Lateral Recovery, LLC v. Queen Funding, LLC

Background

The plaintiffs included FTE Networks, Inc., and its three subsidiaries—Benchmark Builders, Inc., Jus-Com LLC, and Focus Wireless, LLC—collectively called FTE. Lateral Recovery LLC was an assignee of FTE’s claims pursuant to a foreclosure. The defendants included Queen Funding, LLC, Yehuda Klein, and unidentified investors who funded Queen Funding’s operations.

The complaint alleged that Queen Funding, a merchant-cash-advance company controlled by Klein, entered into seven agreements with FTE between November 2017 and November 2018. The agreements described the transactions as purchases of a portion of FTE’s receivables in exchange for upfront payments. According to the complaint, Queen Funding advanced approximately $6.5 million but collected about $10.5 million in daily payments over two years. The agreements had stated effective annual interest rates ranging from 100% to 300%.

The agreements required fixed daily payments, allowed direct withdrawals from FTE’s bank accounts, restricted FTE’s ability to transfer or sell its business or assets, and contained default provisions. The agreements also allowed Queen Funding to demand the unpaid purchased amount immediately after specified defaults and to collect against personal guarantees if FTE could not pay or became bankrupt.

Motion and legal standard

The defendants moved under Federal Rule of Civil Procedure 12(b)(6), which asks whether a complaint states a legally sufficient claim, to dismiss the substantive RICO claim and the RICO-conspiracy claim. On such a motion, the court accepts well-pleaded factual allegations as true and draws reasonable inferences for the plaintiffs, but it does not accept bare legal conclusions. The complaint must allege enough facts to make relief plausible rather than merely possible.

Wire-fraud theory

The complaint alleged that the agreements contained false statements, including that the transactions were not loans, that the daily payments were good-faith estimates of FTE’s receivables, that fixed payments were for FTE’s convenience, and that fees reflected the costs of an allegedly labor-intensive automated clearing house withdrawal program.

The court held that these allegations described the alleged fraud with sufficient particularity. The agreements themselves identified the statements, and the complaint explained why the plaintiffs claimed they were false. For example, the complaint alleged that the transactions functioned as loans because of the fixed payments, security interests, personal guarantees, and reliance on FTE’s creditworthiness rather than the performance of its customers’ receivables. It also alleged that all seven agreements used a 13% figure despite differing receivables amounts and daily payments.

The court further held that the complaint adequately alleged use of interstate wires. The alleged uses included email communications to originate, underwrite, service, and collect on the agreements, as well as interstate electronic debits from FTE’s accounts.

The court found sufficient continuity to plead a RICO pattern based on wire fraud. The alleged conduct involved seven agreements over two years and was described as part of the defendants’ regular business practices. The alleged automated withdrawals were also described as a regular means of collecting payments.

Unlawful-debt theory

The complaint also alleged that the defendants collected unlawful debt. Under RICO, unlawful debt includes debt that is unenforceable under state or federal usury law and that arose from lending at a rate at least twice the enforceable rate.

Applying New York law, the court explained that substance, rather than the agreement’s label, determines whether a transaction is a loan. The key issue is whether the lender actually bears the risk that the receivables will not be paid. The court considered three factors: the reconciliation provision, the term of the agreement, and the lender’s recourse if the merchant becomes bankrupt.

The court found the allegations sufficient to show that the reconciliation provision may have been a sham. The complaint alleged that Queen Funding did not have a reconciliation department, did not perform reconciliations, and had never refunded a merchant as required. The agreements also made reconciliation dependent on documentation requested in Queen Funding’s discretion and stated that Queen Funding had no obligation to reconcile past overpayments.

Although the agreements appeared to have an indefinite term, the court found that a fixed term plausibly existed because the payment period could be calculated from the amount owed and the daily payment amount. The default provisions also allowed Queen Funding to accelerate the debt and enforce its security interest and guarantees.

The bankruptcy-recourse factor favored treating the transactions as loans. The court found that the default, immediate-payment, collateral, and personal-guarantee provisions largely protected Queen Funding from the risk that the receivables would not be collected. The court therefore held that the complaint plausibly alleged that the transactions were loans rather than purchases of receivables.

The complaint also adequately alleged usury. The stated rates of 100% to 300% per year exceeded New York’s 25% criminal-usury limit, and the court found that the complaint sufficiently alleged the required intent at the pleading stage. The court concluded that the complaint plausibly alleged collection of unlawful debt under RICO.

Standing and timeliness

The defendants argued that the plaintiffs lacked RICO standing because they had not alleged definite damages. The court rejected that argument, holding that the alleged fraudulent or usurious interest payments constituted concrete injury to business or property.

The defendants also argued that the claims were untimely. The court held that the four-year RICO limitations period applied and that the complaint, filed on November 19, 2021, was filed one day less than four years after the first agreement was signed.

Other RICO elements and conspiracy

The court held that the complaint adequately alleged a RICO enterprise. Queen Funding could qualify as the enterprise, while Klein was a legally distinct natural person. The court also held that the RICO-conspiracy claim survived because the defendants’ only challenge to that claim depended on dismissal of the substantive RICO claim, which the court rejected.

Disposition

The court denied the defendants’ motion to dismiss. In a footnote, the court also denied the defendants’ motion to strike the plaintiffs’ notice of supplemental authority. The court lifted the discovery stay and ordered the parties to file a proposed case-management plan by July 27, 2022. The order addressed whether the complaint sufficiently pleaded claims; it did not determine whether the defendants ultimately violated RICO or owed damages.