New England Data Services, Inc. v. Becher

• Decision Date: 05 May 1987
• Docket Number: No. 86-1692,86-1692
• Citation: 829 F.2d 286
• Parties: , 9 Fed.R.Serv.3d 312, RICO Bus.Disp.Guide 6755 NEW ENGLAND DATA SERVICES, INC., Plaintiff, Appellant, v. Barry BECHER, et al., Defendants, Appellees. . Heard
• Court: U.S. Court of Appeals — First Circuit

Page 286

829 F.2d 286

56 USLW 2201, 9 Fed.R.Serv.3d 312, RICO

Bus.Disp.Guide 6755

NEW ENGLAND DATA SERVICES, INC., Plaintiff, Appellant, v.Barry BECHER, et al., Defendants, Appellees.

No. 86-1692.

United States Court of Appeals First Circuit.

Heard May 5, 1987.

Decided Sept. 28, 1987.

John D. Deacon, Jr. with whom Edwards & Angell, Providence, R.I., was on brief, for plaintiff, appellant.

Michael H. Feldhuhn with whom Max Wistow and Wistow & Barylick Inc., Providence, R.I., were on brief, for defendants, appelleesBarry Becher and Edward Valenti.

Marc DeSisto, with whom Joseph A. Kelly and Carroll, Kelly & Murphy, Providence, R.I., were on brief, for defendants, appelleesDavid Schechter and Monarch Investments.

Before BOWNES, BREYER and TORRUELLA, Circuit Judges.

TORRUELLA, Circuit Judge.

This appeal arises from an order of the Rhode Island District Court dismissing plaintiffNew England Data Services, Inc.'s complaint.The complaint alleged a violation of the Racketeer Influenced and Corrupt Organizations Act,18 U.S.C. Sec. 1961 et seq., ("RICO"), and three state law claims.The district court dismissed the RICO claim for failure to plead the predicate acts of mail and wire fraud with sufficient particularity pursuant to Fed.R.Civ.P. 9(b).The court then dismissed the pendent state claims because federal subject matter jurisdiction was based solely on the RICO claim.

I

New England Data alleged that a sale of the stock in two corporations by defendants Becher and Valenti to defendants Monarch Investments and Schechter was a fraudulent transfer that prevented plaintiff from satisfying state court judgments it had against the corporations.Becher and Valenti were the officers and stockholders of International Broadcast Industries, Inc.(IBI) and Ginsu Products, Inc.(Ginsu), and Schechter was their attorney.Plaintiff had brought suit in state court against Ginsu and IBI, for monies owed.Shortly after entry of judgment in favor of plaintiff, Becher, Valenti and Schechter, pursuant to an alleged conspiracy to defraud creditors, sold all the stock of Ginsu and IBI to buyers, including defendants Schecter and Monarch Investments, an entity created by Schecter.Purportedly to secure payment for the sale of stock, Becher and Valenti were given a first priority security interest in the assets of Ginsu and IBI.The transfer of the security interest was made without fair consideration to the corporations, thereby rendering the corporations insolvent.The sale of stock and the transfer of the security interest were allegedly sham transactions conducted by defendants for the purpose of defrauding creditors, including plaintiff.After plaintiff commenced efforts to collect its judgment against Ginsu and IBI, defendants Becher and Valenti declared a default under the stock sale agreement, and exercising their rights as holders of a security interest, took possession of Ginsu's and IBI's assets.

After plaintiff commenced this suit in federal court, defendants moved to dismiss.A magistrate recommended that the motion be granted on the grounds that plaintiff failed to allege with particularity the RICO predicate acts of mail and wire fraud, as required by Fed.R.Civ.P. 9(b).After a hearing on the issue, the district court denied the motion to dismiss and allowed plaintiff to serve interrogatories upon defendants limited to the question of whether defendants used the wires and, or, mails in executing the alleged transactions.Defendants denied any knowledge thereof and the court dismissed the complaint pursuant to Rule 9(b).¹

II

RICO provides for a private right of action for "[a]ny person injured in his business or property by reason of a violation of Sec. 1962 ..."18 U.S.C. Sec. 1964(c).This plaintiff alleges violations of 18 U.S.C. Sec. 1962(b), (c) and (d).²"Racketeering activity," as defined in Sec. 1961(1)(B), includes two "predicate acts" of mail or wire fraud under 18 U.S.C. Sec. 1341and18 U.S.C. Sec. 1343, respectively.

In regards to pleading mail and wire fraud, plaintiff's complaint stated:

On information and belief, in effecting the stock sale agreement, the grant of the security interest, in purporting to exercise remedies to enforce said security interest, and in furtherance of the fraudulent scheme, defendants on two or more occasions used the mails and/or transmitted communications by wire in interstate or foreign commerce ...

The issue on appeal is how Fed.R.Civ.P. 9(b)'s special pleading requirement interacts with mail and wire fraud allegations under RICO.Although this circuit has not yet addressed this issue, it is clear that in a general fraud case, Rule 9"requires specification of the time, place, and content of an alleged false representation, but not the circumstances or evidence from which fraudulent intent could be inferred."McGinty v. Beranger Volkswagen, Inc., 633 F.2d 226, 228(1st Cir.1980).The major purpose of Rule 9 is to give adequate notice of the plaintiff's claim of fraud.Id. at 228-29.

