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MAJCHROWSKI v. NORWEST MORTG.

May 19, 1998

STANISLAW MAJCHROWSKI and DANUTA MAJCHROWSKI, on behalf of themselves and all others similarly situated, Plaintiffs,
v.
NORWEST MORTGAGE, INC. and JOHN DOES 1-10, Defendants.



The opinion of the court was delivered by: CASTILLO

MEMORANDUM OPINION AND ORDER

 In recent years, the line between civil RICO, a formidable weapon authorizing treble damages and attorneys' fees, and conventional breach of contract actions has faded considerably. Put succinctly by Justice Powell, "only a small fraction of the scores of civil RICO cases now being brought implicate organized crime in any way. Typically, these suits are being brought -- in the unfettered discretion of private litigants -- in federal court against legitimate businesses seeking treble damages in ordinary fraud and contract cases." Sedima, S.P.R.L. v. Imrex Co., 473 U.S. 479, 529, 87 L. Ed. 2d 346, 105 S. Ct. 3275 (1985) (Powell, J., dissenting). There is no better illustration than the case before this Court. The Majchrowskis, representative plaintiffs in this certified class action, claim that Norwest Mortgage, their mortgage service company, violated RICO, committed unfair and deceptive practices, and breached mortgage agreements when it filed in the Majchrowskis' Chapter 13 bankruptcy proceedings a Proof of Claim that charged $ 66.00 in property inspection fees and a $ 100.00 proof of claim fee. The Majchrowskis allege that these routinely imposed "bogus" fees -- which allegedly appear nowhere in the mortgage agreements -- are part of a diabolical scheme to defraud and encumber the property of unwitting mortgage borrowers who find themselves in bankruptcy. Norwest vehemently denies any fraudulent activity; moreover, it insists that its standard form mortgage contracts fully authorize property inspection and proof of claim fees against defaulting borrowers who have filed for bankruptcy. Before the Court are the parties' cross-motions for partial summary judgment on the discrete issue of whether Norwest's standard mortgage contracts authorize these fees, as well as Norwest's motion to dismiss the plaintiffs' RICO claims.

 RELEVANT FACTS *fn1"

 A. The Majchrowskis' Mortgage and Bankruptcy

 In 1995, the Majchrowskis decided to buy a home in Illinois. They obtained a mortgage loan from Mega Mortgage Company, which then transferred the loan to Norwest for servicing. Pls.' Facts P 8. In June 1996, the Majchrowskis stopped making mortgage payments. Affidavit of Scott Walker P 20. In light of their failure to cure the loan default, Norwest began foreclosure proceedings against the Majchrowskis on November 11, 1996. Those proceedings were stayed when the Majchrowskis filed for Chapter 13 bankruptcy in December 1996. Later, the bankruptcy court lifted the automatic stay because the Majchrowskis were unable to make the mortgage payments required under the bankruptcy plan. Id. PP 21-22. The Majchrowskis' mortgage loan is currently in foreclosure. Def.'s Facts P 10.

 While the Majchrowskis' Chapter 13 proceedings were still pending, Norwest filed a Proof of Claim with the bankruptcy court. The "Statement of Amount Due" included, inter alia, a $ 100 "file proof of claim" fee, as well as a $ 24.75 charge for "collection property inspections" and a $ 41.25 charge for "foreclosure property inspections." Pl.'s Facts P 9; Walker Aff. Ex. C. The legitimacy of these fees drives this entire case -- the question is whether they were "authorized" by Norwest's standard form mortgage agreements.

 B. The Mortgage Agreements

 The Majchrowskis executed two agreements in connection with their mortgage loan -- a Multistate Fixed Rate Note ("Note") and a Uniform Security Instrument ("Security Instrument"). See Walker Aff. Ex. A & B. These agreements are standard form contracts that contain mostly uniform provisions, with slight variations for some jurisdictions. See Note P 10; Security Instrument at 2. Essentially, the Note embodies the terms governing the lender's promise to loan money in exchange for the borrower's pledge to repay it with interest. The Security Instrument confirms that agreement and includes additional covenants to protect the lender "from possible losses which might result if [borrower] does not keep the promises" made in the Note. Note P 10; see Ford v. Dovenmuehle Mortgage, Inc., 273 Ill. App. 3d 240, 248, 651 N.E.2d 751, 757, 209 Ill. Dec. 573 (1st Dist. 1995) (promissory note "evidenced an indebtedness only for the principal sum and interest payable"; mortgage contract both acknowledged this and "created additional obligations and indebtedness").

