Hemi Group, LLC v. City of New York (08-969)

Oral argument: Nov. 3, 2009

Appealed from: United States Court of Appeals for the Second Circuit (Sept. 2, 2008)

RACKETEER INFLUENCED AND CORRUPT ORGANIZATIONS ACT, RICO, TAXES, STANDING, INJURY

Both the State and the City of New York have enacted laws that require the imposition of taxes on all cigarettes sold or used within their boundaries. The City of New York sued a group of Internet cigarette retailers under the Racketeer Influenced and Corrupt Organizations Act (“RICO”). The City of New York claimed that the retailers had violated federal and state laws in selling cigarettes to New York residents without charging a tax on tobacco products, constituting a form of consumer fraud as well as tax evasion. The District Court for the Southern District of New York dismissed the City's claims, holding that the City did not plead that the Internet retailers were an enterprise as defined by RICO. The Court of Appeals for the Second Circuit vacated the judgment of the lower court and held that the State could hold the retailers liable for its loss of tax revenue. The Supreme Court's decision in this case will affect the ability of Internet sites to sell tobacco products at a discounted price, as well as refine the application of RICO in civil suits.

Question presented

Whether city government meets the Racketeer Influenced and Corrupt Organizations Act standing requirement that a plaintiff be directly injured in its “business or property” by alleging con-commercial injury resulting from non-payment of taxes by non-litigant third parties.

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Issues

Does loss of taxable revenue constitute an injury to business or property under RICO and was the City’s injury direct enough to meet the direct injury requirement for standing under RICO?

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Facts

The State of New York imposes a tax on all cigarettes sold or used in the State (known as a use tax). See City of New York v. Smokes-Spirits.com, Inc., 541 F.3d 425, 432 (2nd Cir. 2007). A similar tax exists for cigarettes sold or used within New York City. See id. Out-of-state cigarette sellers, however, do not have to pay the state and city taxes for cigarettes sold within New York. See id. at 432-433. This creates an opportunity for cigarettes to be sold more cheaply out-of-state. See id. 

To combat the loss of state taxes from out-of-state cigarette sales, and to control the incidence of tax evasion, Congress passed the Jenkins Act in 1949. See id. at 433; 15 U.S.C. §§ 375–78. The Jenkins Act requires all out-of-state cigarette sellers to register in states where they sell their cigarettes and provide a list of cigarette buyers to New York tax officials. See 541 F.3d at 433. Both New York State and New York City have entered into agreements where city officials also receive Jenkins Act reports. See 541 F.3d at 433-434. However, certain Internet websites have not complied with the reporting requirements. Under the Racketeer Influenced and Corrupt Organizations Act (“RICO”), no employee of any enterprise that engages in interstate commerce may participate in the enterprise’s racketeering schemes. See id. at 434. The City of New York filed suit in the Southern District of New York against four Internet franchises, claiming that they had engaged in fraud under RICO by selling cigarettes to purchasers without complying with the reporting requirements. See id. The defendants did not mention the use tax requirement to their customers and advertised that they did not have to divulge customer information to authorities. See 541 F.3d at 434.

The City claims defendants’ fraudulent actions—including labeling their cigarettes “tax-free” and hiding sales records to keep customer loyalty—amount to false representations in violation of the Jenkins Act. See id. The City claimed that as a result, it lost millions of dollars each year in unpaid taxes and sought damages for three times the amount of lost tax revenue, as well as injunctive relief enforcing compliance with the reporting requirements. See id. The City sued for, among other things, the Internet franchises’ violation of RICO and fraud. See id. at 436. The court dismissed the RICO claims on the ground that the City failed to show the individuals involved had a duty to file Jenkins Act reports. See id. at 438.

On appeal, the United States Court of Appeals for the Second Circuit remanded the RICO claims, finding that the City of New York did sufficiently plead a RICO enterprise and that the individual owners’ activities violated the Jenkins Act. See id. at 446.

The Hemi Group petitioned the Supreme Court for review, which granted certiorari on May 4, 2009, to determine whether the City of New York has standing to bring a complaint under RICO and whether their actions constitute an injury under RICO .

