion offers practical suggestions to aid lenders in avoiding RICO claims through careful drafting of loan documents and communication with the borrower.
I. RICO
RICO is a penalty-enhancement statute, [20]and does not make any act illegal that is not already prohibited under another statute.[21] Rather, certain federal and state felonies are defined as RICO predicate acts.[22]Commission of two predicate acts within a 10-year period potentially subjects one to criminal[23]or civil[24]liability under RICO. RICO is based on the concept of "enterprise" criminality.[25]A RICO defendant must invest income derived from a "pattern of racketeering activity, "[26] acquire an interest in an enterprise through a pattern of racketeering activity, [27]participate in or operate an enterprise through a pattern of racketeering activity, [28]or conspire to commit any of these acts to be subject to RICO liability.[29]While RICO opponents often claim that the statute was not aimed at legitimate enterprises, such as banks and businesses, [30] courts have disagreed with equal consistency.[31] RICO was enacted with the specific legislative directive to interpret the "provisions of this title. . .liberally to effectuate its remedial purposes."[32]
To prevail in a RICO suit, the plaintiff must offer proof of the following elements, in addition to evidence of predicate acts: first, the conduct of an enterprise which affects interstate or foreign commerce;[33]second, the operation of the enterprise must be through a pattern of racketeering activity;[34]third, by a "person;"[35]and fourth, that the violation caused injury to the plaintiffs business or property.[36]A minimum of two predicate offenses must have been committed within 10 years.[37]
II. Prime Rate Fraud & RICO
A. AN OVERVIEW OF PRIME RATE FRAUD
The "prime rate" is the rate of interest which a lender charges its most creditworthy commercial borrowers, usually for short-term loans.[38]The prime rate has been a key financial indicator since the Depression era.[39] Residential mortgagees monitor the prime carefully, retreating from new commitments when the prime rate remains high.[40]Government agencies use the Wall Street Journal daily prime rate listings as a basis for official lending programs.[41]The announced prime rate forms the basis for competition among lenders seeking to woo large borrowers. Therefore an honest posting of the prime rate is vital to a free economy.
Discounted prime loans and lawsuits related to them are not recent developments; lenders have been sued under similar theories since the beginning of this century.[42]Undergirding these actions is a social policy of promoting competition and deterring the economically harmful effects of unreliable reports of the cost of borrowing. Prime rate interest fraud cases acquired new glamour in 1980 when Jackie Kliener, a business law professor, began a plan to sue lenders on a "bank of the month" club plan under RICO.[43]Kliener, dissatisfied with his bank's lending practices, brought a class action prime rate fraud suit against the First National Bank of Atlanta.[44]
B. RICO ELEMENTS APPLIED TO PRIME RATE FRAUD
The first, and formerly most difficult, hurdle that the RICO plaintiff must traverse is the requirement that his injury resulted from a "pattern of racketeering activity."[45]Until the summer of 1989, the pattern element puzzled both courts and counsel, as the Supreme Court had not spoken directly to the issue.[46]In H.J., Inc. v. Northwestern Bell Telephone Co.[47]the Court addressed the standard for a RICO pattern. The Court rejected a "separate schemes"[48]test in favor of a "separate acts" test, so that two or more predicate acts within a single scheme could support a RICO complaint.[49]
In endorsing the single scheme, separate acts standard, the Court stated that "to prove a pattern of racketeering activity a plaintiff or prosecutor must show that the racketeering predicates are related, and that they amount to or pose a threat of continued criminal activity."[50]Nonetheless, the Court offered few guidelines regarding the type of requisite relationship between the predicate acts.[51] The Court also noted that continuity could be shown in a variety of fashions, stating that the inquiry was fact-specific.[52]The Court's vagueness left abundant discretion for lower courts to develop conflicting definitions of pattern. Justice Scalia stated that while the pattern element requires some-thing more than two bare predicate acts, "what that something more is, is beyond me. As I have suggested, it is also beyond the Court."[53]
The predicate acts which underlie prime rate fraud actions are generally claims of mail fraud, [54]which merely requires that a fraudulent scheme be advanced through the mails.[55] The defendant lender sends interest and billing statements through the mail to the plaintiff borrower. Assuming that the prime rate fraud causes a loss to the plaintiff, it is a simple matter for the plaintiff to show that the mailing of statements furthered the fraudulent scheme by giving notice of the fraudulent interest payments due.
The plaintiff must next demonstrate the existence of an "enterprise."[56]There is no requirement that the enterprise be criminal in character; the enterprise may be a legitimate business, [57]such as a bank or a bank holding company. Indeed, even the office of state governor has been found to be an enterprise subject to RICO.[58]Nor must the enterprise be formally organized; it may be an "association-in-fact."[59]The enterprise may be the perpetrator, instrument, victim or prize of the fraud.[60]The enterprise must be distinguished from the pattern of racketeering activity.[61]Notwithstanding, the same evidence may be used to establish both the pattern and the existence of the enterprise.[62]
Under 1962 the plaintiff has available three non-exclusive alternative theories of relief. Section 1962(a) proscribes the use of money derived from the operation of the enterprise. A plaintiff may easily allege that the bank is both the person operating the racketeering activity through the fraudulent prime rate scheme, and the enterprise into which the profits of the scheme are poured.[63]Section 1962(b) prohibits a person from controlling or acquiring any enterprise through a pattern of racketeering activity. Again, the bank may be alleged to be the person controlling itself, the enterprise bank. Finally, 1962(c) requires that the person be...
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