Hundreds of white-collar criminals are convicted every year under federal and state laws that give the government the right to seek the forfeiture of assets gained by crime.
Most of those who are convicted are businesspeople with seemingly "clean" firms. And, like most business owners, they have bankers.
When a bank's customers are convicted of a crime and their assets are seized by the government, the collateral may become the property of the government simply by forfeiture.
In many cases, the government's forfeiture claims can supersede claims of secured lenders. Lenders are being left empty-handed by the reach of forfeiture provisions.
The Department of Justice has just issued new guidelines that will help clarify the government's position in moving to seize assets under such federal laws as the Racketeer Influenced and Corrupt Organizations Act (RICO), the Money Laundering Control Act, and the Controlled Substances Act.
Those guidelines contain protections that secured lenders can use to safeguard their collateral, but those protections are most effective in advance of the problem, not in reaction to it.
Forfeiture is not limited to cases of drug dealing or organized crime, but may be applied in a wide variety of white-collar cases. These may have a direct impact on the owner of commercial property as well as on the secured lender.
Burden of Proof
Lenders fighting the government over property in which they thought they had a secured interest may find they must prove that they did not consent to the illegal conduct, know of it, or have reason to know of it.
One of the leading cases dealing with forfeiture is Collaro-Tolado v. Pearson Yacht Leasing Co., (U.S. 1974). In that case, one marijuana cigarette found on a yacht led to seizure of the vessel. The seizure and forfeiture were upheld by the Supreme Court.
The court found no constitutional impediment to forfeiture. But it did recognize that, under certain circumstances, constitutional considerations may provide owners with an opportunity to prove their entitlement.
The court said that an owner would have to prove "not only that he was uninvolved in and unaware of the wrongful activity, but also that he had done all that reasonably could be expected to prevent the prescribed use of his property."
Claim of Innocence Not Enough
Under Pearson, an owner or interest holder cannot simply claim innocence, but must "step up to the plate" and be prepared to prove the basis for the claim of being innocent.
RICO, the Money Laundering Control Act, and the Controlled Substances Act provide very broad definitions of the property that is subject to forfeiture.
RICO permits the forfeiture of any interest a person has acquired or maintained in violation of the RICO law. This would include "any property constituting or derived from any proceeds which the person obtained directly or indirectly from racketeering."
What is racketeering under RICO? Many more seemingly legitimate enterprises than anyone would have thought when RICO was enacted in 1970.
Defining the 'Enterprise'
Only after the prosecutor identifies the "enterprise" in the indictment are defendants or third parties - e.g., secured lenders - able to determine the scope of the possible forfeiture.
The Controlled Substances Act is also very broad. It permits the forfeiture of "any property constituing or derived from any proceeds the person obtained, directly or indirectly, as the result of violation."
It also permits forfeiture of any of the "property used, or intended to be used in whole or in part, to commit or to facilitate" the criminal act.
Property subject to forfeiture under the Controlled Substances Act includes vehicles, monies, securities, anything of value used or intended to be used in exchange for controlled substances, all proceeds traceable to any such exchange, and all real property used, in addition to the illegal materials themselves.
Minor Offenses Included
Many states have civil forfeiture laws that are based on the Uniform Controlled Substances Act. Some states have extended criminal forfeiture to include even minor offenses.
For example, a bill was introduced in New Jersey last year to extend forfeiture of property to disorderly conduct or disorderly persons offenses, something that even some New Jersey prosecutors objected to.
The Money Laundering Control Act is similarly broad. It permits forfeiture of any real or personal property involved in a prohibited transaction, any property traceable to such a transaction, and any proceeds derived from such a transaction.
Any kind of money laundering offense may fall under the act, including violating currency transaction reports and structuring transactions to circumvent cash-reporting requirements.
Also included are other criminal statutes available to the government, such as those on mail fraud and wire fraud, when they relate to assets bought or held by the Resolution Trust Corp. or the Federal Deposit Insurance Corp.
Paying a High Price
The scope of forfeiture is broad. The Princeton/Newport case is a good example of how property that is the subject of forfeiture can be much greater than the actual proceeds of the alleged crime.
In that case, the government sought forfeiture of assets totaling about $15 million, though only about $97,000 in illegally received tax benefits was in question.
The threat to security interests, the drying up of lines of credit and of liquidity, is a very powerful tool in the hands of the prosecutor. In Princeton/Newport, the restraint on assets and the threat of forfeiture arose well before trial, let alone conviction. It caused the unindicted partnership to fold four months after entry of the restraining order.
Some believe that the threat of forfeiture may have been one of the reasons that Drexel Burnham, facing RICO indictment, entered into a plea agreement with the United States to pay a fine of $650 million.
Not Much Choice
Given the negative impact that a RICO indictment would have had on its commercial relationships and on its ability to maintain the liquidity necessary to participate in the financial markets, there are some who believe that Drexel was left with little choice but to settle.
Lenders must also be concerned about the "relation back" doctrine under the three key statutes. This doctrine provides that title and interest in the property vests in the United States "upon the commission of the act giving rise to forfeiture."
A bank could make a secured loan in 1988 relying for collateral on assets somehow connected to an illegal act that occurred in 1985, and the government could move to seize the assets in 1990.
The substitute-asset provision is also common to the three principal statutes. It provides that if the particular assets used is the criminal activity are not themselves available, other assets may be substituted and become subject to forfeiture. Again, the potential exposure of the secured lender is broad and cannot be anticipated.
The primary recourse available to a lender facing loss of collateral is the assertion of innocent-owner status. The statutes contain different standards for innocent owners.
Under RICO, people claiming innocent-owner status must prove that when they acquired their interest in a property they were "reasonably without cause to believe that the property was subject to forfeiture."
Under the Controlled Substances Act, the standards differ, depending on the nature of the property. Generally, the standard that innocent owners or interest holders must meet is that the criminal act or omission occurred without their "knowledge or consent."
Under the Money Laundering Control Act, knowledge rather than consent is the focus. It is up to the owner or lien holder to show that the criminal act - utilizing the property in question - was committed without the knowledge of the owner or lien holder.
Other defenses are potentially applicable. Meeting these standards is far more difficult than it would appear. The courts have given different interpretations to the statutory innocent-owner defenses, and it is not clear what the standard may be in any particular case.
For example, there are obviously many kinds of knowledge - actual or constructive knowledge, unsubstantiated hearsay, rumors, and so on. What may constitute knowledge, and what other duties may be imposed on one claiming an innocent-owner status, are unclear.
There is also a split in the circuit courts on whether an innocent-owner defense requires proof that "due care" was exercised by the owner or lender to prevent the illegal conduct.
Secured lenders should be sure they have procedural safeguards in place to establish innocent-owner or innocent-interest status in the event of a forfeiture proceeding.
This takes on even greater importance given the latest policy announced by the Justice Department, which establishes expedited-settlement procedures the United States may follow in forfeiture proceedings.