RICO or Recession? Court Rules Against Investors

(CN) - A group of investors failed to show that, rather than the Great Recession, a vast fraud caused their real estate losses, the 9th Circuit ruled Wednesday.

Eclectic Properties East LLC and two dozen other plaintiffs alleged that real estate developers Paul Morabito and Jack Waelti, along with brokers Marcus & Millichap Company and others, violated federal anti-racketeering law in a $30 million deal that went bad around 2008.

The plaintiffs claimed that Morabito and Waelti began the scheme by purchasing 22 commercial properties in California for about $20 million, building Jiffy Lube franchises on some and Church's Chicken franchises on others. The developers then sold the properties to Sovereign Investment Co. and leased them back.

By 2004, when the plaintiffs began purchasing the properties, defendant PGP Valuation Inc. had put the price at $30.3 million. The plaintiffs claimed in their RICO complaint that the properties were actually worth about $11.1 million, and that the sale-leaseback transaction and an allegedly fixed valuation had inflated the price.

The franchises owned by Morabito and Waeiti paid about $8.1 million in rents after plaintiffs bought all of the properties, but each lease was eventually breached, leaving unpaid some $59 million in expected rent.

U.S. District Judge Ronald Whyte in San Jose, Calif., dismissed the RICO complaint, finding no showing of intent to defraud the plaintiffs with a planned-out conspiracy.

A three-judge appellate panel affirmed on Wednesday, saying that the recession of 2008 and 2009 could have had as much to do with the plaintiffs' loses as any RICO conspiracy.

"All of the facts Plaintiffs have presented are consistent with both their theory of liability and this innocent alternative, that the recession decreased business viability and property values," Judge Ronald Gould wrote for the panel in San Francisco.

The high standard for RICO allegations requires proof of a "specific intent to defraud" that the plaintiffs could not show, the panel found.

"The complaint purported to allege intentional fraud in the inflation of property values on properties sold to Plaintiffs," Gould wrote. "However, the complaint's factual allegations do not support a plausible inference that defendants had the required specific intent to defraud, nor do they tend to exclude the alternative explanation that the transactions were merely a group of business deals gone bad during a deep recession."

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