Basil H. Lorch III
______________________
United States Bankruptcy Judge
ORDER ON DEFENDANTS'
MOTIONS TO DISMISS
This proceeding was initiated by the filing of the Complaint on December 21, 2012, which was subsequently amended on February 15, 2013, and now comes before the Court on the Defendant ADM Investor Services, Inc.'s Motion to Dismiss Amended Complaint, with Prejudice [Docket No. 39]; Defendant Larry Zeien II's Motion to Dismiss Amended Complaint with Prejudice [Docket No. 41]; and Defendants Robert Rufenacht and Rufenacht Commodities, Inc.'s Motion to Dismiss Amended Complaint, with Prejudice [Docket No. 43], each filed on March 25, 2013. The Trustee's Response to Motions to Dismiss was filed on May 8, 2013. On June 7, 2013, a Reply by ADM Investor Services, Inc. to Trustee's Response to Motions to Dismiss was filed, along with Defendant Larry Zeien II's Reply and Defendants Robert Rufenacht and Rufenacht Commodities, Inc's Reply. The Court conducted a hearing on July 10, 2013, at which time the parties presented oral argument to the Court.
The Trustee's pleading is a combined response to the three separate motions filed by individual Defendants.
Background Facts
The Trustee's Amended Complaint consists of five counts. The focus of the Trustee's action involves the transfer of $31,150,300 from the Debtor's accounts into the personal bank account of the Debtor's principal, Thomas Gibson, through the hands of Zeien, Rufenacht, Rufenacht Commodities and then to ADM Investor Services, Inc., before it completed the round-trip circuit back into Gibson's personal account. Those transfers, according to the Trustee, enabled Gibson to manipulate his financial records so as to orchestrate a massive check kiting scheme to the detriment of his creditors and ultimately, the Debtor. The Trustee now seeks to avoid and recover those transfers based upon actual and constructive fraud and has asserted a violation of the Indiana RICO statute. He also asks the Court to disallow any of the Defendants' claims in the underlying bankruptcy proceeding.
For purposes of this motion to dismiss, the Court must assume the truth of the facts alleged in the amended complaint and view those facts and any inferences therefrom in the light most favorable to the Plaintiff. Yeksigian v. Nappi, 900 F.2d 101, 102 (7th Cir. 1990). The Court, therefore, accepts the following pertinent facts as true:
1. Eastern Livestock Corporation ("ELC") was one of the largest cattle dealers in the United States until its closure on or about November 2, 2010, processing cattle sales and operating branch facilities in eleven states.
2. Thomas Parish Gibson ("Gibson") was an owner of ELC and manager of the business. Defendant Michael Steven McDonald ("McDonald") was ELC's Operations Manager and was responsible for management and oversight of ELC's Line of Credit, among other things;
3. Defendant Larry Zeien, Jr. ("Zeien") was an employee of ELC and was responsible for the operations of Defendant Rufenacht Commodities, Inc.'s ("RCI") branch office located within ELC's headquarters.
4. Defendant Robert Rufenacht ("Rufenacht") is an owner and agent of RCI and a branch manager and financial consultant for ADM Securities, Inc., a subsidiary of ADMIS.
5. ADMIS is a wholly-owned commodity futures brokerage subsidiary of Archer Daniels Midland Company ("ADM") and is a futures clearing merchant. ADMIS specializes in providing commercial hedgers, traders, brokers, and risk managers with execution and clearing services. ADMIS works through a network of Introducing Brokers ("IB"), non-clearing futures commission merchants, branch offices, subsidiaries and sister companies across the United States and around the globe.
6. ADMIS engaged RCI as an IB.21. On or about September 21, 2011, Gibson and McDonald were charged with Mail Fraud in violation of 18 U.S.C. § 1341 in the United States District Court for the Western District of Kentucky under Cause Number 3:11-cr-00123-TBR-1, for actions related to the check kiting scheme. On or about December 13, 2012, Gibson pled guilty to the federal charge of Mail Fraud.
