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SHEPERD v. AMERICAN HONDA MOTOR CO.

UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA


January 25, 1993

WILLIAM SHEPERD, an individual, MARY JO SHEPERD, an individual, Plaintiffs,
v.
AMERICAN HONDA MOTOR CO. INC, et al., Defendants.

The opinion of the court was delivered by: EUGENE F. LYNCH

ORDER GRANTING MOTION TO DISMISS

 I. BACKGROUND

 This suit involves two federal counts brought under the Racketeer Influenced and Corrupt Organizations Act ("RICO"), as well as several pendent state law claims -- breach of covenant of good faith and fair dealing, fraud, negligent misrepresentation, intentional interference with prospective economic advantage, and negligent interference with prospective economic advantage. The case was removed by defendants to this Court from the Superior Court of Contra Costa County.

 Defendants in this case include American Honda Motor Company, Inc. ("American Honda"), Honda Motor Co. Ltd. of Japan, three Honda car dealerships situated in Northern California, and three individuals associated with American Honda. Defendants have filed motions to dismiss this case on several grounds. The Court, after considering the parties' briefs in this matter, announced its tentative inclination to grant defendants' motions to dismiss at a November 13, 1992 hearing. However, in an abundance of fairness to plaintiffs in this case, the Court requested further briefing on three issues pertaining to plaintiffs' RICO claims: (1) the requirement of standing as set forth in Imagineering, Inc. v. Kiewit Pacific Co., 976 F.2d 1303 (9th Cir. 1992); (2) the requirement that the RICO enterprise be distinct from the pattern of predicate acts; and (3) the requirement that defendants have managerial control of the RICO enterprise.

 Having carefully considered the parties' original and supplemental briefs in this matter, the Court will grant defendants' motion to dismiss with respect to plaintiffs' RICO claims and tentatively deny plaintiffs' request for leave to amend. And the Court will, in the discretionary exercise of its jurisdiction over pendent claims, remand this case to state court for the adjudication of the remaining state law claims.

 II. DISCUSSION

 The allegations of plaintiffs' complaint are briefly summarized below. Plaintiffs have operated a dual Pontiac and Honda car dealership in Concord, California since 1973. From 1973 through the mid-1980s plaintiffs' Honda dealership was profitable. From 1973 through the present, American Honda and the other RICO defendants perpetrated a scheme ("the 'turn and earn' scheme") of false reporting of dealer sales. The scheme was aimed at increasing allocations of Honda vehicles to the United States and promoting one of Honda's cars, the Accord, as the number one selling nameplate.

  In the years 1987-1988, plaintiff William Sheperd acted as president of the Northern California Motor Car Dealers Association ("NCMCDA"). During his tenure as president of the NCMCDA, he assisted in the drafting and promoted the passage of the Broker-Dealer Act which, among other things, expressly prohibited the falsification of sales records by car dealerships. Sometime during plaintiff's tenure as president, he made known to the RICO defendants that he would not engage in unlawful activities involving the reporting of "sham" and "phantom" sales.

 Dealers who went along with the unlawful false reporting practices of the RICO defendants were rewarded with a superior mix of highly popular vehicles. Those who were not cooperative, such as plaintiffs, were punished with lower allocations and allocations of more unpopular models. Beginning around January 1989, plaintiffs' dealership began receiving inferior allocations of cars because of plaintiffs' refusal to engage in false reporting in contravention of the Broker-Dealer Act. As a result of defendants' wrongful diversion of popular cars from plaintiffs' dealership to other dealerships, plaintiffs' dealership became unable to compete effectively with other dealerships, and its business suffered greatly. In March 1991 plaintiffs sold their dealership at a distressed price, which reflected the dealership's inability to compete effectively in light of defendants' ongoing misallocation of cars.

