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Elavon, Inc. v. Northeast Advance Technologies Inc.

United States District Court, S.D. New York

October 27, 2017

ELAVON, INC., Plaintiff,
v.
NORTHEAST ADVANCE TECHNOLOGIES, INC., SAMUEL BRACH, JOSHUA BRACH, ELIEZER KOHEN, ESTEBAN CASTILLO, JOEL FRIEDMAN, RIVKY FRIEDMAN, SILVERSTONE WIRELESS, LLC d/b/a J R CLOSEOUTS, MOSHE KESTENBAUM, JOEL FRIEDLANDER, MENACHEM WEISS, HINDY WEISS, CUBITAC CORP., JOSEPH RUBIN, DOVID KAPLAN, JOSHUA WEIDER, HAVA REICHMAN, ALEX LOWY, D-TECH MANAGEMENT COMPANY INC., JOHN DOES 1-50 and ABC COMPANIES 1-50, Defendants.

          OPINION & ORDER

          KATHERINE B. FORREST, UNITED STATES DISTRICT JUDGE

         On October 9, 2015, Elavon, Inc. (“Elavon” or “plaintiff”), a credit card processor, filed a complaint alleging a fraudulent credit card “chargeback” scheme that cost it over two million dollars. This is plaintiff's third bite at the apple; the Second Amended Complaint alleges violations of the Racketeer Influenced and Corrupt Organizations Act (“RICO”), 18 U.S.C. §§ 1961-68, as well as common law fraud, breach of contract, unjust enrichment, and conspiracy.[1] (Second Am. Compl. (“SAC”) (ECF No. 75) ¶¶ 119-84.) Specifically, plaintiff has asserted nine counts:

1. Breach of contract against Northeast Advance Technologies, Inc. (“Northeast”) (Count I);
2. Breach of guaranty against Esteban Castillo (Count II);
3. Operating a business using funds derived from racketeering activity, in violation of 18 U.S.C. § 1962(a), against Northeast Defendants, Joel Friedman, Rivky Friedman, Silverstone Wireless (“JR”), Menachem Weiss, Hindy Weiss, Cubitac Corp. (“Cubitac”), and D-Tech Management Company (“D-Tech”) (Count III);
4. Acquiring and maintaining an interest in an enterprise through a pattern of racketeering activity, in violation of 18 U.S.C. § 1962(b), against Northeast Defendants, J. Friedman, R. Friedman, JR, M. Weiss, H. Weiss, Cubitac, and D-Tech (Count IV);
5. Participating in the conduct of an enterprise engaged in a pattern of racketeering, in violation of 18 U.S.C. § 1962(c), against all defendants (Count V);
6. Conspiracy to violate 18 U.S.C. § 1962(a)-(c), in violation of 18 U.S.C. § 1962(d), against all defendants;
7. Fraudulent misrepresentation against Northeast Defendants and Cardholder Defendants (Count VII);
8. Unjust enrichment (Count VIII); and
9. Conspiracy (Count IX).[2]

         Pending before the Court are five motions to dismiss, collectively, Counts III, IV, V, VI, VII, VIII, and IX, filed by various of the named defendants.[3] (ECF Nos. 114, 118, 119, 123, 125, 129.[4]) For the reasons described below, those motions are GRANTED.

         I. BACKGROUND

         The factual allegations below are drawn from the SAC and assumed true for purposes of this motion.

         A. The Parties and the Contract

         Elavon, a subsidiary of U.S. Bank National Association, is a credit card processor. (SAC ¶ 69.) It provides merchants with access to the VISA, MasterCard, American Express, and Discover payment networks and connects them to their customers' issuing banks for payment. (Id. ¶¶ 3, 44.) Northeast has allegedly “portrayed itself as a manufacturer of engraving plates, a producer of acupuncture and tattoo needles, a computer programming firm, a maker of metal writing instruments, and a fabricator of ‘faceted diamond scribers for the semi-conductor industry.'” (Id. ¶ 78.) Elavon claims it entered into a contract (“Merchant Application”) in May 2011 with Northeast, which is run by defendants S. Brach, J. Brach, Kohen, and Castillo. (Id. ¶¶ 9-11, 51, 54; see also id., Ex. 1.) Elavon asserts that the Merchant Application incorporated by reference Elavon's Terms of Service and a Merchant Operating Guide (collectively, the “Contract”). (Id. ¶ 41.) An “included material element of the Contract” was the guaranty promised by Castillo, who allegedly represented himself as Northeast's President. (Id. ¶ 51.)

