United States District Court, Northern District of Illinois, W.D
November 6, 1984
WAYNE M. MILLER AND EUNICE E. MILLER, PLAINTIFFS,
AFFILIATED FINANCIAL CORPORATION, ET AL., DEFENDANTS.
The opinion of the court was delivered by: Shadur, District Judge.
MEMORANDUM OPINION AND ORDER
Wayne ("Wayne") and Eunice ("Eunice") Miller (collectively
"Millers") have filed an eight-count complaint (the "Complaint")
against Delaware corporation Affiliated Financial Corporation
("Affiliated"), Illinois corporation Credit-Pak Corporation of
Illinois ("Credit-Pak"), Stephen J. Smith ("Stephen"), Jack D.
Smith ("Jack") and Joann Smith ("Joann," apparently Jack's wife).
Millers seek damages and equitable relief under federal
securities and antiracketeering statutes, Illinois securities and
consumer fraud statutes and the common law, charging harm
suffered as a result of having entered into a limited partnership
agreement devised and promoted by defendants. Defendants have now
moved under Fed.R.Civ.P. ("Rule") 12(b)(6) to dismiss all eight
counts of the Complaint. For the reasons stated in this
memorandum opinion and order, their motion is denied in principal
In July 1982 Wayne responded to an advertisement in the Prairie
Farmer by Credit-Pak, representing itself as an organization
equipped to help financially straitened farmers in resolving
their money woes. On July 29 and on several occasions in August,
Wayne met with Stephen, Vice President of Credit-Pak and
Affiliated, to discuss ways in which Wayne might resolve
his own money problems. In conjunction with those discussions
Stephen undertook a review of Wayne's affairs. On September 1 he
wrote Wayne, noting "we are continuing to work on your matter on
a best efforts basis" and including an invoice for $4,821.08 for
services rendered to date.
Defendants having expended no further efforts on his behalf, in
the spring of 1983 Wayne sought the return of documents and
papers he had delivered to Stephen the previous summer. During
the course of their conversation, Stephen told Wayne it still
might be possible to arrange a "creative financing" plan to
alleviate Wayne's financial worries. Over the course of further
conversations Stephen described the plan as involving a sale and
repurchase of land (the "Land") owned by Wayne's mother Eunice,
having a fair market value of $700,000 and subject to a first
mortgage of some $100,000. Repurchase would take place five years
after sale, though it would be subject to extension for an
additional five years at Wayne's option, and would involve an
increase in the indebtedness on the Land of about $100,000. There
would be a $25,000 fee for arranging the financing, payable at
the end of the original five-year repurchase period. Defendants
also required immediate payment of $8,500 to cover legal and
accounting fees associated with preparing the financing plan
documents. Eunice paid the required $8,500 to defendants in
On December 19 Stephen telephoned Wayne to say a "creative
financing" agreement (the "Agreement") had been prepared and had
to be signed by the end of the day because the lender would not
be accepting loan applications thereafter. Later that day Stephen
met with Wayne and spent three to five minutes outlining the
Agreement's contents. Stephen repeated his previous
representations about the five-year term of the Agreement, the
renewal option, the increase in debt on the Land and the $25,000
fee. Under the terms of the Agreement, he explained, Credit-Pak
would in effect purchase a portion of the Land, which Wayne would
have a right to repurchase over a five-year period. Most
importantly, Stephen said the proceeds of the sale to Credit-Pak
would be turned over to Wayne so he could pay his debts. Wayne
asked whether he could have his lawyer review the Agreement.
Stephen discouraged him from doing so, saying a lawyer would not
understand a "creative" arrangement of the sort contemplated by
the Agreement.*fn2 Wayne then signed the Agreement. Stephen and
Wayne proceeded immediately to Eunice's house where, after
Stephen had repeated the explanation and representations
previously made to Wayne, Eunice too signed the Agreement.