 Both agreements have provisions for charging the borrower various fees. For example, the Note imposes "Late charges for overdue payments" (P 6(A), and, if the borrower defaults and the lender chooses to accelerate payment, the Note requires the borrower to reimburse lender for "all of its costs and expenses in enforcing this Note to the extent not prohibited by applicable law . . . including, for example, reasonable attorneys' fees" (P 6(E)). The Security Instrument reiterates the Note's late charge provision (P 1), and requires the borrower to pay funds into an escrow account for taxes, assessments, and insurance (P 2); to remedy any shortage in the escrow accounts (P 2); to purchase hazard or property insurance (P 5); to buy mortgage insurance if the lender requires it (P 8); and to pay the costs of recording the discharge releasing the mortgage (P 22). Another protection the Security Instrument affords the lender is the right to inspect the mortgaged property upon notice to the borrower:

 
Inspection. Lender or its agent may make reasonable entries upon and inspections of the Property. Lender shall give Borrower notice at the time of or prior to an inspection specifying reasonable cause for the inspection. (P 9).

 Paragraph 9 says nothing, however, about charging the borrower for inspections conducted under its provisions.

 In the event the borrower defaults, or becomes involved in legal proceedings that may impair the lender's rights in the property, the Security Instrument provides the lender with sweeping remedies:

 
Protection of Lender's Rights in the Property. If Borrower fails to perform the covenants and agreements contained in this Security Instrument, or there is a legal proceeding that may significantly affect Lender's rights in the Property (such as a proceeding in bankruptcy . . .), then Lender may do and pay for whatever is necessary to protect the value of the Property and Lender's rights in the Property. Lender's actions may include paying any sums secured by a lien which has priority over this Security Instrument, appearing in court, paying reasonable attorneys' fees and entering on the Property to make repairs. . . .
 
Any amounts disbursed by Lender under this paragraph 7 shall become additional debt of Borrower secured by this Security Instrument. . . . (P 7) (emphasis added)

 Failure to cure a default on the mortgage loan further entitles the lender to "require immediate payment in full" and to "foreclose this Security Instrument by judicial proceeding." (P 21). The lender then has the right "to collect all expenses incurred in pursuing the remedies provided in this paragraph 21, including, but not limited to, reasonable attorneys' fees and costs of title evidence." Id.

 C. Norwest's Fees

 Norwest contends that these contractual provisions, particularly paragraph 7 of the Security Instrument, authorized it to impose the proof of claim and property inspection fees in its Proof of Claim. According to Scott Walker, an assistant Vice President who manages Norwest's bankruptcy department in Charlotte, N.C., the purpose of filing a Proof of Claim in bankruptcy is to protect the secured lender's rights in the borrower's property; otherwise, he explains, the lender "would not be paid on outstanding arrearages." Walker Aff. P 12. Norwest thus passed on to the Majchrowskis the cost of assembling the Proof of Claim, a service performed by a law firm with an on-site office across from Norwest's bankruptcy department. *fn2" Pls.' Supp. Facts P 2. The firm has a contract with Norwest to prepare Proofs of Claim at a cost of $ 100 each. *fn3" Walker Dep. at 55.

 The property inspections, states Walker, were likewise necessary to protect the value of and Norwest's rights in the Majchrowskis' property. Walker Aff. P 18. He explains that an inspection may reveal whether the property is still occupied, whether the utilities remain connected, and whether the property has fallen into disrepair. Id. P 16. After the Majchrowskis defaulted on the loan, Norwest hired outside vendors to inspect their property periodically. The $ 24.75 and $ 41.25 fees in Norwest's Proof of Claim represent vendor charges that Norwest claims it actually incurred and passed "straight through" to the Majchrowskis. *fn4" Id. P 18. It is undisputed that Norwest did not give the Majchrowskis notice before inspecting their property, and that the company frequently dispenses with notice when the borrower has defaulted on the mortgage loan. Walker Dep. at 179, 182.