         According to the SAC, the Contract established a relationship between Elavon and Northeast, whereby Elavon was to serve as a credit card processor for transactions in Northeast's normal course of business. (Id. ¶ 42.) The Contract also obligated Northeast to reimburse Elavon for “chargebacks” when customers disputed transactions with their issuing banks and Elavon facilitated returns of their payments. (Id. ¶¶ 42, 45.)

         B. Credit Card Processors and Chargebacks Generally

         Because plaintiff's core allegation rests on a purported “chargeback scheme” in which defendants defrauded plaintiff, an explanation of the role of credit card processors may be instructive. The Court here provides a brief overview based on plaintiff's allegations in the SAC.

         Credit card processors like Elavon act as intermediaries between banks that issue credit cards and merchants that sell goods by providing access to credit card networks such as VISA and MasterCard. (Id. ¶ 42, 44.) Processors are bound by rules established by the credit card networks. (Id. ¶ 69.) Typically, when a consumer buys something using a credit card, the merchant relays the transaction to the processor, which transmits the transaction to the issuing bank; the consumer's account is debited, and the funds are transferred back down the chain, through the processor, to the merchant's account. (Id. ¶¶ 90-91.)

         As particularly relevant here, when a transaction is cancelled by a merchant that, for example, failed to produce a promised good, a “chargeback” may be initiated by the consumer. This is a “reversal of a transaction between a merchant and a customer credit card holder resulting from a dispute between the customer and the merchant.” (Id. ¶ 46; see also id., Ex. 1 (“Contract”) at 42 (defining “chargeback”).) Often, merchants and customers are able to resolve the dispute and initiate a return, but consumers can make the request to their issuing bank, which can then initiate the chargeback. (Id.) When a consumer makes a claim for a chargeback to her bank, she may submit evidence, such as a cancellation letter, demonstrating she never received the goods or services for which she paid. (Id. ¶ 105.) When this occurs, the bank credits the customer, and the credit card processor reimburses the issuing bank for the amount of the disputed transaction. (Id.) The processor then typically debits the merchant's account or, if sufficient funds are unavailable, it can seek reimbursement from the merchant. (Id. ¶ 104.)

         Plaintiff alleges that, because of requirements placed on it by VISA and MasterCard, it bears “full pecuniary responsibility for Northeast's incoming chargebacks to the card issuing banks, . . . notwithstanding the fact that Northeast did not maintain sufficient reserves for Plaintiff to immediately recoup for itself the amount of the refunds.” (Id. ¶ 69.) Put another way, the credit card processor allegedly must repay the bank for the chargeback, irrespective of whether the merchant holds up its own end of the bargain by reimbursing the processor.

         C. The Alleged Scheme

         Between June 2015 and January 2016, Elavon allegedly reimbursed issuing banks over $2.2 million-through chargebacks-for disputed transactions between cardholders and Northeast. (Id. ¶ 98.) Elavon claims that Northeast never repaid it the sum owed under the Contract and now owes it $1, 933, 645.22.[5] (Id. ¶ 48-49.) The SAC alleges that the credit card networks' rules-specifically, that the processor is responsible for paying the issuing bank in response to a chargeback, regardless of whether the merchant reimbursed the processor-were manipulated by defendants as part of a “wide-ranging fraudulent enterprise and conspiracy orchestrated” against it. (Id. ¶ 71.)

         First, it alleges that Northeast never planned to provide goods or services to the customers whose credit cards it charged. (Id. ¶ 84.) To support this assertion, plaintiff claims that its representative visited the address which Northeast represented was its manufacturing facility location (the “Industrial Park”) in the Contract. (Id. ¶ 72-73.) The representative allegedly learned that much of the Industrial Park-including Northeast's offices-had been destroyed by a fire in 2012, and that at the time the SAC was filed, Northeast's office was located “behind an unmarked door” in the “sole building . . . that remained undamaged.” (Id. ¶ 74-75.) In addition, Northeast's name purportedly “does not appear anywhere in the Industrial Park, ” and there is no mailbox with Northeast's name on it even though other companies do have designated mailboxes at the Industrial Park. (Id. ¶ 75-77.) Furthermore, plaintiff asserts, Northeast's office is not “capable of producing the intricate metal work that it claimed to Plaintiff it produced, ” and it has no website or employees with experience in metal work. (Id. ¶ 79-81.)

