Lorenz v. CSX Corp.

United States Court of Appeals for the Third Circuit · Corporations

CorporationsDebenturesIndenture trusteesRICOSecurities fraudFiduciary dutiesparent-subsidiaryenterprise-person distinctness

Facts

Plaintiffs held B & O convertible debentures on December 13, 1977, when B & O transferred non-rail assets to a subsidiary, MAC, and declared a MAC stock dividend to shareholders without advance notice, preventing debentureholders from converting in time to receive the dividend. Earlier litigation produced a remedy for certain debentureholders, but these plaintiffs were excluded because they had sold their debentures without ever converting them. They alleged that B & O, its parent entities C & O and CSX's predecessor, and indenture trustee Chase Manhattan Bank failed for years to disclose the dividend, letter agreements, the Hochwarth Stipulation, and developments in the prior litigation. Plaintiffs sued on RICO, securities fraud, fiduciary duty, and implied-covenant theories.

Issue

Whether plaintiffs stated viable claims against the parent corporations and indenture trustee based on nondisclosure after the 1977 dividend transaction, and whether their federal securities claims were timely. Also at issue was whether a parent corporation could be the RICO person while its subsidiary was the enterprise on the facts pleaded, and whether denial of leave to amend the RICO claim was proper.

Rule

Under section 1962(c), a RICO defendant must be distinct from the alleged enterprise; a parent corporation and its subsidiary are not sufficiently distinct unless the complaint clearly pleads that the parent played a role in the racketeering activity distinct from the subsidiary's conduct, and no claim lies where the subsidiary merely acts on behalf of or to the benefit of the parent. Under New York law, an indenture trustee's duties are defined exclusively by the indenture except for the duty to avoid conflicts of interest, and the implied covenant of good faith and fair dealing cannot add new terms not contained in the indenture. A corporation owes debentureholders contractual, not fiduciary, duties, including with convertible debentures before conversion. For section 10(b), nondisclosure is fraudulent only if there is a duty to speak, and under pre-Lampf Third Circuit law such claims must be brought within one year of discovery and no more than three years after the violation.

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In Pittsburgh, Keystone Freight Holdings owns 97% of River Belt Rail Lines. A complaint alleges that Keystone used River Belt to mail false statements to noteholders and names Keystone as the RICO person and River Belt as the enterprise.

Is the RICO claim against Keystone adequately pleaded?

Explanation. Under the majority rule, a § 1962(c) defendant must be distinct from the enterprise. A parent and subsidiary are not sufficiently distinct when the complaint merely alleges that the parent controlled the subsidiary or caused it to commit the fraudulent acts. The complaint must clearly show the parent played a role in the racketeering activity distinct from the subsidiary's conduct. Partial ownership does not change that result. (Derived from Lorenz v. CSX Corp. (n.d.).)