Stephen signed the Agreement in his capacity as Vice President of
In fact the Agreement turned out to be a limited partnership
agreement*fn3 designating Affiliated as sole general partner and
Wayne and Eunice as sole limited partners of the Miller Farm
Partnership (the "Partnership"). It required Eunice and Wayne to
make capital contributions to the Partnership: Eunice, the Land
subject to the existing mortgage; Wayne, certain farm machinery
and equipment.*fn4 In exchange
Eunice was to receive a 45% interest and Wayne a 25% interest in
the annual net profits or losses of the Partnership. Affiliated,
which was to contribute only its services as general partner,
received the remaining 30% interest. Other terms of the Agreement
1. authorization for Affiliated to obtain on behalf
of the Partnership a $400,000 mortgage loan on the
Land (the "Mortgage");
2. a $75,000 fee (payable from the Mortgage
proceeds) to Affiliated for services rendered as
3. a lease agreement, in effect obligating Wayne to
lease the Land and certain farm equipment from the
4. a purchase agreement, in effect obligating Wayne
to purchase the Land from the partnership within five
years for $900,000;
5. assignment by Wayne of one-half his partnership
interest to Affiliated to secure his obligations
under the Lease and Land purchase provision; and
6. authorization for Affiliated, at its option, to
borrow from the Partnership any surplus proceeds of
the Mortgage on an interest-free demand-note basis.
There was however no renewal option covering Wayne's repurchase
After the Agreement was signed the authorized $400,000 Mortgage
was consummated, increasing the encumbrance on the Land and
yielding $300,000 in net proceeds after paying off the
pre-existing mortgage. But contrary to Stephen's representations,
little of that sum has been distributed to Millers:
1. Eunice's $8,500 advance to cover expenses
incurred in forming the Partnership has been
2. Two interest-bearing demand loans aggregating
$27,000 have been extended to Wayne.
Pointing to those and other discrepancies between the terms of
the Agreement and Stephen's description of those terms (upon
which plaintiffs had relied in signing),*fn5 Wayne and Eunice filed
this action May 18, 1984.
Count I alleges violations of Securities Exchange Act of 1934
("1934 Act") § 10(b) ("Section 10(b)") and SEC Rule 10b-5 ("Rule
10b-5"*fn6). Defendants urge the Complaint lacks any allegation of
the use of an instrumentality of interstate commerce, necessary
to confer jurisdiction under the statute:
1. All the asserted misrepresentations occurred in
wholly intrastate telephone communications.
2. All the mail communications alleged to satisfy
the interstate commerce requirement were not causally
related to the securities fraud.
Neither argument succeeds, but before this opinion turns to an
explanation of why they do not, it must pause over an argument
defendants have now abandoned.
Count I is captioned "SECURITIES FRAUD," and it unquestionably
seeks to allege material misrepresentations and purchase of
securities in reliance thereon — a classic Section 10(b) case.
Complaint Count I ¶ 35 accurately quotes Section 10(b) but
erroneously cites it as 15 U.S.C. § 78i (b) ("Section 78i(b),"
Section 9 of the 1934 Act) (it should have read 15 U.S.C. § 78j
(b)). Focusing on that proofreading error, defendants originally
based their motion to dismiss Count I on the inapplicability of
Section 78i (b) to the facts alleged. They chose to ignore the
between the mistaken citation and the statutory language actually
quoted at length in the Complaint.*fn7 Then, after putting Millers'
counsel through the unnecessary exercise of addressing the patent
error in citation in the course of their responsive memorandum,
defendants engaged in a bit of posturing (R.Mem. 1-2):
With the Plaintiffs' admission of a crucial citation
error, Defendants have been apprised of Plaintiffs'
securities claim. Plaintiffs have stretched the
concept of "notice pleading" to its limits by
suggesting that Defendants should have divined the
nature of Plaintiffs' claim by reading an incorrect
It is now unnecessary to decide specifically whether
defendants' counsel acted in bad faith (even though that prospect
does appear far more likely than the "empty head, pure heart"
alternative), for they surely appear to have violated Rule 11 as
amended in 1983. Rule 11 now requires that every paper filed with
the court by the parties be signed by an attorney who thereby
that he has read the pleading, motion, or other
paper; that to the best of his knowledge,
information, and belief formed after reasonable
inquiry it is well grounded in fact and is warranted
by existing law or a good faith argument for the
extension, modification, or reversal of existing law,
and that it is not interposed for any improper
purpose, such as to harass or to cause unnecessary
delay or needless increase in the cost of litigation.