         These allegations are intended as factual support for the assertion that all or most of the transactions which Elavon processed for Northeast were not “bona fide, ” in that the cardholders who engaged with Northeast “did not expect Northeast to provide them with any goods or services.” (Id. ¶ 84; see also id. ¶¶ 85-88.) Rather, according to plaintiff, the Cardholder Defendants would charge their cards with Northeast, and once the issuing banks distributed funds to Northeast, it would deposit the “vast majority of those payments” into other accounts, including those belonging to D-Tech and JR. (Id. ¶ 89-91.) Then, according to Elavon, defendants Northeast, D-Tech, and JR “transferred moneys to the Cardholder Defendants” so that they could pay the debts incurred by the initial transactions. (Id. ¶ 92-93.) Plaintiff alleges that the Cardholder Defendants were motivated by the rewards they would receive from their issuing banks for the charges, as well as “other inducements.” (Id. ¶ 89.)

         This alleged scheme, though, was only the precursor to the purported “chargeback scheme” that underlies much of plaintiff's claims. Starting in June 2015 and continuing through January 2016, Northeast allegedly initiated 369 chargebacks, amounting to over two million dollars. (Id. ¶ 98.) Allegedly, these chargebacks occurred because Northeast, D-Tech, JR, and/or one or more of the ABC Companies was “unwilling” or “unable” to satisfy the credit card debt owed by the Cardholder Defendants to their banks. (Id. ¶ 100.) As a result, Northeast issued letters (“Cancellation Letters”) to the Cardholder Defendants canceling the transactions and recommending that the Cardholder Defendants forward the letters to their banks to assist with a chargeback, so that their credit card debt would thereby be diminished or eliminated. (Id. ¶¶ 100, 105.)

         Finally, Elavon makes a number of assertions as to defendants' knowledge of and communication of the credit card companies' “rules and regulations” regarding chargeback procedures, including that they “agreed, colluded, and conspired together to defraud Plaintiff by utilizing the Processing Rules to their advantage.” (Id. § 101.) They also claim that the Northeast Defendants “provided instruction to the Cardholder Defendants concerning various proper bases pursuant to the Processing Rules upon which to initiate chargebacks . . . to maximize the chances” that the issuing banks would validate the requests. (Id. ¶ 109.)

         As factual support for its allegations in the SAC, plaintiff submitted four exhibits to the Court. Exhibit 1, the Contract, includes Merchant Application Northeast allegedly submitted to Elavon, as well as Elavon's Terms of Service, which plaintiff claims are incorporated by reference. The Contract appears to be signed by “E. Castillo” and “David Hirsch, ” a sales representative for Elavon. (Contract at 6.) The Terms of Service require that merchants submit “bona fide” transactions only and that no transaction “involves the use of a Payment Device for any purpose other than the purchase of goods or services . . . . No Transaction involves a Customer obtaining cash from Merchant unless allowed by the Payment Network Regulations and agreed to in writing with Elavon.” (Contract at 19.) The Terms of Service also require that merchants are “fully liable to Elavon and [the relevant financial institution] for all transactions returned . . . for whatever reason including all Chargebacks.” (Contract at 14.)

         Exhibit 2 is a list of credit card transactions between Northeast and certain of the Cardholder defendants. (SAC, Ex. 2 (“Transaction List”).) The table below summarizes the number of chargebacks per defendant:

         Table 1.

Defendant

Number of Chargebacks

J. Friedman

262

R. Friedman

38

M. Kestenbaum

14

J. Friedlander

0

M. Weiss

16

H. Weiss

7

J. Rubin

5

D. Kaplan

0

J. Weider

2

H. Reichman

5

A. Lowy

1

Unknown/Doe

7

         Exhibit 3 collects thirty-nine Cancellation Letters from Northeast Defendants to Cardholder Defendants. (SAC, Ex. 3 (“Cancellation Letters”).) It includes only letters to J. Friedman, R. Friedman, M. Kestenbaum, and H. Reichman, with the bulk of them addressed to the Friedmans.

         Exhibit 4 collects letters that the Cardholder Defendants sent to their credit card issuing banks, though many of them are duplicates. (SAC, Ex. 4 (“Letters to Issuing Banks”).) It includes only letters sent by the Friedmans.

         Based on plaintiff's exhibits, two defendants-J. Friedman and R. Friedman-are on the transaction list, have cancellation letters included in Exhibit 3, and have letters included in Exhibit 4. Table 2 provides a summary.

         Table 2.

Defendant

Transaction List

Cancellation Letters

Letters to Issuing Banks

J. Friedman

X

X

X

R. Friedman

X

X

M. Kestenbaum

X

X

J. Friedlander

M. Weiss

X

H. Weiss

X

J. Rubin

X

D. Kaplan

J. Weider

X

H. Reichman

X

X

A. Lowy

X

Unknown/Doe

X


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