22. Further, Gibson, McDonald, and two others were indicted by a Kentucky grand jury of 17 counts of theft by deception over $10,000, 144 counts of theft by deception over $500 and under $10,000 and 11 counts of theft by deception under $500. Gibson and McDonald pled guilty to all of the state charges and were both sentenced to ten years in prison.
Discussion
The Trustee has brought a claim against the Defendants for violation of Indiana's RICO Act and also seeks to recover transfers of property from ELC deposit accounts to ADMIS in the two years preceding the filing of this bankruptcy which totaled in excess of thirty-one million dollars. As to the Defendants' individual roles in the scheme, the Trustee alleges that Gibson and McDonald wrongfully siphoned funds out of ELC and into the TPG/YCB Account; that Gibson conspired with Rufenacht and/or RCI to create one or more financial services accounts at ADMIS; that Zeien aided and abetted in causing checks to be written out of the TPB/YCB Account payable to ADM Investor Services c/o RCI and deposited into one of the ADMIS Accounts. As to ADMIS in particular, the Trustee alleges that the ADMIS checks and wires served no legitimate business purpose and were merely part of the massive check kiting scheme. He further asserts that ADMIS was complicit in the transfer of funds into the TPG/YCB Account knowing that the funds were owned by ELC and not Gibson.
Sufficiency of Pleading
The Defendants argue that the allegations of fraud contained in the Trustee's Complaint are inadequate under Twombly standards and lack the particularity required by virtue of Rule 9(b) of the Federal Rules of Civil Procedure. The Court rejects both of these arguments and finds that the Trustee's allegations are sufficient to state a claim upon which relief can be granted under Rule 12(b)(6). As noted by ADMIS in their brief, in order to survive a motion to dismiss post-Twombly, "'the plaintiff must give enough details about the subject matter of the case to present a story that holds together,' and the question the court should ask is 'could these things have happened, not did they happen.'" Estate of Davis v. Wells Fargo Bank, 633 F.3d 529, 533 (7th Cir. 2011) (quoting Swanson v. Citibank, N.A., 614 F.3d 400, 404-405 (7th Cir. 2010)).
The Trustee contends that, in a complex case such as this, he should be afforded greater latitude in pleading fraud. See, Picard v. Estate of Stanley Chais (In re Bernard L. Madoff Inv. Sec. LLC), 445 B.R. 206, 219 (Bankr.S.D.N.Y. 2011) ("[g]reater liberality in the pleading of fraud is particularly appropriate in bankruptcy cases, because . . . it is often the trustee, a third party outsider to the fraudulent transaction, that must plead the fraud on secondhand knowledge for the benefit of the estate and all of its creditors"). Defendants, on the other hand, assert that the complexity of this case demands more factual specificity instead of less. Limestone Dev. Corp. v. Vill. of Lemont, 520 F.3d 797, 803 (7th Cir. 2008) (affirmed dismissal of RICO complaint, noting "[i]n a complex antitrust or RICO case a fuller set of factual allegations. . . may be necessary to show that the plaintiff's claim is not 'largely groundless' [cit. omit]"); Kaye v. D'Amato, 357 Fed.Appx. 706, 710 (7th Cir. 2009) ("[w]hile dismissal of a RICO claim is appropriate if the plaintiff fails to allege sufficient facts to state a claim that is plausible on its face, the adequate number of facts varies depending on the complexity of the case"). The parties do, however, seem to agree that in order to survive dismissal on a Rule 12(b)(6) motion, the complaint must state the "who, what, when, and where" of the alleged fraud. See, Lachmund. v. ADM Investor Services, Inc., 191 F.3d 777, 781 (7th Cir. 1999).