 D. The Alleged Scheme to Defraud

 Plaintiffs not only deny that the proof of claim and property inspection fees were authorized by the mortgage contracts, they take the dispute to another level -- alleging elements of deception and racketeering activity under the Racketeer Influenced and Corrupt Organizations Act. In essence, plaintiffs' civil RICO claims assert that Norwest knowingly extorts these "unauthorized and bogus" charges from bankrupt borrowers in order to produce ill-gotten gains for Norwest and its corporate parents. In short, Norwest allegedly used its otherwise legitimate mortgage servicing business as a means of defrauding its customers. *fn5" This scheme to profit from collecting unauthorized fees was purportedly hatched by Norwest and ten of its (unnamed) corporate officers, "John Does 1-10." *fn6" It forced the plaintiffs to choose between paying the allegedly illegal fees or leaving them to encumber their property.

 E. The Case's Procedural Posture

 Based on the above events, plaintiffs filed a five-count class action complaint in May 1997. Count I asserts a RICO claim against Norwest; Count II, a RICO claim against unnamed corporate officers "John Does 1-10"; Count III alleges unfair and deceptive practices in violation of several state laws; and Count IV claims a breach of the mortgage agreements. *fn7"

 On July 25, 1997, plaintiffs filed their motion for class certification, defining the class as all persons who "were obligated on, or owned property secured by, a real estate mortgage or deed of trust or other security instrument"; whose loans were serviced by Norwest; and against whom Norwest assessed "file proof of claim," "collection property inspection" or "foreclosure property inspection" fees. Briefing was not completed until December 19, 1997. The Court granted plaintiffs' motion for class certification on January 14, 1998.

 On September 5, 1997, the plaintiffs filed their motion for partial summary judgment, asking the Court to construe the mortgage contracts. Norwest filed its cross-motion for partial summary judgment on the same issue, as well as a motion to dismiss the RICO claims under Rule 12(b)(6), on October 17, 1997. For the reasons that follow, we deny Norwest's motion to dismiss as to Count I, but grant the motion as to Count II. Summary judgment on the contract interpretation issue is granted to Norwest, and denied to plaintiffs. We begin with Norwest's Rule 12(b)(6) motion to dismiss.

 STANDARDS GOVERNING MOTIONS TO DISMISS

 A motion to dismiss tests the sufficiency of the complaint, not the merits of the suit. Triad Assocs., Inc. v. Chicago Housing Auth., 892 F.2d 583, 586 (7th Cir. 1989). The court must view all facts alleged in the complaint, as well as any reasonable inferences drawn from those facts, in the light most favorable to the plaintiff. Doherty v. City of Chicago, 75 F.3d 318, 322 (7th Cir. 1996); Dawson v. General Motors Corp., 977 F.2d 369, 372 (7th Cir. 1992). Any ambiguities are likewise resolved in the plaintiff's favor. Dawson, 977 F.2d at 372. A complaint will not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts warranting relief. Triad Assocs., 892 F.3d at 586.

 These liberal pleading standards, derived from Fed. R. Civ. P. 8(a), apply with as much force to civil RICO claims as to other civil causes of action brought in federal court. Perlman v. Zell, 938 F. Supp. 1327, 1337 (N.D. Ill. 1996) (citing Vicom, Inc. v. Harbridge Merchant Servs., Inc., 20 F.3d 771, 776 (7th Cir. 1994)); see also Haroco, Inc. v. American Nat'l Bank & Trust Co., 747 F.2d 384, 404 (7th Cir. 1984) ("We note that in our prior RICO decisions we have applied ordinary civil standards to pleadings in civil RICO cases."). Only when the predicate acts on which the RICO claim is based sound in fraud must the plaintiff meet the more exacting standards of pleading under Fed. R. Civ. P. 9(b) -- and even then 9(b) applies only to pleading the particulars of those fraudulent acts. Id. (citation omitted). A recent RICO decision from our colleague Judge Zagel reiterated the impropriety of flouting Rule 8(a)'s dictates:

 
Our Court of Appeals' flirtation with heightened pleading requirements ended in 1993 with the Supreme Court's reaffirmation of Conley v. Gibson, 355 U.S. 41, 45-46, 2 L. Ed. 2d 80, 78 S. Ct. 99 (1957) [citations omitted]. Today, Conley's declaration that "a complaint should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief' resonates in the Seventh Circuit: "the plaintiff receives the benefit of imagination, so long as the hypotheses are consistent with the complaint." Sanjuan v. American Bd. of Psychiatry & Neurology, Inc., 40 F.3d 247, 251 (7th Cir. 1994).