"Improper purpose" was intended to work a substantive change
from the older bad-faith test: That is made clear both by the
changed language and by the Advisory Committee Notes to revised
Rule 11. Because it is utterly unreasonable for anyone to read
Count I of the Complaint as setting forth a claim under Section
78i(b), counsel's argument to that effect raises a strong
inference of improper purpose. Perhaps Millers' lawyers sustained
an easy burden in answering so patently frivolous an argument,
but their having to bear it (and Millers' having to pay for it)
at all qualifies as harassment. So too, while no court could
possibly be misled in any substantive way by such an empty
contention, its interposition in the litigation diverts attention
from the relevant issues, wastes time and serves to trivialize
the litigative and adjudicatory process.*fn8
It remains, then, to impose an appropriate sanction on
defendants' counsel if they cannot show the absence of an
"improper purpose." To that end the order issuing in the present
motion includes the following:
1. On or before November 19, 1984(a) defendants'
counsel shall file a memorandum
detailing any claimed justifications or mitigating
factors for their conduct and (b) Millers' counsel
shall file a memorandum detailing the damage
inflicted by counsel's frivolous argument.
2. On or before November 29, 1984 defendants'
counsel shall identify any issues posed by either
submission as to which an evidentiary hearing is
This Court will then either schedule a hearing or decide the
This opinion now reverts to the substantive issues mentioned
earlier. Both turn on asserted jurisdictional flaws in Count I.
First, defendants say any misrepresentations made during the
course of intrastate telephone calls do not constitute a use of
any "means or instrumentality of interstate commerce."*fn10 Though
our Court of Appeals has not had occasion to decide whether local
calls satisfy Section 10(b)'s jurisdictional requirement, Hidell
v. International Diversified Investments, 520 F.2d 529, 536 & n.
15 (7th Cir. 1975) (per curiam), most courts addressing the
question have held such telephone calls do confer jurisdiction.
See, e.g., Loveridge v. Dreagoux, 678 F.2d 870, 873-74 (10th Cir.
1982); Gower v. Cohn, 643 F.2d 1146, 1151-52 (5th Cir. 1981);
Spilker v. Shayne Laboratories, Inc., 520 F.2d 523, 524-25 (9th
Cir. 1975).*fn11 True enough, a dictum by this Court's colleague
Judge Aspen has expressed his disinclination to find the
jurisdictional requirement satisfied where the only connection
with interstate commerce was an intrastate letter and an
intrastate telephone call, both occurring before the negotiations
giving rise to the fraud began. Barsy v. Verin, 508 F. Supp. 952,
955 & n. 4 (N.D.Ill. 1981). Here by contrast at least one of
Stephen's telephone conversations with Wayne (on December 19)
occurred in the midst of negotiations over the Agreement
(Complaint Count I, ¶¶ 25-26); indeed it was the vehicle for
crucial misrepresentations. In light of the clear weight of
precedent treating intrastate telephone calls as jurisdictionally
sufficient, together with the equally clear connection between
Stephen's telephone communication and the alleged fraud,
defendants' argument fails.*fn12
As to their second position, defendants correctly state
plaintiffs cannot prevail in a Section 10(b) action without
showing a causal connection between (1) the use of an
instrumentality of interstate commerce or the use of the mails
and (2) the alleged fraud. But as Trecker v. Scag, 481 F. Supp. 861,
864 (E.D.Wis. 1979) said:
It is not required that the manipulative or deceptive
device be communicated in the mailed materials, as
long as such a device is employed in connection with
the use of the mails or of the instruments of
Stephen's letters to Wayne described in the Complaint (Count II
¶ 49) — two invoices, a letter authorizing the sale/leaseback
arrangement and a letter concerning the substitution of rents for
the farm equipment as Wayne's capital contribution to the
Partnership — satisfy that standard. While none of those
documents is a self-contained misrepresentation or other
fraudulent communication, they all implement the continuing
course of dealings between the parties that constituted the
fraudulent scheme. In other words, the letters represent a use of
the mails in connection with a transaction alleged to constitute
a securities fraud. That is enough to satisfy the Section 10(b)
Count II purports to state a cause of action under the civil
remedies provision of the Racketeer Influenced and Corrupt
Organizations Act ("RICO"), 18 U.S.C. § 1964(c):*fn13
(c) Any person injured in his business or property by
reason of a violation of section 1962 of this chapter
may sue therefor in any appropriate United States
district court and shall recover threefold the
damages he sustains and the cost of the suit,
including a reasonable attorney's fee.