In Pirelli Armstrong Tire Corp. - Retiree Medical Benefits Trust v. Walgreen Co., 631 F.3d 436 (7th Cir. 2011), the Court elaborated on the particularity requirement of the Rules of Civil Procedure. In that case, the plaintiff alleged that Walgreens pharmacy systematically took prescriptions that were written for a generic form of two popular drugs and illegally substituted a more expensive form of the drug. The plaintiff based its allegations of fraud on a "preliminary review" of its own reimbursement data, on information contained in an earlier whistleblower suit, as well as from an investigation conducted by another benefit management firm in other jurisdictions. The Court, in "adding flesh to the bones of the word particularity", noted:
. . .because courts and litigants often erroneously take an overly rigid view of the formulation, we have also observed that the requisite information - what gets included in that first paragraph - may vary on the facts of a given case.
Emery v. Am. Gen. Fin., Inc., 134 F.3d 1321, 1324 (7
th Cir. 1998) (flexibility when information lies outside of plaintiff's control);
In re HealthCare Compare Corp. Secs. Litig., 75 F.3d 276, 285 (7
th Cir. 1996) (Ripple, J., dissenting) (noting that reasonable minds can and will differ on the adequacy of a given fraud averment);
see also Shushany v. Allwaste, Inc., 992 F.2d 517, 521 (5
th Cir. 1993) ("[w]hat constitutes 'particularity' will necessarily differ with the facts of each case....").
Id. at 441-442. Explaining the level of detail required, it was further noted that while a plaintiff does not have "unlimited leeway" in pleading allegations on information and belief, "the practice is permissible so long as (1) the facts constituting the fraud are not accessible to the plaintiff and (2) the plaintiff provides 'the grounds for his suspicions.'"
Id. (citing
UniQuality, Inc. v. Infotronx, Inc. 974 F.2d 918, 924 (7
th Cir. 1992);
Bankers Trust Company v. Old Republic Insurance Company, 959 F.2d 677, 684 (7
th Cir. 1992).) In that case, the Court ultimately concluded that the plaintiff could "easily have done more" in substantiating its allegations of fraud. Because the further particulars of the alleged fraud could have been obtained without discovery by taking "a more fulsome look at its own data", the Court found that it did not fulfill Rule 9(b)'s purpose and thus dismissed the plaintiff's complaint.
The Court, having carefully reviewed the specific allegations of the Amended Complaint, finds that the Trustee has given grounds for his suspicions and thus has met the threshold requirements required by Rule 9(b).
Safe Harbor Provision of § 546(e)
Additionally, the Defendants contend that the safe harbor provision set out in section 546(e), which provides that "the trustee may not avoid . . . a transfer made by or to (or for the benefit of) a commodity broker . . . in connection with a . . . commodity contract" serves to preclude the Trustee's attempts to avoid the subject transfers under 548(a)(1)(B). The Trustee asserts, in response thereto, that the transfers were not legitimate business transactions and were not "in connection with" a commodity contract, and thus section 546(e) is inapplicable. The Court is inclined to agree at this juncture of the proceedings.
As noted by this Court in an earlier decision, the safe harbor provision is designed to protect the stability of financial markets. If, in fact, the challenged transfers were in furtherance of a check kiting scheme and not legitimately related to a commodity contract, it would hardly serve the purposes underlying the statute to enforce that provision. See, Grede v. FCStone, LLC, 485 B.R. 854, (N.D.Ill 2013). As noted by that court, "[t]he safe harbor functions as a firewall that insulates legitimate securities and commodities transactions from avoidance because of the potential destabilizing effects that unwinding such trades could have on the broader market." Id. at 885 (emphasis added).
