Those plaintiffs counsel practicing in the Third Circuit should rejoice in knowing that RICO provides a powerful tool for creditors against debtors using fraudulent means to avoid paying.
In the January 5, 2023 edition of The Legal Intelligencer, Edward T. Kang wrote “Sophisticated Schemers Beware: Civil RICO Expands Creditors’ Arsenal“
In a recent settlement conference for a RICO case I am prosecuting, one of the defense counsel was commenting about how the case is “just a business dispute,” not a RICO case. Of course, he was downplaying the strength of the RICO case. But he surprised me when he said how no one understands RICO, including the court. It was obvious that he did not read any of my columns discussing RICO. See Civil RICO and Proximate Cause: A Tool for Defendants and Challenge for Plaintiffs; The Forgotten and Often Misunderstood Sections of RICO; and How RICO Plays a Role in the World of Harvey Weinstein and #MeToo. Contrary to counsel’s comments, the reach of RICO is expanding, not contracting, especially in the U.S. Court of Appeals for the Third Circuit.
Until recently, creditors who attempted to recover their monies against debtors using sophisticated schemes to conceal or transfer their assets could collect either under fraudulent transfer law or reverse veil-piercing. Most states have enacted the Uniform Fraudulent Transfer Act, which was intended to prevent debtors from divesting themselves of assets to prevent creditors from collecting. Reverse veil-piercing allows creditors to prove that an entity is essentially the debtor and thus the entity’s assets are used to satisfy the obligations of the debtor. Many states, however, refuse to apply this doctrine because it bypasses the normal judgment collection procedures and fails to protect nonculpable shareholders that would be prejudiced if the corporation’s assets were attached. Both the Uniform Fraudulent Transfer Act and reverse veil-piercing have their shortcomings as they are often unable to penetrate the sophisticated networks and structures designed by savvy fraudsters. Even when these legal theories are “successful,” the creditor is typically only able to salvage a limited recovery against part of a debtor’s protected assets.
Unlike fraudulent transfer law and reverse veil-piercing, civil claims under the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. Sections 1961-1968 can be used effectively by plaintiffs for collection against debtors using a sophisticated system to avoid the creditor because, if successful, RICO provides for mandatory treble damages and attorney fees. The recent development of civil RICO theories, particularly in the Ninth Circuit, has sharpened the tools at the creditors’ disposal by allowing them to use RICO as a means to attack sophisticated debtor schemes. On June 10, 2022, for instance, the Ninth Circuit issued its decision in Smagin v. Yegiazaryan, 37 F.4th 562 (9th Cir. June 10, 2022), aligning itself with the Second and Third Circuits’ expansion of RICO.
In Smagin, defendant Ashot Yegiazaryan and several other Russian citizens used a series of transactions to steal plaintiff Vitaly Smagin’s (also a Russian citizen) shares in a joint real estate investment in Moscow, Russia between 2003 and 2009. In 2010, the defendant and the other schemers were criminally indicted in Russia for that fraud. As a result of the indictment, Yegiazaryan fled to Beverly Hills, California to escape criminal prosecution. Meanwhile, the plaintiff commenced arbitration proceedings in London, U.K. against the defendant for his fraudulent conduct and for his attempts to conceal the fraud. In November 2014, the arbitration panel rendered an award against the defendant for $84 million.
Following the arbitration award, the plaintiff filed an enforcement action in the U.S. District Court for the Central District of California to confirm and enforce the award against the defendant. In December 2014, a district judge confirmed the arbitration award and entered judgment against the defendant under the Convention of the Recognition and Enforcement of Foreign Arbitral Awards, also known as the New York Convention. At the time, the defendant Yegiazaryan was in the midst of another arbitration proceeding. In 2015, the defendant settled an arbitration dispute against Suleyman Kerimov and was awarded $198 million. The plaintiff alleged that the defendant created a web of offshore entities with complex ownership structures to hide his arbitration award to avoid using the funds to pay the plaintiff’s award and judgment entered in California. The plaintiff also alleged that the defendant schemed to have associates file fraudulent claims against him in foreign jurisdictions so that they could obtain sham judgments designed to impede the California judgment. On Dec. 11, 2020, the plaintiff filed his complaint against Yegiazaryan and his associates bringing a substantive RICO claim of participating in a criminal enterprise in violation of 18 U.S.C. Section 1962(c) and a RICO conspiracy claim of conspiring to participate in a criminal enterprise in violation of 18 U.S.C. Section 1962(d). The district court dismissed the complaint on the ground that the plaintiff failed to adequately plead a “domestic injury” in support of his RICO claims.
