Appeals from the United States District Court for the Northern District of Illinois, Eastern Division. No. 81 C 1475 -- THOMAS R. McMILLEN, Judge.
Cummings, Chief Judge, Wood, Circuit Judge, and Hoffman, Senior District Judge.*fn*
This is an interlocutory appeal from the district court's order denying defendants' motion to dismiss the complaint; it was certified to this court for resolution of controlling questions of law, pursuant to 28 U.S.C. § 1292(b). While the district court did not limit its certification to a particular question, it stated that it viewed the "controlling question" to be whether the plaintiff may sue for the type of injury he alleges here under the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. §§ 1961-1968 (hereinafter, RICO). In order to reach this jurisdictional issue, however, we find it first necessary to determine the standing of the plaintiff, the Director of Insurance of the State of Illinois (Director), who is the statutory liquidator of Reserve Insurance Company (Reserve), to maintain the action, and to determine the sufficiency of the complaint. We conclude that the Director has standing, that his complaint is sufficient, and that it alleges an injury which may be redressed by a civil action under RICO.
Although the alleged events giving rise to this action are complex, they may be outlined briefly for the purposes of this appeal. The main focus of the allegations is that, as a result of the fraudulent actions of the various defendants, Reserve's corporate parent was caused to continue Reserve in business even though the latter was insolvent, and was caused to saddle Reserve with additional liabilities and drive deeper into insolvency, all of which consequences resulted in damage to Reserve, as well as its policyholders and creditors, exceeding $100,000,000.
The complaint recites that, as of December 31, 1974, Reserve was insolvent as a result of its policy of accepting extraordinarily high-risk insurance business and underreserving and maintaining insufficient surplus for potential claims. In late 1974, the Director alleges, the Illinois Department of Insurance became concerned about the diminution of Reserve's surplus, and initiated negotiations with the officers and directors of Reserve and American Reserve Corporation (ARC), Reserv's corporate parent, to rectify the problem. While these negotiations were proceeding, however, the officers and directors of Reserve and ARC caused their companies to enter into an agreement with defendants Societe Commerciale De Reassurance (SCOR), a deal brokered by SCOR Reinsurance Company (SCOR Re). Under the terms of this agreement, Reserve ceded to SCOR most of its more profitable and least risky business (in return for SCOR's payments of commissions to Reserve), most of which business SCOR in turn secretly retroceded to another ARC subsidiary, Guarantee Reserve Co., Ltd. (GRC). Also, because the capitalization of GRC was insufficient to cover the potential losses involved in this retrocession, the Director alleges, ARC's officers and Directors secretly agreed to guarantee GRC's obligations to SCOR. The purpose of these agreements, the Director charges, was to enable Reserve to report on paper a smaller volume of business and an increase in surplus and thus a lower liability-to-surplus ratio, a fraudulent result which concealed and exacerbated Reserve's actual insolvency.
By concealing Reserve's continued liability for the retroceded business and hence Reserve's continued insolvency, the Director alleges, the defendant directors and officers were able to fraudulently obtain approval of the Illinois Department of Insurance for the cession agreements and were able to reach a consent agreement with the Department in April, 1975 which enabled Reserve to continue operations if certain surplus requirements were met. In addition, the subsequent continuation of these concealments effected through the SCOR agreements enabled Reserve's officers to violate the explicit surplus maintenance requirements of the consent agreement, the Director avers, while the SCOR agreements had the further cumulative effect of draining away from Reserve its more profitable and less risky business and over $3,000,000 in income. If the Department had at any time known of Reserve's actual insolvency, the complaint charges, it would not have permitted Reserve to continue to write insurance and suffer further dissipation of its assets, but would have caused Reserve to stop writing insurance pursuant to Ill. Rev. Stat., ch. 73, § 756.1 (1981). The complaint alleges that defendants SCOR and SCOR Re were aware of the fraudulent purposes (and the further crippling impact upon Reserve) of the underlying agreements which they entered into and brokered. The director further alleges that the defendant accounting firms, Coopers and Lybrand, Alexander Grant and Co., and Arthur Andersen and Co., knew of Reserve's insolvency and of the further impairing effect of the SCOR agreements and Reserve's continued operations, but that, despite this knowledge, each of them prepared unqualified opinion letters as to ARC's consolidated financial statements in 1974, 1975, 1976 and 1977, even though those statements failed to disclose that the SCOR agreement was entered into to conceal Reserve's insolvency, that the SCOR agreement did not remove any substantial risk of loss from Reserve and ARC, that the SCOR arrangement had been used to evade the consent agreement, that Reserve was at all times insolvent, and that the SCOR arrangement resulted in the multiplication of Reserve's high risk business while draining it of its least risky and most profitable business. In short, the Director claims that SCOR, SCOR Re and the accounting firm defendants joined with ARC and Reserve's officers and directors in a multifaceted, fraudulent scheme which kept Reserve operating long past insolvency in a manner which resulted in enormous losses to the latter company.