Nor does the Court find, contrary to the Defendants' suggestion, that the rationale of In re Lehman Holdings Inc., 469 B.R. 415 (Bankr. S.D.N.Y. 2012), mandates a different result. In that case, Lehman Holdings brought suit against a bank whose economic coercion fueled Lehman's financial ruin. The bankruptcy court noted that the challenged transactions were "precisely the sort of contractual arrangements that should be exempt from being upset by a bankruptcy court under the more lenient standards of constructive fraudulent transfer or preference liability: these are systemically significant transactions between sophisticated financial players at a time of financial distress in the markets - in other words, the precise setting for which the safe harbors were intended." Id. at 422. While the bank may have abused the power of its position to improperly extract additional collateral and other concessions shortly before Lehman's bankruptcy, the transfers were admittedly "legitimate" and "in connection with" a securities contract. That case, unlike this one, presented "important questions as to what a lender can do in managing its exposure to potential losses and protect its interests at a time of intensifying concerns about systemic risk." Id. at 419.
Implication of Section 550(a)
ADMIS and Rufenacht, citing Weinman v. Simons (In re Slack-Horner Foundries, Co.), 971 F.2d 577 (10th Cir. 1992) assert that section 550 of the Bankruptcy Code requires the Trustee to avoid the initial transfer to Gibson under section 548 before he can look to subsequent transferees for recovery. The Trustee, citing IBT International, Inc. v. Northern (In re International Administrative Services, Inc.), 408 F.3d 689 (11th Cir. 2005), notes that courts have utilized differing approaches to section 550. Where an initial transferee acts merely as an intermediary in passing funds to another transferee, some courts employ a "mere conduit" concept which allows recovery from the subsequent transferee as the "initial recipient." Id. at 705. Yet another approach to avoiding transfers, the "pragmatic" approach, eliminates the distinction between initial transferees and mediate transferees and permits recovery against any transferee. In such cases, however, "in order to incur liability as a transferee, a party must have exercised a degree of dominion and control over the property transferred, or held some sort of beneficial right in it." Id. at 707 (citing In re Paramount Citrus, Inc., 268 B.R. 620 (M.D.Fla. 2001)). Although the Seventh Circuit has not had occasion to address this issue, at least one court within this circuit has adopted the so-called pragmatic approach, holding that section 550(a)(1) "allows the Trustee to pursue either the initial transferee or the entity for whose benefit the transfer was made." Brown v. Phillips (In re Phillips), 379 B.R. 765, 786 (N.D.Ill. 2007). This Court likewise adopts such logic.
Zeien contends that he was a "mere conduit" and, as such, bears no responsibility for any funds that passed through his hands. A "mere conduit" may not be considered an initial transferee for purposes of section 550(a) where no control is exercised over the debtor's property. This analysis is most often used where a bank acts as an intermediary in transferring assets. See, e.g., In re Coutee, 984 F.2d 138 (5th Cir. 1993); Bonded Financial Services, Inc. v. European American Bank, 838 F.2d 890 (7th Cir. 1988). But Zeien goes even further to assert that he was not a transferee at all. As argued by Zeien, the term transferee does not include anyone who touches the money, and must mean something different from "possessor" or "holder" or "agent." Bonded Fin. Servs., Inc. v. European American Bank, 838 F.2d 890, 893 (7th Cir. 1988). In that case, the Seventh Circuit noted that "the minimum requirement of status as a 'transferee' is dominion over the money or other asset, the right to put the money to one's own purposes." Id. at 893.
ADMIS adopted Zeien's arguments in support of the "conduit" defense in its Reply Brief and, as such, asserts that all the Defendants were mere conduits of the ADMIS checks with the counterparties to the commodity contracts being the ultimate transferees.
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The conduit rule, according to the Eleventh Circuit, "presumes that the facilitator of funds acts without bad faith, and is simply an innocent participant to the underlying fraud." In re IAS, 408 F.3d at 705 (citations omitted). In that case, the court observed:
These initial transferees do not conjure images of well-intentioned, but gullible, parties who mistakenly fell victim to a massive conspiracy between the Debtor and the Defendants. To the contrary, these entities had intimate and thorough knowledge of the transactions and their desired effect. Money changed multiple hands, twenty-three entities filtered IAS funds away from creditors. [They] were the architects of a masterful plan aimed at diluting [Debtor's] coffers and lining their own pockets. To hold them to be innocent parties would contravene the character of a fraudulent transfer action, the purpose of which is to expose fraudulent dealings.