 A. Plaintiffs' RICO Standing

 The Court's discussion herein addresses the requirements for RICO standing -- proximate cause and concrete financial loss -- as set forth in two recent cases: (1) the Supreme Court's decision in Holmes v. Securities Investor Protection Corp., 117 L. Ed. 2d 532, 112 S. Ct. 1311 (1992); and (2) the Ninth Circuit's opinion in Imagineering Inc. v. Kiewit Pacific Co., 976 F.2d 1303 (1992).

 The supreme Court announced in Holmes that Congress, in its promulgation of 18 U.S.C. § 1964(c), intended to import a proximate cause requirement into the RICO statutory scheme. Holmes, 112 S. Ct. at 1318. The Supreme Court, referring to the many forms the principle of proximate cause had assumed at common law, found that the RICO proximate cause requirement embodied "a demand for some direct relation between the injury asserted and the injurious conduct alleged." Id. Quoting from Associated General Contractors of Cal., Inc. v. Carpenters, 459 U.S. 519, 534, 74 L. Ed. 2d 723, 103 S. Ct. 897 (1983), an earlier supreme Court decision which had quoted from Justice Holmes, the Court wrote, "'The general tendency of the law, in regard to damages at least, is not to go beyond the first step.'" Id. at 1319.

 In Holmes the Supreme Court reversed the Ninth Circuit's finding of proximate case in a factual context analogous to the context of the case at bar. The plaintiff in Holmes was the Securities Investor Protection Corporation ("SIPC"). It alleged that defendants had conspired in a stock manipulation scheme that had disabled two broker-dealers from meeting obligations to customers. The SIPC brought suit on behalf of customers of the disabled broker-dealers whom the SIPC had reimbursed for losses after the broker-dealers had become insolvent.

 Assuming, arguendo, that the SIPC could as a subrogee assert the rights of these customers of the disabled broker-dealers, the Court nevertheless found that the link between the alleged stock manipulation and the harm to the customers was too remote to be actionable under RICO since such harm was purely contingent on the harm suffered by the broker-dealers. According to the Court, insolvency of the broker-dealers was the harm caused by the defendants, and this insolvency in turn left the broker-dealers unable to pay the injured customers' claims. It was only the intervening insolvency of the broker-dealers that connected the defendants' acts to the losses suffered by the customers, but a direct connection between stock manipulation and the customers' losses was lacking. Hence, the Supreme Court found that plaintiffs had failed to demonstrate proximate cause.

 The Ninth Circuit in Imagineering, 976 F.2d 1303 (1992), elucidated the proximate cause requirement adopted by the Supreme Court in Holmes and reaffirmed the injury requirement it had enunciated in earlier cases. In Imagineering, plaintiffs were two minority and woman-owned business enterprises ("MWBEs") who appealed the dismissal of their action against two government contractors which had allegedly procured government contracts for public works construction contracts by circumventing government regulations requiring the use of MWBEs. Federal, state, and local set-aside regulations required certain levels of participation by MWBEs on public works construction contracts awarded to prime contractors. And government award letters to primary contractors required the participation of designated MWBEs as a condition of the contracts. According to plaintiffs, defendants developed and utilized a conduit scheme to avoid complying with the set-aside regulations while maintaining the appearance of full compliance. Each plaintiff was an MWBE subcontractor for the contractor with the lowest complying bid on at least one project improperly awarded to defendants. Plaintiff sued to recover the lost profits which they allegedly would have earned on these projects in the absence of a conduit scheme by defendants.

 The Ninth Circuit cited Holmes for the proposition that, "there must be a direct relationship between the injury asserted and the injurious conduct alleged." Imagineering, 976 F.2d at 1311. Although the Imagineering court assumed that defendants' wrongful conduct deprived complying prime contractors of specified projects, and foreseeably deprived the plaintiff MWBE subcontractors of subcontracts on these projects, the court nonetheless found proximate cause lacking. Analogizing to the insolvent broker-dealers in Holmes, the court found that it was the intervening inability of the prime contractors to secure the primary contracts that was the direct cause of plaintiffs' injuries. Hence, the court found that the MWBE plaintiffs were missing the direct relationship necessary to show that the defendants had proximately caused their injuries.