In the context of securities litigation, we have expressed the fear that a plaintiff with a largely groundless claim will bring a suit and conduct extensive discovery in the hopes of obtaining an increased settlement, rather than in the hopes that the process will reveal relevant evidence.Wayne Investment, Inc. v. Gulf Oil Corp., 739 F.2d 11, 13(1st Cir.1984)(citingRoss v. A.H. Robins Co., 607 F.2d 545(2d Cir.1979), citingBlue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 741, 95 S.Ct. 1917, 1928, 44 L.Ed.2d 539(1975)).In Wayne, this court further stated that allegations based on "information and belief," as in the instant complaint, do not satisfy the particularity requirement unless the complaint sets forth the facts on which the belief is founded.Id.Furthermore, this requirement of pleading supporting facts applies "even when the fraud relates to matters peculiarly within the knowledge of the opposing party."Id. at 14.Thus, in the securities context, and in general, this circuit has strictly applied Rule 9(b).See alsoHayduk v. Lanna, 775 F.2d 441, 443(1st Cir.1985)("in cases in which fraud lies at the core of the action, the rule does not permit a complainant to file suit first, and subsequently to search for a cause of action.")(citingLopez v. Bulova Watch Co., Inc., 582 F.Supp. 755, 766(D.R.I.1984)).

Although this circuit has not yet ruled on how Rule 9(b) impacts on the pleading of RICO predicate acts, it is clear that Rule 9(b) does apply to civil RICO claims.See, e.g., Micro-Medical Industries, Inc. v. Hatton, 607 F.Supp. 931(D.P.R.1985);Carbone v. Proctor Ellison Co., 102 F.R.D. 951(D.Mass.1984);see alsoC.M. Flowers v. Continental Grain Co., 775 F.2d 1051(8th Cir.1985);Bosteve, Ltd. v. Marauzwski, 642 F.Supp. 197(E.D.N.Y.1986);Federal Deposit Insurance Corp. v. Kerr, 637 F.Supp. 828, 834(W.D.N.C.1986).The issue now becomes whether Rule 9(b) should be applied to RICO mail and wire fraud as strictly as this circuit has applied the Rule to securities fraud and general fraud.

Generally, there are three purposes behind Rule 9(b)'s particularity requirement: (1) to place the defendants on notice and enable them to prepare meaningful responses; (2) to preclude the use of a groundless fraud claim as a pretext to discovering a wrong or as a "strike suit"; and (3) to safeguard defendants from frivolous charges which might damage their reputations.In re Longhorn Securities Litigation, 573 F.Supp. 255, 263-64(W.D.Okla.1983).See alsoGaudette v. Panos, 644 F.Supp. 826, 834(D.Mass.1986).

There is a definite split among the circuits in their treatment of Rule 9(b) and predicate acts.Some courts have espoused a more lenient approach and advocated the allowance of discovery before dismissing a claim, whereas others tend to mandate dismissal in order to avoid "strike suits" or the like.We will discuss the pros and cons of these two approaches.

Some courts have held that Rule 9(b) must be harmonized with Fed.R.Civ.P. 8(a), the modern rule of notice pleading which mandates only short and plain statements sufficient to place the defendant on notice.SeeMcGinty, 633 F.2d at 229;see alsoMicro-Medical Industries, Inc. v. Hatton, 607 F.Supp. at 936;Eaby v. Richmond, 561 F.Supp. 131, 137(E.D.Pa.1983).

In Eaby v. Richmond, although the court found that the complaint clearly did not sufficiently particularize the RICO predicate act of mail fraud, the court declined to impose the "draconian result of dismissal."561 F.Supp. at 137.The court considered plaintiffs' argument that the facts underlying their claim were particularly within the defendants' knowledge.Also, plaintiffs argued that if granted an opportunity to discover, they could amend their complaint and cure any pleading defect.The court, in light of the liberal federal policy favoring amendments, Zenith Radio Corp. v. Hazeltine Research, Inc., 401 U.S. 321, 91 S.Ct. 795, 28 L.Ed.2d 77(1971), allowed the plaintiffs sixty days to conduct discovery and then amend their complaint.

In Federal Deposit Insurance Corp. v. Kerr, 637 F.Supp. at 835, the court found that a basic outline of a scheme to defraud had been set forth, however the complaint did not set forth with particularity which defendants had used the mails or interstate wires.The court considered the fact that this information was peculiarly within the knowledge of the defendant, and thus less detail should be required.The plaintiffs were ordered to amend their complaint and plead the RICO predicate acts more specifically.

Whether the facts are peculiarly within the defendant's control is a factor given different weight by different courts.Those courts that focus on avoiding the drastic result of dismissal tend to include this consideration as a persuasive factor, whereas those that focus on avoiding "strike suits" or the like tend to not include it as a consideration.See, e.g., Federal Deposit Insurance Corp. v. Kerr...