In 1979, Reserve was finally adjudicated insolvent and the Director was designated as the Liquidator of Reserve pursuant to Ill. Rev. Stat., ch. 73, §§ 799 et seq. (1981). Under that statute, the Director is vested with all rights of action belonging to Reserve. Ill. Rev. Stat., ch. 73 §§ 805 (1981). Pursuant to that mandate, the Director filed this action in district court in 1981, seeking relief for damages sustained by Reserve as a result of the alleged fraudulent scheme under RICO and a variety of Illinois statutory and common law theories. In January, 1982, the district court granted the defendants' motion to dismiss fifteen pendant state law claims, but denied their motion to dismiss Counts II and IV, seeking relief under RICO, and Counts I and III, alleging and seeking relief for damages resulting from a criminal conspiracy under Illinois law.
After discovery had commenced, the district court denied defendants' motion to reconsider, but certified its order to this court for an interlocutory appeal; we thereafter granted defendants' petition for interlocutory appeal. The defendants' chief contention on appeal is that the district court lacks jurisdiction over the present matter because Reserve's injuries as alleged in Count II and Count IV of the Director's complaint are not actionable under RICO's civil damage provision, 18 U.S.C. § 1964(c), but some of the defendants also argue that, even assuming that RICO applies, the Director still lacks standing to maintain the present action, and that in any event the Director's complaint insufficiently invokes the formal elements of a RICO claim. We first address the defendant's standing arguments, and then consider defendants' RICO-related contentions.
II. The Director's Standing: Capacity and Equitable Estoppel
RICO considerations aside, defendants Grant, Coopers and Lybrand, Arthur Andersen, and SCOR and SCOR Re argue that the Director either lacks standing ab initio to maintain the present action or is estopped from doing so.*fn1 Their main argument proceeds in two stages. First, they note, the Director as Liquidator acquires only those rights of action that would accrue to Reserve itself; the Director may not assert the legal claims of Reserve's policyholders or creditors. As the next step, they argue that since the Director admits that Reserve's officers and directors instigated the illegal conduct here, the Director, standing in the shoes of Reserve, is estopped*fn2 from proceeding against the extra-corporate confederate defendants under our decision in Cenco, Inc. v. Seidman & Seidman, 686 F.2d 449 (7th Cir. 1982). SCOR and SCOR Re argue additionally that, Cenco considerations aside, prevailing law does not permit an insurance liquidator to pursue on behalf of the corporation he represents claims for losses stemming from the artificially and fraudulently prolonged life of the corporation and its consequent dissipation of assets.
Even accepting the first step of the defendants' argument,*fn3 i.e., that the Director may prosecute only those legal actions available to the corporate body, we disagree with the defendants' contention that Cenco applies to the instant case, or that, even if it does apply, its underlying policy forbids the Director from maintaining the present action on behalf of Reserve. In addition, we reject SCOR and SCOR Re's fallback position that Reserve lacks standing to sue, either derivatively or through a receiver, to recover damages resulting from the fraudulently extended life of the corporation and its concomitant dissipation of assets.
Our reasons for finding Cenco inapplicable to the estoppel issue in the present case are twofold. First, the main controverted claim in Cenco arose under Illinois common law, and therefore this court's analysis of circumstances under which the knowledge of fraud on the part of the plaintiff's directors be imputed to the plaintiff corporation were merely an attempt to divine how Illinois courts would decide that issue. Cenco, 868 F.2d at 455. By contrast, the cause of action here arises under RICO, a federal statute; we therefore write on a clean slate and may bring to bear federal policies in deciding the estoppel question.
Second, even if the estoppel holding in Cenco were relevant to a RICO claim, an important prerequisite for its invocation in the present case is lacking. The Cenco court limited its estoppel analysis to cases where "the managers are not stealing from the company . . . but instead are turning the company into an engine of theft against outsiders." Cenco, 686 F.2d at 454. As the court explained,
Fraud on behalf of a corporation is not the same theory as fraud against it. Fraud against the corporation usually hurts just the corporation; the stockholders are the principal if not only victims . . . . But the stockholders of a corporation whose officers commit fraud for the benefit of the corporation are beneficiaries of the fraud.
