White Collar Criminal Defense Attorney
Free Case Consultation

The Sixth Circuit’s “Functional Approach” Regarding Distinctness

The Sixth Circuit breaks with the Second Circuit and others and employs a “functional approach” to find a corporate defendant distinct from an enterprise consisting of the corporation and wholly owned and controlled subsidiaries when each played distinct roles that helped the fraudulent scheme.

In Classic Star Mare Lease Litig., the Sixth Circuit affirmed the grant of a summary judgment to plaintiff investors finding the “non-identity” or “distinctness” requirement satisfied. It is established law that “[u]nder RICO, a corporation cannot be both the ‘enterprise’ and the ‘person’ conducting or participating in the affairs of that enterprise.” In Begala v. PNC Bank, Ohio, N.A., 214 F.3d 776, 781 (6th Cir. 2000), the court explained that if RICO imposed liability on a corporation for the ordinary conduct of its agents and employees, every claim of corporate fraud would automatically become a violation of RICO.

The court explained that federal courts have encountered significant conceptual difficulties when attempting to apply the distinctness requirement in the context of complex relationships among affiliated and non-affiliated corporations and individuals. The court examined the case law over the last 20 years, including the Supreme Court’s decision in Cedric Kushner Promotions, Ltd. v. King, 533 U.S. 158 (2001), and concluded that two important principles emerged: 1) individual defendants are always distinct from corporate enterprises because they are legally distinct entities, even when those individuals own the corporations or act only on their behalf; and 2) corporate defendants are distinct from RICO enterprises when they are functionally separate, as when they perform different roles within the enterprise or use their separate legal incorporation to facilitate racketeering activity. Applying these principles in this case revealed that each Defendant was sufficiently distinct from the RICO enterprise to satisfy the statute’s distinctness requirement.

Thus, it was alleged that Geostar, the RICO defendant, was distinct from an enterprise consisting only of GeoStar’s agents, subsidiaries, and affiliates. GeoStar, which controlled two key participants in the enterprise — i.e., Gastar and Classic Star, LLC — argued that GeoStar could not be liable under RICO because it could not be both a RICO “person” and the “enterprise” whose affairs are conducted by that person.

The court noted that typically a parent corporation and its subsidiaries do not satisfy the distinctness requirement because they cannot form an enterprise distinct from the parent. Citing to Riverwood Chappaqua Corp. v. Marine Midland Bank, N.A., 30 F.3d 339, 344-45 (2d Cir. 1994). But, the court stated that the distinctness requirement may be satisfied when the parent corporation uses the separately incorporated nature of its subsidiaries to perpetrate a fraudulent scheme. Id., citing cases. The court stated that it would be strange indeed to absolve a parent corporation of liability for doing precisely what RICO was designed to prevent: the use of an association of legally distinct entities “as a vehicle through which unlawful … activity is committed.”

Therefore, the court found that GeoStar and each of its subsidiaries performed distinct roles that helped facilitate the fraudulent scheme. GeoStar’s role was that of an external, financially stable guarantor while subsidiary ClassicStar’s role was to “provide a funding source for GeoStar that was attractive to investors.” Because the enterprise successfully carried out its fraudulent scheme by enlisting the participation of GeoStar and its separately incorporated subsidiaries, with each playing a key role, the court concluded that the enterprise was sufficiently distinct from GeoStar itself.

Moreover, the court noted that even if GeoStar were not considered distinct from Gastar and ClassicStar, the alleged RICO enterprise was comprised of other entities that were neither owned by GeoStar nor acting as its agents, and they played an important part of the scheme to lure investors into the Mare Lease Program. On this basis alone, the district court properly concluded that the enterprise and GeoStar were distinct. Because the district court correctly found that each of the Defendants was distinct from the alleged RICO enterprise, it properly held each of them liable under RICO, either as individually culpable RICO “persons,” or by holding the corporations vicariously liable for the RICO violations of their employees. Therefore, because the defendants did not introduce any evidence that would create a genuine dispute about any material facts, the district court properly concluded that Plaintiffs were entitled to judgment as a matter of law.