Under RICO “any person injured in his business or property by reason of a violation of section 1962 of this chapter may sue in an appropriate U.S. district court …” To have statutory standing a civil RICO plaintiff must show: the alleged harm qualifies as injury to his business or property; and (2) that his harm was by reason of the RICO violation, which requires the plaintiff to establish proximate causation. Moreover, the U.S. Supreme Court held in RJR Nabisco v. European Community, 579 U.S. 325 (2016) that although RICO may have some extraterritorial effects, a private plaintiff must be able to prove that the injury to its business or property is domestic in nature. The court did little, however, to define what amounted to a “domestic injury.”
The Ninth Circuit concluded that a judgment is indeed considered property and the injury here was in fact domestic. The court noted that while the judgment in this case confirmed a foreign arbitration award, it existed as property in California because the rights that the judgment provided to the plaintiff could only be enforced in California, not Russia. Moreover, the court explained that its conclusion was bolstered by the fact that much of the defendants’ underlying conduct occurred in California. The defendants allegedly “corruptly illegally prevented the plaintiff from executing the judgment by filing false documents in the California court, intimidating a witness who resided in California, and directing, from California, a scheme to funnel millions of dollars into the United States through various companies, including a U.S.-based company that Ashot effectively controlled.” For all these reasons, the Ninth Circuit determined that the plaintiff’s rights under the judgment constituted a “domestic injury.”
The Ninth Circuit’s ruling in Smagin is consistent with the approaches taken by the Second and Third Circuits following the RJR Nabisco decision. But, it differs from the approach the Seventh Circuit has adopted, a “rigid residency”-based test for domestic injuries involving intangible property. In Amada (Singapore) PTE v. Amcol International, 885 F.3d 1090 (7th Cir. 2018), a Singapore shipping carrier entered into a contract with an Indian mining company that was owned by an Illinois company. Similar to Smagin, the Singapore carrier sued the defendants under RICO claiming that the Illinois company had divested the Indian company’s assets that were subject to a U.S. district court judgment that confirmed a foreign arbitration award. The Seventh Circuit determined that in locating the existence of intangible property, such as a judgment, the key inquiry is where the injury is suffered. The Seventh Circuit explained that a party sustains injuries to its intangible property at its residence, which for a corporate is its principal place of business. The court reasoned that because the plaintiff’s principal place of business was in Singapore, that is where the harm was experienced and therefore the injury was not domestic. As there was no domestic injury, the Seventh Circuit held that the plaintiff failed to plead a plausible claim under RICO.
For now, the Supreme Court has not weighed in as to which of the two diverging approaches is correct under RICO and the prevailing case law. The Ninth Circuit’s adoption has certainly given momentum to what has now clearly become a “majority approach” beneficial to out-of-country plaintiff’s seeking to recover for harm committed in the United States. While Uniform Fraudulent Transfer Acts and reverse veil-piercing exists as weapons for creditors to collect from fraudsters, the developments in civil RICO law have greatly expanded the creditors’ arsenal. RICO permits creditors to group the debtor, all of the entities the debtor controls and all of the conspirators together and recover treble damages as well as costs and attorney fees. Until the Supreme Court decides to significantly curtail creditors’ cause of action under RICO, fraudsters should sleep with one eye open. Those plaintiffs counsel practicing in the Third Circuit should rejoice in knowing that RICO provides a powerful tool for creditors against debtors using fraudulent means to avoid paying.
Edward T. Kang is the managing member of Kang Haggerty. He devotes the majority of his practice to business litigation and other litigation involving business entities. Contact him at ekang@kanghaggerty.com.
Reprinted with permission from the January 5, 2023 edition of “The Legal Intelligencer” © 2023 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.