its required minimum capital ratio, plaintiff had to shrink its assets and liabilities by selling loans and consumer savings accounts, thereby diminishing its earnings. Thus, plaintiff alleges injury from the date it took additional reserves until the date it recovers any loss on the loans, if ever. Plaintiff claims that "this is precisely the sort of injury that RICO was intended to remedy," (Pl. Mem. at 28)
Plaintiff has not stated a RICO claim relating to this second type of injury. This remote injury is not "precisely the sort of injury that RICO was intended to remedy." Even accepting plaintiff's argument that "consistent with the broad remedial purpose of RICO, there is no single appropriate measure of damages," (Pl. Mem. at 34) the second type of injury does not meet RICO's pleading requirements. Civil RICO damages "are unrecoverable if the fact of their accrual is speculative or their amount and nature unprovable." Bankers Trust Co. v. Rhoades, 859 F.2d 1096, 1104 (2d Cir. 1988), cert. denied, 490 U.S. 1007, 104 L. Ed. 2d 158, 109 S. Ct. 1642 (1989). "A plaintiff only has standing if, and can only recover to the extent that, he has been injured in his business or property by the conduct constituting the violation." Sedima, S.P.R.L. v. Imrex Co., 473 U.S. 479, 496, 87 L. Ed. 2d 346, 105 S. Ct. 3275 (1985).
Plaintiff alleges that because it "is required to take a specific reserve for the actual losses incurred on an individual loan," (Pl. Mem. at 30) its losses are neither speculative nor unprovable. In deciding whether a party may recover lost profits for RICO violations, a court should look to "appropriate common law remedies in the forum state." Shulton, Inc. v. Optel Corp., 698 F. Supp. 61, 62 (D.N.J. 1988); see also Sound Video Unlimited, Inc. v. Video Shack Inc., 700 F. Supp. 127, 141-42 (S.D.N.Y. 1988) (applying Illinois law, which allows recovery of lost profits in fraud cases); De Ment v. Abbott Capital Corp., 589 F. Supp. 1378, 1386 (N.D. Ill. 1984) (same); AAMCO Transmissions, Inc. v. Marino, 1992 U.S. Dist. LEXIS 2081, at *16, 20 (E.D. Pa. Feb. 20, 1992) (applying Pennsylvania law, which allows recovery of lost profits in fraud cases). New York law expressly prohibits recovery of "lost profits" in fraud actions, and plaintiff's RICO claims -- which sound almost exclusively in fraud -- cannot include a claim for "lost profits." See, e.g., AFA Protective Sys., Inc. v. American Tel. & Tel. Co., 57 N.Y.2d 912, 456 N.Y.S.2d 757, 442 N.E.2d 1268 (1982); Reno v. Bull, 226 N.Y. 546, 124 N.E. 144 (1929). Nevertheless, plaintiff argues that New York courts have allowed recovery of certain consequential damages in fraud cases where the additional damage was, as plaintiff's note, a "direct pecuniary loss." (Pl. Mem. at 34) See, e.g., Cayuga Harvester v. Allis-Chalmers Corp., 95 A.D.2d 5, 23, 465 N.Y.S.2d 606, 618 (1983); Morris v. Lewis, 75 A.D.2d 844, 427 N.Y.S.2d 858 (1980).
Although it is not clear whether and when a plaintiff in federal court in New York may recover lost profits for a RICO claim which is predicated on fraud, plaintiff's second type of injury is not a "direct pecuniary loss," That plaintiff was required to take reserves against loan losses reveals little about plaintiff's actual loss, or even whether plaintiff's assessment of the loan losses was correct. Plaintiff cannot allege RICO injury simply by stating that it followed a statutory requirement in connection with a transaction that may result in a loss. Plaintiff cannot recover every additional expense it can think of by alleging that it incurred that expense while following rules and guidelines. If a loan does not itself result in a provable loss, plaintiff cannot recover expenses incurred in a transaction that may turn out no worse than it would have if the underlying information had been truthful. To put the matter more starkly, expenses incurred in making a profit do not become fraud damages simply because the transaction would not have been entered into had the truth been known. Moreover, the taking of loan loss reserves is based on managerial guesswork about the future economic fortune of a commercial real estate loan portfolio -- guesswork that includes, at minimum, an assessment of the amount of the loan that may be lost due to fraud, as well as the capacity of the loan collateral to generate cash flow over time, a capacity that in turn depends on the economics of the real estate market. Plaintiff cannot survive a motion to dismiss by alleging novel and speculative compensatory damages that may or may not arise from fraud.
