By: William A. Dreier and Steven A. Karg
August 2000

A recent case applying Texas Law, Summit Properties, Inc. v. Hoechst Celanese Corp., ___ F. 3d ___ (5th Cir. 2000), affirmed the dismissal of RICO (“Racketeer Influenced and Corrupt Organizations”) claims against the defendants who were manufacturers of polybutylene (PB) plumbing systems and components. A RICO claim under 18 U.S.C. Section 1961 et seq. asserts that the defendants acted as part of racketeering activity, which is roughly defined in both federal and state law as two or more acts within a ten-year period which satisfy the statute’s definition of criminal conduct, including fraud or fraudulent practices. Plaintiffs contended that the manufacturing and marketing of the PB systems were in reality a complex scheme to defraud purchasers, in that PB plumbing was “worse than worthless.” Plaintiffs claimed that PB systems not only failed to transmit hot and cold potable water, but soon after installation degraded, cracked and leaked. Nonetheless, the system had been marketed as lasting fifty years without corrosion and would be reliable and fit for plumbing systems without serious service problems. Plaintiffs contended that defendants directed a fraudulent marketing plan to make PB the material of choice in the plumbing market.

Manufacturers and sellers, however, must take note of the narrow basis on which the 5th Circuit affirmed the dismissal of the RICO claim. Defendants prevailed because plaintiffs failed to prove their own detrimental reliance on the alleged fraudulent misrepresentations of defendants.

[W]hen civil RICO damages are sought for injuries resulting from fraud, a general requirement of reliance by the plaintiff is a commonsense liability limitation.

The court was concerned that a contrary holding

would allow the threat of treble damages and attorney’s fees to infiltrate garden variety products liability cases whenever marketing promotions touted the merits of the products, even if no plaintiff relied on these representations.

But what if a plaintiff did rely? In the PB case, the alleged fraudulent marketing had been directed at building contractors. What if the marketing in a PB case or marketing in any other case had been directed to the end users of the product and contained material misstatements of fact or even material omissions? By the 5th Circuit’s pointed reference to the lack of reliance, rather than to the inapplicability of the RICO statute to failure to warn or even design defect product liability cases, does Summit Properties signal that product liability defendants must be prepared to defend RICO claims?

We can reasonably predict that New Jersey would probably require the same individual reliance because of the Supreme Court’s recent 4 to 3 rejection of a “fraud on the market” theory of recovery in a securities violation setting. See Kaufman v. i-Stat, Corp., ___ N.J. ___ (July 22, 2000). However, the United States Supreme Court’s contrary decision in the class action securities fraud case of Basic, Inc. v. Levenson, 485 U.S. 224 (1988), might well lead other courts to reject the 5th Circuit’s analysis. While, after Kaufman the New Jersey Supreme Court most probably will follow Summit Properties if the question of individual reliance is presented, manufacturers and sellers of products in other states must be wary of RICO claims under both the individual reliance and “fraud on the market” theories.

It is not enough that interstate manufacturers and sellers are aware of the Federal RICO statute and especially the civil remedies permitted by 18 U.S.C. Section 1964(c). Even in the absence of interstate commerce, manufacturers and sellers must also be aware that most states have their own RICO statutes. For example, in New Jersey N.J.S.A. 2C:41-1 to 6.2 covers not only the criminal RICO offense, but also includes a civil remedy, albeit buried in the midst of the Code of Criminal Justice. N.J.S.A. 2C:41-4 provides for civil remedies, including treble damages, attorney’s fees and costs, available to “any person damaged in his business or property by reason of a violation of [the activities described in N.J.S.A. 2C:41-2.]” Any court of competent jurisdiction may award these damages, and, following a successful criminal prosecution, the defendant is estopped from denying the essential elements of the criminal offense in a subsequent civil RICO proceeding.

To date, we are unaware of any wave of RICO claims in product liability actions. We believe, however, that it is better to warn our clients and friends of potential problems than to be forced to solve them in the wake of an unanticipated claim.