 The Imagineering court also invoked the policy concerns underlying the proximate cause "direct relationship" requirement, and found that they had been implicated. The court observed, "Essentially, the rule has more to do with problems of proof than with foreseeability." Id. at 1312. The court pointed out the difficulty, in the factual context before it, of ascertaining what amount of damage suffered by the plaintiffs was attributable solely to defendants' conduct, apart from other independent factors. And the court made note of the potential difficulty in apportioning damages among the prime contractors and the plaintiff subcontractors without permitting multiple recoveries.

 The Ninth Circuit in Imagineering also preserved the validity of its line of cases addressing the RICO requirement of proof of concrete financial loss. Id. at 1310; see also Oscar v. University Students Co-operative Ass'n, 965 F.2d 783, 785 (9th Cir. 1992); Berg v. First State Ins. Co., 915 F.2d 460, 464 (9th Cir. 1990). Indeed, there is some suggestion in the Imagineering opinion that the Ninth Circuit, to recognize a cognizable RICO injury, might even require proof that plaintiff actually paid money out as a result of racketeering activity. See Imagineering, 976 F.2d at 1310; see also Oscar, 965 F.2d at 785 (citing with approval Fleischhauer v. Feltner, 879 F.2d 1290, 1299-31 (6th Cir. 1989)).

 For the following reasons, which seem to this Court to echo concerns traditionally embodied in the proximate cause requirement, the Imagineering court found that plaintiffs had failed to allege a sufficiently concrete financial loss. First, the Court found that even if the specified government projects had not been awarded to defendants, plaintiffs nonetheless could not establish that those contracts would have been awarded to plaintiffs' prime contractors. The court, in reaching this conclusion, relied upon a Washington state law which would have permitted the awarding agency to reject all bids and readvertise for a new round of bidding. Second, the Court found that, even assuming plaintiffs' prime contractors would have received the contracts and that they were obligated to award subcontracting work to the plaintiffs, there nonetheless was no guarantee that other subcontractors would not be substituted for plaintiffs during the pendency of the contracts. Finally, from the failure of plaintiffs' amended complaint to designate specific bids submitted by the MWBE plaintiffs that had been accepted by the prime contractors, the Imagineering court found it impossible to determine whether plaintiffs were claiming loss of specific identifiable profits, as opposed to the mere opportunity to realize profits. Hence, plaintiffs' amended complaint alleged only a "speculative injury." Id. at 1311.

 Plaintiffs William and Mary Jo Sheperd allege in this case that "hot" selling cars were diverted from their dealership to other Honda dealerships which participated in the "turn and earn" scheme of false reporting of sales. Plaintiffs' dealership, apparently, received lower allocations of cars and less popular makes and models in lieu of the diverted "hot" cars. As a result of this wrongful diversion of cars, the Sheperds allege that they became unable to compete effectively, and ultimately sold their dealership at a distressed price. The Sheperds allege damages in excess of $ 11 million. *fn1"

 Although the Ninth Circuit in Imagineering did not go so far as to say that the wrongful conduct must have directly resulted in the disbursement of money by plaintiffs, it implicitly suggested an exacting standard in cases involving any less than this. Using the Imagineering case as a benchmark, the Court cannot escape the conclusion that plaintiffs in this case have failed to allege a sufficiently direct relationship between the wrongful conduct and injury, and have failed to allege a sufficiently concrete financial loss. Although the Imagineering court addressed separately the questions of proximate cause and concreteness of the financial loss, the same concerns underlie both inquiries and the Court will take them up together here. *fn2"

 The Imagineering opinion demonstrates that the requirement of a concrete financial loss proximately caused by the wrongful conduct of RICO defendants is not easily met. The Imagineering court found a "speculative" injury not proximately caused by defendants' wrongful conduct in a context far more concrete than the one before this Court. The MWBE subcontractors (Imagineering plaintiffs) retained by the lowest complying primary contractors in Imagineering were very likely to receive government contract work in the absence of foul play by the Imagineering defendants. *fn3" And when government contracts were awarded to non-complying primary contractors (Imagineering defendants), the Imagineering plaintiffs lost out on specific government contract jobs -- a rather tangible financial loss.