Id. at 706.
The Trustee alleges that Zeien was an active participant in the fraud, that he issued some of the ADMIS Checks which were sent to Rufenacht and subsequently deposited by Rufenacht into an ADMIS account owned by Gibson. ADMIS allegedly wired funds directly back into the TPG/YCB Account, which transfers, according to the Trustee, served no legitimate purpose. If the Trustee's allegations are correct, the Defendants' actions enabled Gibson to create the "float" which gave life to his massive check kiting scheme, and Zeien, Rufenacht and ADMIS all benefitted by the scheme by taking commissions and fees on the transactions.
While the Defendants are not foreclosed from asserting the conduit theory at trial, for purposes of this motion, the Court is bound to accept the allegations of the Trustee's amended complaint as true. Because the Trustee has alleged that the Defendant transferees benefitted from, and were complicit in, the check kiting scheme, good faith is in issue, and thus the defense fails.
Estoppel, Laches, or Waiver
The Defendants argue that the Trustee's fraudulent transfer claims are barred by the doctrine of collateral estoppel because this Court determined that the funds in the ADMIS Account are property of the Gibsons' bankruptcy estate and thus cannot be property of the ELC estate. Because the Trustee's claims in this case differ significantly from the operative facts giving rise to the trustee's turnover motion in the Gibson case, however, the Court finds that estoppel is not warranted. Further, the Court finds that Trustee has acted diligently in pursuing claims and, there being no showing of material prejudice to the Defendants, rejects the Defendants' claim of laches. Finally, the Court finds no basis for holding that the Trustee has waived its claims against the Defendants.
Indiana RICO
Under I.C. 34-24-2-6(b), an "aggrieved person" may bring a civil RICO action against a person who has violated Indiana Code Section 35-45-6-2 "for damages suffered as a result of corrupt business influence." The Defendants contend that the Trustee does not qualify as an "aggrieved person" and cannot show that any actions allegedly committed by them directly or proximately caused damage to the Debtor, inasmuch as the Debtor, by and through its principal, Thomas Gibson, was the instigator and mastermind behind the check kiting fraud. Defendants also assert that the Trustee did not adequately plead the elements of the Indiana RICO claim, including knowing and intentional participation, the existence of a RICO enterprise, a pattern of racketeering activity, or causation. Finally, perhaps foremost among the Defendants' respective arguments in support of dismissal is the asserted defense of in pari delicto.
Under the Indiana RICO provisions, a party commits a corrupt business influence:
(1) who has knowingly or intentionally received any proceeds directly or indirectly derived from a pattern of racketeering activity, and who uses or invests those
proceeds or the proceeds derived from them to acquire an interest in property or to establish or to operate an enterprise;
(2) who through a pattern of racketeering activity, knowingly or intentionally acquired or maintains, either directly or indirectly, an interest in or control of property or an enterprise; or
(3) who is employed by or associated with an enterprise, and who knowingly or intentionally conducts or otherwise participates in the activities of that enterprise through a pattern of racketeering activity;
I.C. § 35-45-6-2.
While Indiana's RICO statute is patterned after the federal anti-racketeering law, Wesleyan Pension Fund, Inc. v. First Albany Corp., 964 F.Supp. 1255, 1273 (S.D.Ind. 1997), the Indiana Supreme Court has noted a significant difference between the two statutes. See Keesling v. Beegle, 880 N.E.2d 1202, 1206 (Ind. 2008). The Indiana Act "impose[s] liability both on persons who conduct the activities of a racketeering enterprise and on those who otherwise participate in the activities of a racketeering enterprise." Id.