Plaintiffs predicate their Section 1964(c) suit on an alleged
violation of Section 1962(c):
(c) It shall be unlawful for any person employed by
or associated with any enterprise engaged in, or the
activities of which affect, interstate or foreign
commerce, to conduct or participate, directly or
indirectly, in the conduct of such enterprise's
affairs through a pattern of racketeering activity or
collection of unlawful debt.
Each defendant (1) is said to be a "person" (Section 1961(3))
associated with an "enterprise" in fact (Section 1961(1))
comprising all the defendants and (2) has conducted the affairs
of that enterprise through a "pattern of racketeering activity"
(Section 1961(5)). That "racketeering activity" includes alleged
acts of securities fraud (Section 1961(1)(D)) and mail fraud
Defendants attack those allegations as failing to assert injury
"by reason of a violation of section 1962" (emphasis added), as
Section 1964(c) requires. This Court has never given the
underscored phrase the added (not merely causative) content
ascribed to it by many judges in high places (see, e.g., Bankers
Trust Co. v. Rhoades, 741 F.2d 511, 516-18 (2d Cir. 1984)). And
now the issue is plainly settled in our Circuit, Haroco, Inc. v.
American National Bank & Trust Co., 747 F.2d 384 at 398 (7th Cir.
We conclude that a civil RICO plaintiff need not
allege or prove injury beyond any injury to business
or property resulting from the underlying acts of
This holding by no means renders superfluous the
requirement in section 1964(c) that the plaintiff be
injured "by reason of" a violation of section 1962.
As we read this "by reason of" language, it simply
imposes a proximate cause requirement on plaintiffs.
The criminal conduct in violation of section 1962
must, directly or indirectly, have injured the
plaintiff's business or property. A defendant who
violates section 1962 is not liable for treble
damages to everyone he might have injured by other
conduct, nor is the defendant liable to those who
have not been injured. This causation requirement
might not be subtle, elegant or imaginative, but we
believe it is based on a straightforward reading of
the statute as Congress intended it to be read.
Haroco obviates any need to pore over the Complaint to
determine whether Millers have alleged injury beyond that
resulting from the predicate acts of securities and mail fraud.
They have sufficiently stated injury flowing from defendants'
acts of racketeering, acts that may be properly analyzed into the
configuration set out in Section 1962(c).*fn14
Defendants are however entitled to strike the prayer for
equitable relief from Count II. In addition to treble damages and
attorney's fees, Millers there ask (as they do in Count I) for:
1. a declaratory judgment that the Agreement is
2. an order compelling the return of all property
Millers transferred to defendants pursuant to the
3. an injunction striking the name of any defendant
as a beneficiary of life insurance policies purchased
pursuant to the Agreement; and
4. a declaratory judgment that all notes executed
by Wayne and payable to Affiliated are void.