Id. at 456. In Cenco, this court found that the fraudulent inflation of the corporation's inventories and hence stock prices clearly benefited the corporation to the detriment of outside creditors, stock purchasers and insurers; this fact, in the court's view, made the case ripe for an analysis of whether the directors' knowledge of the fraud should be imputed to the benefited corporation. By contrast, the complaint in the instant case alleges a far-reaching scheme in which, as a consequence of the illegal activities of Reserve's directors and the outside defendants, Reserve was, inter alia, fraudulently continued in business past its point of insolvency and systematically looted of its most profitable and least risky business and more than $3,000,000 in income -- all actions which aggravated Reserve's insolvency. In no way can these results be described as beneficial to Reserve.*fn4 Compare Security America Corp. v. Schact, No. 82-C-2132, slip op. at 3, 4 (N.D. Ill. Jan. 31, 1983) ("particular fact pattern" established that plaintiff corporation had been created solely to carry out fraudulent scheme and thus had no other purpose than to be "engine of theft" against outsiders under Cenco).
Defendants argue nonetheless that since the alleged fraudulent scheme had the effect of continuing Reserve's active corporate existence past the point of insolvency to the detriment of outside creditors and policyholders, Reserve was pro tanto benefited. But the fact that Reserve's existence may have been artificially prolonged pales in comparison with the real damage allegedly inflicted by the diminution of its assets and income. Under such circumstances, the prolonged artificial insolvency of Reserve benefited only Reserve's managers and the other alleged conspirators, not the corporation. See In re Investor's Funding Corp.,  Fed. Sec. L. Rep. (CCH) P97,696 at 98,655 (1980). More colloquially put, if defendants' position were accepted, the possession of such "friends" as Reserve had would certainly obviate the need for enemies. We do not believe that such a Pyrrhic "benefit" to Reserve is sufficient to even trigger the Cenco analysis which seeks to determine the propriety of imputing to the corporation the directors' knowledge of fraud.
Even if a Cenco - type analysis were applied to the instant case, however, it would not yield the result that defendants urge, i.e., estoppel of the Director based on the imputation to Reserve of the directors' knowledge of fraud. In Cenco, we undertook a two-pronged analysis to determine whether such imputation should occur: whether a judgment in favor of the plaintiff corporation would properly compensate the victims of the wrongdoing, and whether such recovery would deter future wrongdoing. Cenco, 686 F.2d at 455. We find that, if warranted by the proof at trial, recovery by the Director on behalf of Reserve would do both.
First, any recovery by the Director from the instant suit will inure to Reserve's estate. And under the distribution provisions of the governing liquidation statute, it is the policyholders and creditors who have first claim (after administrative costs and wages owed) to the assets of the estate. Ill. Rev. Stat., ch. 73, § 817 (1981). Thus, the claims of these entirely innocent parties must be satisfied in full before Reserve's shareholders, last in line for recovery, receive anything.
Moreover, there is no indication here that the Director's success entails the likelihood of the kind of "perverse" compensation pattern which we declined to permit in Cenco. In Cenco, the court was troubled first by the fact that among the shareholders benefiting from a successful recovery were the corrupt officers themselves, Cenco, 686 F.2d at 455; here, the defendants do not claim that the wrongdoing officers or directors hold equity positions in Reserve entitling them to recover from the instant suit. We were also troubled in Cenco by the prospect of double recovery by the shareholders via the plaintiff corporation in view of the previous successful recovery of damages by these same shareholders in a direct suit against the defendants. In this case, by contrast, the other actions noted to this court based on these alleged events have yet to result in any recovery. Of course, if the Director recovers successfully in the instant suit, the defendants in these actions will be able to assert the previous satisfaction of the claims of the shareholders, policyholders and creditors of Reserve as a bar to subsequent recovery.
Second, from the standpoint of deterrence, this court in Cenco based its refusal to permit the plaintiff to recover unimpeded by the directors' knowledge in large part on two circumstances not present here: 1) that the directors, as shareholders, would recover directly from the suit, and 2) that there existed large corporate shareholders in a position to police the plaintiff's corrupt officers, an activity that would be discouraged by allowing the shifting of corruption-caused loss to outside defendants. Cenco, 686 F.2d at 456. By contrast, here, as noted earlier, there is no evidence that the wrongdoing officers of Reserve would benefit directly from the instant suit. There is also no evidence here of the existence of large corporate shareholders capable of conducting an independent audit, as in Cenco, and whose lack of investigatory zeal would be rewarded by a decision favorable to the Director.
The court in Cenco also expressed reluctance to permit even innocent, atomized shareholders to recover damages for wrongdoing in which their officers were implicated, but that concern must be viewed against the background of the recovery of many of those same shareholders in an earlier action, and the fact that, suing directly, the full recovery in the later suit would inure to them. Significantly, due to the operation of the liquidation statute here, Reserve's shareholders are last in line for recovery from Reserve's estate and will receive only a residual recovery from the instant suit, if successful after trial, after all of the policyholders and creditors are compensated in full. Thus, unlike the situation in Cenco, permitting recovery in this case would not send unqualified signals to shareholders that they need not be alert to managerial fraud since they may later recover full indemnification for that fraud from third party participants.*fn5 In ...