 Butler v. Platte Valley Mortgage Corp., 1995 U.S. Dist. LEXIS 21956, 1995 WL 875412, at *1 (N.D. Ill. Oct. 25, 1995) (parenthetical omitted). This cardinal rule of pleading weighs heavily in our decision today. Despite the Court's discomfort with the plaintiffs' cagey deployment of civil RICO provisions, we are bound by Rule 8(a)'s mandate that the federal civil pleading burden is simply to set forth "a short and plain statement of the claim showing that the pleader is entitled to relief."

 ANALYSIS -- RICO CLAIMS

 Plaintiffs' RICO claims (Counts I and II) are brought under 18 U.S.C. § 1962(c), which makes it unlawful for "any person employed by or associated with [an] enterprise . . . 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." To state a claim under this section, plaintiffs must plead (1) conduct (2) of an enterprise (3) through a pattern (4) of racketeering activity. Richmond v. Nationwide Cassel, L.P., 52 F.3d 640, 644 (7th Cir. 1995) (citing Sedima, S.P.R.L. v. Imrex Co., 473 U.S. 479, 496, 87 L. Ed. 2d 346, 105 S. Ct. 3275 (1985)). For purposes of its motion to dismiss, Norwest does not challenge plaintiffs' pleading of elements (3) and (4). It focuses instead on the first two prongs, arguing forcefully that plaintiffs cannot show Norwest engaged in the "conduct of an enterprise." Our synthesis of case law in this Circuit reveals that this phrase can be broken down into three pleading requirements: identifying the enterprise, demonstrating that the enterprise is distinct from the RICO "person," i.e., the defendant, and pleading that the RICO person participated in the operation or management of the enterprise. We now examine the plaintiff's complaint for compliance with these standards.

 I. Plaintiffs' RICO Allegations

 We begin with a summary of plaintiffs' RICO allegations. The complaint states that Norwest is in the consumer financing business, deriving much of its income from mortgage origination fees and charges, sales of mortgage servicing rights, servicing mortgage loans, and secondary market sales. Norwest is a mortgage banking subsidiary of Norwest Nova, Inc., which in turn is a wholly owned subsidiary of Norwest Corporation ("NC"). Complt. PP 7-8. NC is a diversified financial services organization that provides, among other things, banking, insurance, and investment services. It has delegated control of its residential mortgage servicing business to Norwest. Id. PP 9-10.

 Norwest allegedly used its delegated authority over this legitimate line of business to engage in a fraudulent scheme of charging bankrupt borrowers unauthorized property inspection and proof of claim fees. "John Does 1-10," identified as corporate officers of Norwest, are alleged to be "personally knowledgeable and responsible for these fraudulent practices." Id. PP 6, 10. Plaintiffs claim that Norwest and the John Does engaged in a "pattern of racketeering activity" by knowingly imposing and collecting these unauthorized fees through the mail (mail fraud) and through Proofs of Claim filed in bankruptcy court (bankruptcy fraud.) Id. PP 23-26. Through this activity, Norwest conducted the affairs of two "enterprises": (1) NC, its indirect parent corporation, and (2) the entire corporate group headed by NC. Id. P 43. The John Does conducted the affairs of three enterprises through this activity: (1) Norwest, (2) NC, and (3) the corporate group headed by NC. Id. P 55.

 Plaintiffs allege that the income Norwest derives from imposing the allegedly unauthorized property inspection and proof of claim fees benefitted the enterprises: it was "upstreamed to [NC], and was reported on [NC's] financial statements." Id. P 11. These financial statements provided the basis for NC to raise capital in public securities markets -- capital that NC used to fund the operations of Norwest and the entire corporate group. Id. We find that these allegations are sufficient to maintain the RICO claim in Count I, but not in Count II. We address each Count in turn.

 II Count I -- Plaintiffs' RICO Claim ...


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