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Discussion

The Supreme Court's decision in this case will refine the application of the Racketeer Influenced and Corrupt Organizations Act ("RICO”) in civil suits, and could affect how Internet retailers market their products. The petitioners, Hemi Group LLC and Kai Gapuchin (collectively, "Hemi Group"), claim that they never owed the taxes at issue to the State of New York in the first place. See Brief for Petitioners, Hemi Group, LLC and Kai Gapuchin at 21. However, the respondent, the City of New York, ("the City"), contends that Hemi Group’s actions deprive the City of money it is entitled to, and therefore, the lost tax revenue should be recoverable. See Brief for Respondent, City of New York at 22–23.

Effects of Finding Standing and Direct Injury Under RICO

The City asserts that the purpose of RICO is to stop organized criminal activity and the economic harms that result; in light of this purpose, the City contends that the Hemi Group's fraudulent activity effectively steals profits away from the City. See Brief for Respondent at 31. Not only would finding the City has standing under RICO give effect to this legislative intent, the City argues, it would also prevent those economic harms, which could grow exponentially, from occurring. The City contends that given the many Internet businesses starting up at very little cost, if the Court were to allow all of them to evade taxes, a sizeable portion of tax revenue would be lost. See id. at 32. The Campaign for Tobacco-Free Kids further argues that if the Court sides with the Hemi Group, not only will local and state governments continue losing tax revenue, the decision will lead to other negative economic effects. See Brief of Amicus Curiae the Campaign for Tobacco-Free Kids in Support of Respondent at 3. The Campaign contends that untaxed Internet sales give an unfair competitive advantage to online sellers when compared to traditional brick-and-mortar stores that do comply with state tax laws, which could ultimately drive out long-standing businesses. See id. at 5.

On the other hand, the Hemi Group warns that finding the effect of its actions constitutes an injury under RICO would lead to unintended consequences. By widening the definition of "direct injury" to allow the City of New York to pursue a RICO action, Hemi Group contends that the Court would create an improper expansion of mail and wire fraud. See Brief for Petitioners at 36. The Hemi Group argues that such an expansion would result in plaintiffs bringing more lawsuits against corporations, even in situations where there is no duty to disclose any information to the plaintiffs, which would flood the courts. See id. The Hemi Group contends that this would waste time for both the court and the parties involved, tying up judicial resources. See id. at n. 23. In response to this, however, several state governments contend that because RICO has exacting standards for viable claims, these standards still act to limit the number of RICO filings. See Brief of Amici Curiae the States of Indiana, et al. (“Indiana”) in Support of Respondents at 26. Thus, they contend that the trend would follow that of recent years, where there have been low levels of RICO litigation, rather than an excessive amount of frivolous claims flooding the courts. See id. Further, these states contend that Congress has in fact expanded the application of RICO in civil cases, and no significant increase in frivolous claims has occurred, See id. at 27–28. According to the states, the small amount of frivolous claims that do get filed, are quickly thrown out by the courts, shrinking the threat of a barrage of unsupported RICO claims overwhelming the judicial system. See id. at 26.

Effects of Internet Sales

Another potential effect of this case, according to interest groups, involves the health risks posed by selling cigarettes over the Internet. The Campaign for Tobacco-Free Kids states that under-taxed tobacco products will lead to a much greater use of cigarettes, and a greater chance for youth to engage in smoking. See Brief of the Campaign for Tobacco-Free Kids at 4. The Campaign points to a study that shows that the easy availability of cigarettes over the Internet also leads to an increase in consumption when compared to buying cigarettes at traditional stores for full price, and a decision in favor of petitioners would only increase this trend. See id. at 5. The Campaign argues that without any effective safeguards on Internet sales against underage purchase of cigarettes or incentives against such sales, minors will simply turn to such websites for cigarettes, which in turn may lead to the increase of underage smoking. See id. at 5–6. The Hemi Group maintains that punishing Internet retailers simply because they have a better business model restrains free competition. See Brief for Petitioners at 36. The Hemi Group is concerned that if the Court grants the City permission to pursue its RICO claim, especially when seeking trebled damages, other claims like this will arise, not intended to be covered by RICO; the Hemi Group contends that this will stifle legitimate competitive activity from innocent organization with no connection to organized crime. See id. at 38. The Hemi Group argues that since it is, in fact, the private consumer's obligations to pay taxes, a finding for the City will unfairly force these organizations to shoulder the tax obligation of private consumers. See id. at 38.