Elements of an Enterprise
Initially, the Court finds that the Trustee has pled the existence of an "enterprise" as defined in I.C. § 35-45-6-1(c) and in accord with the structure outlined by the Supreme Court in United States v. Turkette, 452 U.S. 576, 583, 101 S.Ct. 2524, 69 L.Ed.2d 246 (1981); Boyle v. United States, 556 U.S. 938, 129 S.Ct. 2237, 173 L.Ed.2d 1265 (2009); and see Jay E. Hayden Foundation v. First Neighbor Bank, N.A., 610 F.3d 382, 388 (7th Cir. 2010) (an enterprise must have "three structural features: (1) a purpose, (2) relationships among those associated with the enterprise; and (3) longevity sufficient to permit these associates to pursue the enterprise's purpose."). As to the first element, the Trustee has alleged a purpose, specifically that the enterprise served to further the Check Kiting Scheme (Id. ¶ 90), by falsely reporting revenues (Id. ¶¶ 64, 65), which induced Fifth Third to continue to release funds under the Line of Credit (Id. ¶¶ 46, 48), and that each Defendant profited from the scheme (Id. ¶¶ 38, 98).
Next, the Court finds that the Trustee detailed the existence of a relationship among those associated with the enterprise. He alleged, as stated hereinabove, that ADMIS engaged Rufenacht Commodities as an IB; that ADMIS is responsible for the actions of Rufenacht Commodities; that Robert Rufenacht was a branch manager and consultant for ADMIS and an agent of ADMIS (Am. Compl. ¶¶ 35-36, 41); that Rufenacht and/or Rufenacht Commodities conspired with Gibson to create the ADMIS accounts that ultimately received the Transfers (Id. ¶ 40); that Zeien was an employee and agent of Rufenacht Commodities and operated the branch of Rufenacht Commodities co-located within ELC (Id. ¶ 23); that Zeien met with McDonald and Gibson in furtherance of the check kiting scheme; and that Zeien arranged for checks to be written payment to ADMIS and sent to Rufenacht, where they were deposited into an ADMIS account, following which ADMIS would wire funds back to the TPG/YCB account (Id. ¶¶ 52, 54, 57-59).
Finally, inasmuch as the Trustee alleged that the enterprise operated in furtherance of its purpose from December 6, 2008, through December 6, 2010, and resulted in improper transfers on one hundred twenty-five (125) occasions, the Court finds that longevity has been properly pled. As noted by the Court in Boyle, "the instruction that an enterprise's existence 'is oftentimes more readily proven by what it does, rather than by abstract analysis of its structure' properly conveyed Tercet's point that proof of a pattern of racketeering activity may be sufficient in a particular case to permit an inference of the enterprise's existence." Boyle, 556 U.S. at 940. Because the Trustee has sufficiently alleged the existence of an enterprise, the Court finds no basis therein for dismissal.
Proximate Cause
The Defendants argue that Court IV should be dismissed because the Trustee failed to allege plausible facts that they directly or proximately caused any injuries to ELC. As noted by ADMIS in its Reply Brief, this argument is essentially the same as the "standing" argument asserted by Rufenacht and Rufenacht Commodities, so the Court will address these arguments as a whole.
The Indiana RICO statute affords relief to an "aggrieved person" against a person who has violated IC § 35-45-6-2 "for damages suffered as a result of corrupt business influence." I.C. § 34-24-2-6(b). "A person . . . who is employed by or associated with an enterprise, and who knowingly or intentionally conducts or otherwise participates in the activities of that enterprise through a pattern of racketeering activity; commits corrupt business influence. The Defendants essentially contend that the Trustee does not qualify as an "aggrieved person" and cannot show that any actions allegedly committed by them directly or proximately caused damage to the Debtor, inasmuch as the Debtor, by and through its principal, Thomas Gibson, was the instigator and mastermind behind the check kiting fraud.