As this Court explained at some length in Kaushal v. State Bank
of India, 556 F. Supp. 576
, 581-84 (N.D.Ill. 1983), there is
nothing in the language, structure or legislative history of
private civil RICO to suggest Section 1964(c) was meant to grant
private plaintiffs remedies of the sort sought here. See also
Sedima, S.P.R.L. v. Imrex Co., 741 F.2d 482
, 489-90 n. 20 (2d
Accordingly, paragraphs A, B, D and E of Count II's
prayer for relief are stricken.
Liability of Joann
Wayne and Eunice dealt exclusively with Stephen during the
negotiations leading up to their execution of the Agreement.
However he acted as agent for the other individual and corporate
defendants as well as on his own behalf. Defendants have not
challenged those allegations of agency as to Jack, Credit-Pak and
Affiliated, but Joann (the secretary of Credit-Pak and
Affiliated) does assert their insufficiency. Joann contends (1)
corporate officers are not liable
for the illegal actions of others in the corporation merely by
virtue of their position and (2) Millers have alleged no other
facts indicating Joann's participation in the acts giving rise to
Joann's theory seems to be that her position as secretary of
the corporate defendants is so tangential to their daily business
that it cannot serve as the basis for liability absent specific
factual allegations. That argument, however, ignores the
apparently close business and personal relations among the three
individual defendants (reasonably to be inferred from the facts
alleged, see n. 1). It also ignores the specific allegation of
agency, a matter of mixed law and fact. Under notice pleading
principles and the teaching of Conley v. Gibson, 355 U.S. 41,
45-46, 78 S.Ct. 99, 101-102, 2 L.Ed.2d 80 (1957) and Hishon v.
King & Spalding, ___ U.S. ___, 104 S.Ct. 2229, 2233, 81 L.Ed.2d
59 (1984), those are enough to keep Joann in the lawsuit — at
least for purposes of determining whether information developed
in the course of discovery will support the inferences to be
drawn from the Complaint.*fn16
Count V charges common-law fraud based on Stephen's knowing
misrepresentations to Wayne and Eunice. While acknowledging that
would be enough to hold Stephen liable, defendants point to the
absence of knowing misrepresentations by the other defendants.
Because Illinois law requires such knowledge to state a claim for
fraud,*fn17 those other defendants seek dismissal from Count V. Once
again defendants overlook Millers' claim that Stephen acted as
agent for the other defendants. As our Court of Appeals has
stated in CFTC v. Premex, Inc., 655 F.2d 779, 784 n. 10 (7th Cir.
Under common law principles of respondeat superior, a
principal is liable for the deceit of its agent, if
committed in the very business the agent was
appointed to carry out. This is true even though the
agent's specific conduct was carried out without the
knowledge of the principal.
See also 1 I.L.P. Agency §§ 181-82. It is certainly reasonable to
infer Stephen's alleged fraud occurred in the business he was
appointed to carry out. Moreover to the extent the other
defendants in one way or another participated in Stephen's
fraudulent acts, they too are guilty of fraud under Illinois law.
Instituto Nacional de Comercializacion Agricola v. Continental
Illinois National Bank & Trust Co., 530 F. Supp. 279, 281
Here too Millers will have to show Stephen was in fact the
authorized agent of the other defendants or provide other
evidence indicating their participation in his fraudulent acts.
For now it is enough they have alleged as much.
Millers also purport to state a claim for innocent
misrepresentation under Restatement (Second) of Torts, § 552C
(1) One who, in a sale, rental or exchange
transaction with another, makes a misrepresentation
of a material fact for the purpose of inducing the
other to act
or to refrain from acting in reliance upon it, is
subject to liability to the other for pecuniary loss
caused to him by his justifiable reliance upon the
misrepresentation, even though it is not made
fraudulently or negligently.
That provision has been adopted as a common-law rule in some
other jurisdictions. See, e.g., Miller v. Bare, 457 F. Supp. 1359,
1362-64 (W.D.Pa. 1978). But Millers have not cited, and further
research has not uncovered, any Illinois cases to similar effect.