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Analysis

This case turns on whether the City of New York (“the City”) has suffered an injury under the Racketeer Influenced and Corrupt Organizations Act (“RICO”) and whether it has standing under RICO to sue the defendant-petitioners, the Hemi Group and Kai Gapuchin, for a loss of taxable revenue from concealing Internet sales of cigarettes to New York City residents. See City of New York v. Smokes-Spirits.com, Inc., 541 F.3d 425, 432-34 (2nd Cir. 2007). In civil cases, a RICO claimant is required to show (1) a substantive RICO violation as defined in the statute, (2) an injury to the claimant’s “business or property”, and (3) that the injury was the result of the RICO violation. See id. at 439. Courts have interpreted the causation requirement to mean that the RICO violation must be the “but-for” and the proximate cause of the injury. See id. at 440.

Does a loss of Taxable Revenue fall under RICO’s injury to business or property?  

a.   “Business or property” in RICO 

Petitioners, the Hemi Group, LLC and Kai Gapuchin (collectively, “Hemi Group”), maintain that an injury to government cannot be considered an injury to either business or property, meaning the City has no standing to sue. See Brief for Petitioners, Hemi Group, LLC and Kai Gapuchin at 18. The Hemi Group contends that the word “business” is meant to apply only to economic and commercial interests but does not permit action based upon a competitive type of harm, i.e. injuries suffered because of a defendant’s better business practices. See id. at 19-21. The Hemi Group argues that this is particularly relevant in this case because the taxes the City seeks to collect were not owed by the business; they were instead owed by the third-party, non-litigant consumers. See id. at 21.

The Hemi Group also argues that a failure to collect taxes is not an injury to either business or property under RICO. See Brief for Petitioners at 7. According to the Hemi Group, the power of taxation is a matter of sovereignty and does not involve a property right at all. See id. at 8. The Hemi Group asserts that “property” should be defined as “anything of material value owned or possessed.” See id. at 23 (quoting Reiter v. Sonotone Corp., 442 U.S. 330, 338-39 (1979)). The interest in collecting taxes is not something owned or possessed, according to the Hemi Group, and so cannot constitute an injury to property, in order to provide standing under RICO. See id. at 24. This would be especially true for this case, the Hemi Group contends, because the City’s alleged injury is the lost opportunity to collect taxes from non-litigant customers. See id. at 25.

In contrast, the respondent, the City of New York, contends that the City’s lost cigarette tax revenues constitutes an injury to its property, as a direct result of the Hemi Group’s mail and wire fraud schemes. See Brief for Respondent, City of New York, at 15. The City points out that the Supreme Court has consistently used the common-law definition of “property” as including every kind of valuable right, in interpreting RICO. See id., at 21-22. Indeed, the City emphasizes that the Court has previously held that lost tax revenues qualify as “property.” See id. Further, the City maintains that the Court has expressly recognized that a State would have a recoverable injury where the defendants defrauded the State out of tax revenues. See id. at 22-23.

b.   Legislative Intent

The Hemi Group argues that the legislative history of RICO shows that Congress specifically intended for the words “business or property” to be understood according to the common-law principles used in interpreting antitrust acts. See Brief for Petitioners at 9-11.

In contrast, the City argues that far from intending for RICO to be interpreted consistently with the antitrust laws, Congress meant for RICO to have a much broader reach in encompassing all levels of crime. See Brief for Respondent at 26-31. The City also asserts that Congress intended for tax revenues to be included under RICO through passing the Contraband Cigarette Trafficking Act that provides for a civil cause of action against trafficking in cigarettes where the applicable State and local taxes were not paid. See id. at 23.

c.    Judicial Interpretation

The Hemi Group contends that courts have consistently used antitrust case law precedents in order to guide their interpretation of RICO and under antitrust precedent, injuries to sovereign interests, such as taxation, fall outside the range of injuries which Congress meant to include under RICO. See Brief for Petitioners at 16.

The City, however, counters that courts have always construed RICO broadly, in keeping with its broad language. See Brief for Respondent, at 19. The City further attests that tax revenue itself and the right to collect tax revenue is not a sovereign interest at all but a proprietary one. See id. at 25. Furthermore, the City points out that the Hemi Group has engaged in the exact kind of behavior that Congress was trying to end in enacting RICO, a systematic business plan to perpetuate cigarette tax evasion. See id. at 32.