To establish standing to sue, a plaintiff to a civil RICO claim must show injury to his business or property. Evans v. City of Chicago, 434 F.3d 916, 924-25 (7th Cir. 2006). Beyond that, however, the Defendants urge that the RICO plaintiff must be the intended target of the RICO scheme, citing In re Am. Express, 39 F.3d 395, 400 (2d. Cir. 1994) and its progeny. Those cases, having no precedential value, are simply inapplicable. The Indiana statute provides a cause of action for an aggrieved person and not only the intended target of the RICO scheme. Such a finding would supplant the statutory language by redefining "aggrieved person" to be the "intended target" of the RICO scheme. The Court declines the Defendants' invitation to adopt the logic of American Express.
The state court in Keesling v. Beegle, 858 N.E.2d 980 (Ind. App. 2006), discussed liability under Indiana's RICO statute. Finding no cases interpreting the Indiana statute, the court looked to case law interpreting the federal RICO statute and concluded that a showing of proximate cause is required. Id. at 991-992 (citing Holmes v. SIPC., 503 U.S. 258, 112 S.C. 1311, 117 LED.2d 532 (1992); and see Raybestos Prods. Co. v. Younger, 54 F.3d 1234, (7th Cir. 1995) (while there must be a direct relation between the alleged wrongdoing and consequent harm, "notions of justice and policy often dictate the boundaries of 'proximate causation.'"). The court, however, went on to note:
We are not bound by the Seventh Circuit's interpretation of
Indiana Code Section 34-24-2-6(b), but given that this statute is even more specific than
18 U.S.C. § 1964(c) in requiring a causal relationship between a defendant's racketeering activities and a plaintiff's injuries, we agree that a showing of proximate cause is required for an Indiana RICO claim. The Indiana Supreme Court has stated that '[although a rigorous definition is elusive, proximate cause has been defined as 'that cause which, in natural and continuous sequence, unbroken by any efficient intervening cause, produces the result complained of and without which the result would not have occurred.'"
Id at 992 (citing
Peters v. Forster, 804 N.E.2d 736, 743(Ind. 2004)). "Proximate cause is generally a question of fact for the jury to decide."
Goby v. Whitehead, 837 N.E.2d 146, 151 (Ind.Ct.App. 2004). In this case, the Trustee has alleged that the portion of the check kiting scheme involving the Defendants served to increase the cash available to ELC through its line of credit by $20 million daily, resulting in unsustainable debt to ELC. The Court finds that there has been an adequate showing of proximate causation.
In Pari Delicto
The doctrine of in pari delicto stands for the proposition that "where the wrong of both parties is equal, the position of the defendant is stronger." Theye v. Bates, 337 N.E.2d 837, 844 (Ind.App. 1975) (quoting Perma Life Mufflers, Inc. v. Intern. Parts Corp., 392 U.S. 134, 135 (1968)). Because the Trustee stands in the shoes of the Debtor, the Defendants argue that the Trustee's RICO claims are barred as a matter of law based upon the Debtor's pre-bankruptcy misconduct. See, Peterson v. McGladrey & Pullen, LLP, 676 F.3d 594 (7th Cir. 2012); Grede v. McGladrey & Pullen LLP, 421 B.R. 879, 884-885 (N.D. Ill. 2009).
The doctrine has been defined, in this Circuit, through a series of key decisions. The first such case, Scholes v. Lehmann, 56 F.3d 750 (1995), involved a Ponzi scheme wherein a receiver for the Securities and Exchange Commission sought to recover transfers as fraudulent under the Illinois Fraudulent Transfer Act. The second decision, handed down in 2003, likewise involved a Ponzi scheme. Knauer v. Jonathon Roberts Financial Group, Inc., 348 F.3d 230. In both cases, defendants invoked the defense of in pari delicto arguing essentially that "the wrongdoer must not be allowed to profit from his wrong by recovering property that he had parted with in order to thwart his creditors." Scholes at 754. While the Court rejected the defense in Scholes, it found that it did apply in Knauer to bar the receiver's alleged tort claims. As explained by one court:
In the Seventh Circuit's view, the key distinction between
Scholes and
Knauer was that in
Scholes, the plaintiff receiver sought to recover diverted funds from the people who benefitted from the diversions, whereas in
Knauer the receiver sued defendants who had derived no benefit from the embezzlements. The application of the
in pari delicto defense was appropriate in
Knauer because the equitable balancing in that case favored the defendants; they had not seen a cent of the diverted funds and their 'involvement in the Ponzi scheme as a whole was quite minor.' (citations omitted).