Quite the contrary inference is in order here. Any right to
recover damages for innocent misrepresentation in Illinois
appears to be statutory, under the very provision of the Consumer
Fraud and Deceptive Business Practices Act (the "Act"),
Ill.Rev.Stat. ch. 121 1/2, ¶ 262, that forms the basis of Count
IV.*fn18 As Duhl v. Nash Realty, Inc., 102 Ill.App.3d 483, 495, 57
Ill.Dec. 904, 914, 429 N.E.2d 1267, 1277 (1st Dist. 1982)
(citations omitted) put it:
Since the Act affords even broader consumer
protection than does the common law action of fraud,
it is clear that a plaintiff suing under the Act need
not establish all of the elements of fraud as the Act
prohibits any deception or false promise. . . . And
it is clear from the language of the Act,
particularly its reference to false promises, that
liability is not limited to existing material facts.
Furthermore, it is well established that under the
Act the intention of the seller (his good or bad
faith) is not important and a plaintiff can recover
under the Act for innocent misrepresentations.
That language plainly implies the Act is the only source of any
Illinois action for innocent misrepresentation. Count VII (an
attempted common-law counterpart) must be dismissed.
Here Millers advance a claim for equitable relief based on
undue advantage in securing Millers' assent to the Agreement.
Under the proper circumstances, Illinois law provides, "equity
will act in spite of a contract to avoid the unconscionable
result." People ex rel. Department of Public Works & Buildings v.
South East National Bank of Chicago, 131 Ill.App.2d 238, 243,
266 N.E.2d 778, 782 (1st Dist. 1971); see also 7 I.L.P. Chancery §§
58-59. To that end the court must assess "the totality of the
circumstances to determine if there ha[s] been fraud, undue
advantage, or unfairness in securing the agreement." Mearida v.
Murphy, 106 Ill.App.3d 705, 711, 62 Ill.Dec. 380, 384,
435 N.E.2d 1352, 1356 (4th Dist. 1982).
Thus defendants are not in a position to say Count VIII does
not state a claim. Instead they urge it is "redundant of all the
relief requested by Plaintiff in the various counts that precede
Count VIII" (Def.Mem. 10) and should for that reason be stricken
from the Complaint. Millers have indeed used one set of facts to
spawn multiple legal theories, all seeking basically the same
Rule 8(e) provides:
A party may also state as many separate claims or
defenses as he has regardless of consistency and
whether based on legal, equitable, or maritime
In the most important sense a mere difference in legal theories
based on the same facts does not bespeak a different claim. See
our Court of Appeals' discussion in
Minority Police Officers Association of South Bend v. City of
South Bend, 721 F.2d 197
, 199-201 (7th Cir. 1983). Thus no
theoretical justification really exists for labeling as separate
"counts" different sets of legal theories predicated on identical
facts and producing identical relief. But at least until it
becomes necessary to present the trier of fact with the matters
Millers must prove in support of each theory, Count VIII poses no
defined harm to defendants and will be retained.
Apart from their already-discussed specific objections to
Counts V, VII and VIII, defendants contend all the Complaint's
pendent state law claims (Counts III through VIII) must be
dismissed for lack of jurisdiction. They do not discuss this
Court's discretion to decline pendent jurisdiction under United
Mine Workers v. Gibbs, 383 U.S. 715, 725, 86 S.Ct. 1130, 1138, 16
L.Ed.2d 218 (1966). Instead they rely on the proposition that
dismissal of Counts I and II would leave no basis for federal
jurisdiction as to the state law claims. Counts I and II have
survived defendants' motion, and so do the pendent claims.
Defendants' motion to dismiss the Complaint is granted as to
Count VII and the prayer for equitable relief in Count II. In all
other respects it is denied, though Millers will have to redo
Count II to conform to Haroco and Parnes. Defendants are ordered
to answer all surviving portions of the Complaint except Count II
on or before November 19, 1984 and to answer Count II within 14
days after being served with that Count in amended form. In
addition, counsel for the parties are ordered to follow the Rule
11 procedures directed in the text preceding n. 9. Finally, this
action is set for a status report in Rockford at 8:45 a.m.
November 20, 1984.