 The alleged injuries and their causal relationship with the alleged wrongful conduct of the defendants in this case contrast markedly with those alleged in Imagineering. Here the Sheperd plaintiffs complain of the diversion of popular makes, models, and colors of cars to other dealerships, as well as lower allocations of cars, which impeded their ability to compete effectively and resulted in the sale of their dealership at a distressed price. There can be no doubt that the alleged diversion tactics and reduced allocations would have been likely to have some adverse effect on the profitability of the Sheperds' dealership, and consequently affect the market value of the dealership. But the financial losses reflected in reduced profitability and a distressed sale price are too attenuated from the alleged wrongful conduct of defendants to give plaintiffs standing to recover treble damages under RICO.

 Unlike the Imagineering plaintiffs who lost out entirely on specific contract bids, the Sheperd plaintiffs encountered only the possibility of diminished profits on the sales of the vehicles they received. Unlike even a lost-volume seller in a contract case, the Sheperd plaintiffs cannot even point to specific sales which they would have made in the absence of diversionary tactics by defendants. The Sheperd plaintiffs nowhere allege that their showroom was empty or their dealership lot vacant, but only that their inventory of vehicles was such that presumably it would not turn over as fast, or with as high a profit margin, as those of their competitors. Presumably the cars allocated to the Sheperds' dealership were sold by the dealership, and generally sold above cost. Nonetheless, the dealership's inability to sell cars as quickly and profitably as competing Honda dealerships in the area resulted in diminished profitability for the Sheperds' dealership and a decline in its market value. For this Court, or a jury, to assess what portion of the dealership's diminished profitability and market value were attributable to the defendants' wrongful conduct, apart from other factors, would be an exercise in sheer speculation.

 Although courts may be willing to permit such speculation in other contexts, Supreme Court and Ninth Circuit precedent indicate that it is not tolerable in the context of RICO with its provision for treble damages. The supreme Court, in rejecting a finding of proximate cause where stock manipulation by RICO defendants had contributed to the insolvency of broker-dealers and losses by their customers, observed in Holmes:

 

If the [plaintiff] were allowed to sue, the district court would first need to determine the extent to which their inability to collect from the broker-dealers was the result of the alleged conspiracy to manipulate, as opposed to, say, the broker-dealers' poor business practices or their failures to anticipate developments in the financial markets.

 Holmes, 112 S. Ct. at 1320. Similarly, the Ninth Circuit in Imagineering made reference to the difficulty of ascertaining what amount of damage was attributable to the conduct of the non-complying primary contractors, apart from other factors. Imagineering, 976 F.2d at 1312.

 Here a multitude of imaginable factors may have contributed to the diminished profitability of the Sheperds' dealership and its diminished market value, apart from the alleged wrongful conduct of defendants. Among other factors, the managerial decisions of those charged with the management of the Sheperds' dealership may have played a very significant role. In a highly competitive market, like that in which the Sheperds' dealership had to compete, decisions about marketing, pricing strategy, customer service, employee hiring and wages, and overhead allocations, to name a few, may be critical to the profitability and ultimate market value of a business enterprise. Second, the actions undertaken by the dealership's competitors in a fluid and competitive market could certainly influence the profitability and market value of the Sheperds' dealership. And finally, external factors like shifting demographic patterns, local economic trends and consumer demand, and local government regulation might influence the success of a particular dealership.