Marwil v. Ent & Imler CPA Group, PC, 2004 WL 2750255 at *9 (S.D. Ind. 2004).
Finally, in Peterson v. McGladrey & Pullen, LLP, 676 F.3d 594 (7th Cir. 2012), a bankruptcy trustee filed suit against the debtor's auditor, alleging that McGladrey was negligent in failing to discover the debtor's Ponzi scheme. The district court invoked the doctrine of in pari delicto in dismissing the complaint. On appeal, the trustee asked the court to "knock out the pari delicto defense altogether, so that the culpability of a corporate manager never would bar recovery against a negligent auditor." Id. at 597. The Seventh Circuit ultimately held that "a person sued by a trustee in bankruptcy may assert the defense of in pari delicto, if the jurisdiction whose law creates the claim permits such a defense outside of bankruptcy." Id. at 598.
ELC is charged with knowledge of the fraudulent scheme inasmuch as Gibson was the owner and business manager of ELC when the fraud was perpetrated. Because Gibson "caus[ed] billions of dollars of checks to be issued from various bank accounts" and directed and authorized McDonald to prepare fraudulent Borrowing Base Certificates, it is indisputable that ELC was aware of the fraud. Based upon the foregoing, the Court finds that the defense of in pari delicto may be asserted against the Trustee. Whether the defense is applicable so as to bar the Trustee's claim, however, will depend upon the equitable balancing between the parties.
In Knauer, in pari delicto was appropriate because the defendants "involvement in the Ponzi scheme as a whole was quite minor." Knauer, 348 F.3d at 237. Of course, the Court emphasized that there was "no allegation whatsoever that the defendants were directly involved in the embezzlements or benefitted from them." Id. "Had the broker dealers been directly involved in the embezzlements, or attained some tangible benefit from them, this would be a different case." Id. at 237, n. 6.
In Baker v. Ernst & Young LLP, 2004 WL 771230 (S.D.Ind.), Judge Hamilton applied the logic of Scholes and Knauer and concluded that in pari delicto did not require dismissal when there were allegations that the defendants were involved in the fraudulent conduct:
Outside of a fraudulent conveyance scenario, the best case for
not applying the
in pari delicto defense is where the insider and the third-party tortfeasor were essentially acting as co-conspirators. That is a fair summary of plaintiffs' allegations here, though it remains to be seen whether they can be proved. The doctrine of
in
pari delicto does not require dismissal at this stage of the litigation.
Id. at *10. Because the Trustee has alleged that each of the Defendants were involved in the planning of, or helped to perpetuate, the check kiting scheme, the Court finds that the defense of
in pari delicto does not bar the Trustee's RICO claim at this stage of the proceeding.
Section 502(d)
Finally, the Trustee seeks to disallow any claims that these Defendants may have against ELC under section 502(d). To the extent that the Trustee retains a valid claim to recover estate assets against the Defendants, the Court DENIES the respective Motions to Dismiss Count V of the Trustee's Amended Complaint.
Conclusion
For all of the foregoing reasons, the Court finds that the Defendant ADM Investor Services, Inc.'s Motion to Dismiss Amended Complaint, with Prejudice [Docket No. 39]; Defendant Larry Zeien II's Motion to Dismiss Amended Complaint with Prejudice [Docket No. 41]; and Defendants Robert Rufenacht and Rufenacht Commodities, Inc.'s Motion to Dismiss Amended Complaint, with Prejudice [Docket No. 43], are each DENIED in their entirety.
IT IS SO ORDERED AND ADJUDGED.