Does the City qualify as a “person” under RICO? 

Even if there were an injury done to business or property, the Hemi Group argues that the City doesn’t qualify as a “person” under RICO because it does not own a “legal or beneficial interest” in its authority to collect taxes; it is instead a sovereign. See Brief for Petitioners at 29-30. The Hemi Group points out that the Supreme Court has consistently followed the presumption that “person” doesn’t include a sovereign, unless there is some definite indication that the statute intended otherwise. See id. at 27. 

The City asserts that the Hemi Group’s argument that the City is not a “person” under RICO was not included in the petition for certiorari and should not be considered, but even so, the City would qualify as a “person” because it is an “entity capable of holding a legal and beneficial interest in property”, including tax revenue. See Brief for Respondent at 36-37. The City contends that courts have already interpreted RICO to mean that state and local governments are included in the word, “person”, consistent with RICO’s broad language and liberal construction. See id. at 37-38.

Is the City of New York’s injury direct enough to provide standing under RICO?

The Hemi Group maintains that there was no injury as defined by RICO. See Brief for Petitioners at 9. However, even if there were, the Hemi Group asserts that the City of New York also lacks standing because the injury suffered was indirect and only directly-injured parties have standing under RICO. See id. at 30. According to the Hemi Group, because a city’s sovereign power is derived from the people, any injury to that power must by definition be derivative as well and therefore, indirect. See id. at 32.

In contrast, the City contends that the City does have standing because its injuries were a direct consequence of the Hemi Group’s actions. See Brief for Respondent, at 38-40. The City emphasizes that the City imposes its own excise tax on cigarettes and those taxes are owed directly to the City itself, and so the City’s injuries are not derivative of the injuries to the State. See id. at 40-44.

The Hemi Group argues the City also has no standing because its injuries are too indirect to meet RICO’s proximate cause requirement. See Brief for Petitioners at 35. Hemi contends that the City’s only “injury” stems from the lack of information received from the State, denying the City the opportunity to collect sales taxes. See id. at 35. Further, the Hemi Group argues, the City’s failure to collect taxes could have resulted from other causes as it was a consequence of the purchasers from the Hemi Group’s websites individually “[failing] to voluntarily pay use taxes to the City.” See id. at 36-37 (quoting City of New York’s Brief in Opposition to Petition for Writ of Certiorari at 7).

On the other hand, the City contends that the injuries it suffered (the loss of a specific amount for each pack of cigarettes sold for which taxes were not paid) were a direct result of the Hemi Group’s alleged acts of mail and wire fraud, not, as the Hemi Group argues, the result of a failure to report the required information to the State. See Brief for Respondent at 40. The City also argues that the Hemi Group’s actions were the proximate cause of the injury, even if the cigarette purchasers were partly to blame as well, because the Hemi Group was still a leading factor in the sequence of events that led to the injury. See id. at 46. Finally, the City asserts that finding a direct injury in this case is consistent with RICO’s intent of facilitating the prosecution of organized crimes such as mail and wire fraud. See id. at 47.

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Conclusion

This case will decide whether a loss of tax revenue is an injury to "business or property” that is direct enough to provide standing for local and state governments to sue under RICO. The Hemi Group argues that a loss of tax revenue is an injury to government’s sovereign power and cannot provide standing to sue, while the City of New York contends that a broad interpretation of RICO, as required by the statute, would include a loss of tax revenue under an injury to “business or property.” The Supreme Court’s decision is likely to affect the availability of cheaper cigarettes for purchase over the Internet, as well as impacting local and state government’s ability to use civil RICO suits to combat organized crime.

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Authors

Prepared by: Sarah H. Chon and Frederick H. Wu

Edited by: Lara Haddad

Additional Sources

·      Bloomberg.com, Greg Stohr: New York Suits Over Cigarette Sales Get U.S. High Court Review (May 4, 2009)

·      Business Week, Brian Burnsed: Preview of Major Business Cases in Supreme Court’s 2009-2010 Term (Sept. 24, 2009)

·      Trade Regulation Talk, John W. Arden & Mark Engstrom: High Court to Consider RICO’s “Business or Property” Requirement (May 22, 2009)

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