  As the Ninth Circuit observed in Imagineering, 976 F.2d at 1312, "Essentially, the [proximate cause] rule has more to do with problems of proof than foreseeability." The problems of proof in this case, where the injuries alleged are the likely byproduct of a wide range of contributing factors, are simply too momentous for plaintiffs to overcome. The Court finds, therefore, that the Sheperd plaintiffs have failed to allege a concrete financial loss which resulted directly from the wrongful conduct of defendants. Hence plaintiffs lack RICO standing. Accordingly, the Court will grant defendants' motions to dismiss plaintiffs' RICO claims.

 B. Plaintiffs' Request for Leave to Amend

 In the last line of the final page of their supplemental brief, plaintiffs request that if the Court should grant defendants' motion to dismiss, that plaintiffs be granted leave to amend their complaint to "he in compliance with any rulings the Court may issue." Plaintiffs have utterly failed to state any grounds for their request, nor have they given the Court any indication as to how they would amend their complaint consistent with the Court's rulings and the confines of Rule 11 Fed.R.Civ.P.

 Although leave to amend shall be freely given when justice so requires, Fed.R.Civ.P. 15(a), futile amendments should not be permitted. Foman v. Davis, 371 U.S. 178, 182, 9 L. Ed. 2d 222, 83 S. Ct. 227 (1962); Smith v. Commanding Officer, Air Force Accounting, 555 F.2d 234, 235 (9th Cir. 1977). The proper test to be applied when determining the legal sufficiency of a proposed amendment is identical to the one used when considering the sufficiency of a pleading challenged under Rule 12(b)(6) of the Federal Rules of Civil Procedure. 3 J. Moore, Moore's Federal Practice § 15.08[4] (2d ed. 1974).

 Here the Court finds that amendment by plaintiffs would likely be futile in light of the Court's discussion in part II-A of this Order. Accordingly, the Court will tentatively deny plaintiffs' request for leave to amend. Nonetheless, the Court will consider a motion for reconsideration of this decision if filed by plaintiffs no later than January 29, 1993. Any such motion should state with specificity how plaintiffs propose to amend their complaint to overcome the deficiencies discussed in this Order. The Court's tentative ruling on amendment will become final if no motion is timely filed.

 C. Pendent State Law Claims

 The Court will, in the exercise of its discretion, decline to exercise jurisdiction over plaintiffs' remaining pendent state law claims. Since this case was removed to federal court, the Court shall remand the case to the Superior Court of Contra Costa County from whence it came. Jurisdiction, however, shall temporarily remain in this Court pending the Court's consideration of any timely motion for reconsideration which may be filed by plaintiffs pursuant to paragraph four below.

 III. CONCLUSION

 For all of the reasons stated above, the Court hereby ORDERS that:

 (1) Defendants' motions to dismiss are granted with respect to plaintiffs' RICO claims;

 (2) Plaintiffs' request for leave to amend the complaint is tentatively denied;

 (3) All remaining state law claims -- breach of contract, breach of covenant of good faith and fair dealing, fraud, negligent misrepresentation, intentional interference with prospective economic advantage, negligent interference with prospective economic advantage -- shall be remanded to the Superior Court of Contra Costa County in light of this Court's decision to not exercise its supplemental (pendent) jurisdiction over these claims. Jurisdiction, however, shall remain in this Court pending the Court's consideration of a motion for reconsideration which may be filed by plaintiffs pursuant to paragraph four.

 (4) Plaintiffs are invited to file a motion for reconsideration of the Court's decision to deny leave to amend, stating with specificity how they propose to amend the complaint to overcome the deficiencies discussed in this Order. Plaintiffs' motion, if any, as well as any accompanying memorandum may be filed no later than January 29, 1993. Defendants may respond with opposition briefs no later than February 5, 1993;

 (5) This Order shall automatically become the Court's final ruling in this case if plaintiffs fail to timely file a motion for reconsideration pursuant to paragraph four above.

 (6) The Clerk of the Court, without delay, shall mail a copy of this Order to all parties in this case.

 IT IS SO ORDERED.

 DATE: January 25, 1993

 EUGENE F. LYNCH

 United States District Judge


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