In addition to the indirectness of injury caused by taking additional reserves, such injury may have been unnecessary. As defendants point out and plaintiff admits (Pl. Mem. at 27 n.15; Am. Compl. P 17), plaintiff had two options to maintain its minimum required capital: (1) shrinking itself through divestment, which it did and which caused its alleged lost profits, or (2) enlarging itself through infusions of equity capital, which it did not. Apparently, plaintiff chose to shrink because it was unsure of its ability to profit from new loans. Defendants argue that plaintiff had a duty to pursue the second option, an infusion of equity capital, under the "doctrine of avoidable consequences" -- a rule that a tort victim must take reasonable measures to avoid the consequences of another's wrongdoing. (Def. Reply at 19 n.7) See, e.g., Jenkins v. Etlinger, 55 N.Y.2d 35, 447 N.Y.S.2d 696, 432 N.E.2d 589 (1982). Plaintiff argues that this doctrine does not apply here. (Pl. Mem. at 27 n.16) However, even if plaintiff had no duty to pursue the second option, the availability of another option suggests that the injury arising from the loan loss reserves was speculative. As stated above, civil RICO damages "are unrecoverable if the fact of their accrual is speculative or their amount and nature unprovable." Bankers Trust Co. v. Rhoades, 859 F.2d at 1104. Although plaintiff was required to maintain a minimum capital ratio, plaintiff was not required to take loan loss reserves. In other words, plaintiff might not have suffered injury from taking the reserves if it had pursued an infusion of equity capital instead. That plaintiff could have avoided such injury is additional proof that the injury was speculative.
For the above reasons, plaintiff has not alleged RICO injury with respect to the loan loss reserves.
The prior Opinion and Order dismissed plaintiff's claims also because plaintiff failed to allege proximate or "loss" causation. See Opinion and Order at 9-20; Hecht v. Commerce Clearing House, Inc., 897 F.2d 21, 23-24 (2d Cir. 1990). This Court-applied the more specific rule that
a borrower who misstates the value of loan property or its rental income proximately causes injury to a bank when (1) the misrepresented value of the property was substantially above its actual value at the time of the misrepresentation, (2) the injury was sustained soon after the misrepresentation, and (3) external factors did not contribute to the injury.
Opinion and Order at 11 (citing Finkel v. Stratton Corp., 754 F. Supp. 318 (S.D.N.Y. 1990)). The above rule applies when a borrower misrepresents facts to a bank, and the bank alleges injury because those facts induced it to make a loan. Although this plaintiff has indicated that the misrepresented values of the loan properties were greater than their actual values, plaintiff did not sustain injury until five years after it began lending to and through defendants, and the real estate market collapse coincided with plaintiff's injury. Therefore, to the extent this plaintiff continues to allege injury solely because it was induced to make loans to defendants, plaintiff continues to fail the above test.
In addition, for the reasons stated in the previous Opinion and Order, the allegations stemming from additional loan loss reserves do not satisfy the Second Circuit's "loss causation" requirements. See Opinion and Order at 9-20 (citing cases). The taking of loan loss reserves is an inherently speculative and unreliable measure of actual damages because reserves do not represent realized losses, but rather a contingent estimate of anticipated future losses.
On the other hand, plaintiff has satisfied the more general proximate causation test in this Circuit with respect to the first type of injury it alleges -- relating to additional amounts plaintiff loaned to defendants. According to the two-pronged test in Hecht v. Commerce Clearing House, Inc.,
the RICO pattern or acts proximately cause a plaintiff's injury if they are a substantial factor in the sequence of responsible causation, and if the injury is reasonably foreseeable or anticipated as a natural consequence.