GILMAN et al v. WALTERS et al

Filing 75

REPORT AND RECOMMENDATIONS re 40 MOTION to Dismiss for Lack of Jurisdiction and Failure to State a Claim - The Magistrate Judge recommends that this court deny the Defendants' Second Motion to Dismiss. See Report for specifics. Signed by Magistrate Judge William G. Hussmann, Jr., on 4/26/2013.(NRN)

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF INDIANA
EVANSVILLE DIVISION
LARRY GILMAN, et al.,
Plaintiffs,
v.
MANNON L. WALTERS, et al.,
Defendants.

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3:12-cv-114-SEB-WGH

MAGISTRATE JUDGE’S
REPORT AND RECOMMENDATION
ON DEFENDANTS’ MOTION TO DISMISS
FIRST AMENDED VERIFIED COMPLAINT
This matter is before the Honorable William G. Hussmann, Jr., United
States Magistrate Judge, upon the referral by District Judge Sarah Evans Barker
entered on March 29, 2013 (Docket No. 72), for a report and recommendation as
to the Defendants’ Motion to Dismiss First Amended Verified Complaint filed on
June 28, 2012 (Docket Nos. 40-41). A Plaintiffs’ and Nominal Defendants’
Response in Opposition to Defendants’ Second Motion to Dismiss was filed on
July 26, 2012. (Docket No. 53). The Defendants’ Reply Brief was filed on August
6, 2012. (Docket No. 55). The Magistrate Judge heard oral arguments on April
3, 2013.
The Magistrate Judge, being duly advised, now RECOMMENDS that the
Motion to Dismiss be denied.

The First Amended Verified Complaint is brought by certain Plaintiffs who
are investors in limited partnerships against General Partner Mannon L. Walters,
Ivy Morris, and corporations controlled by Walters and Morris. The Complaint
pleads claims in 14 counts and, in addition, seeks that the court “pierce the
corporate veil.”
Counts II through XI of the Complaint allege various state law claims
seeking temporary injunctive relief, breach of fiduciary duty, and various types
of breach of contract claims. The following counts arguably raise federal
questions:
Count I, Declaratory Judgment;
Count XII, Failure to Register – Violations of Federal Securities Law
and State Blue Sky Laws;
Count XIII, Deceptive Trade – Violation of Federal Securities Laws
and State Blue Sky Laws; and
Count XIV, Violations of the Racketeer Influenced and Corrupt
Organizations (“RICO”) Act.
Issue 1:

Does this court have jurisdiction by virtue of diversity of
citizenship with respect to this Complaint?

The Magistrate Judge concludes that the First Amended Verified
Complaint does not plead sufficient jurisdictional facts to enable this court to
find that there is jurisdiction by virtue of diversity of citizenship. Specifically,
there are certain Plaintiffs in this case that are limited liability corporations.
Plaintiffs have failed to plead and identify all the members of the limited liability
corporations, as required, to determine whether diversity jurisdiction exists.

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Muscarello v. Ogle County Bd. of Commissioners, 610 F.3d 416, 424 (7th Cir.
2010). In addition, this action is brought as a derivative action against certain
Delaware, Texas, and Indiana limited partnerships. In a derivative action, the
corporation is a necessary party to the action, and without it, the case cannot
proceed. Hale v. Victor Chu, 614 F.3d 741, 743 n.1 (7th Cir. 2010). Although the
Magistrate Judge does not find specific Seventh Circuit precedent addressing
whether a limited partnership named as a nominal defendant should be
considered a real party in interest in a derivative action, other district courts
have done so, as cited at page 7 of the Defendants’ brief. The Magistrate Judge
believes those cases to be persuasive authority. Because Plaintiffs have not been
able to establish the citizenship of all of the limited partners in the limited
partnerships (perhaps because of Defendants’ refusal to provide that
information), the Magistrate Judge is unable to conclude that Plaintiffs have
established that complete diversity exists at this time.
Issue 2:

Is there jurisdiction because of the existence of a federal
question under 28 U.S.C. § 1331?
Count XIV

The Magistrate Judge concludes that there is federal question jurisdiction
in that Defendants have properly pled a claim under the Racketeer Influenced
and Corrupt Organizations (“RICO”) Act in Count XIV of the First Amended
Verified Complaint.
To state a viable cause of action under 18 U.S.C. § 1962(c), a plaintiff
must allege: (1) conduct; (2) of an enterprise; (3) through a pattern of

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racketeering activity. Slaney v. The International Amateur Athletic Federation, 244
F.3d 580, 597 (7th Cir. 2001). In addition, allegations of fraud in a civil RICO
complaint are subject to the heightened pleadings standard of FED. R. CIV. P.
9(b), which requires the pleading of all averments of fraud with particularity. A
RICO claim must, at a minimum, describe “two predicate acts of fraud with some
specificity and state the time, place, and content of the alleged false
representations, the method by which the misrepresentations were
communicated, and the identities of the parties to those misrepresentations.”
Slaney, 244 F.3d at 597(citing Goran v. New Vision Intern., Inc., 156 F.3d 721,
726, 728-29 (7th Cir. 1998)).
The Plaintiffs’ First Amended Verified Complaint, at paragraph 201, states
with requisite specificity the time, place, and content of alleged false
representations, the manner by which the misrepresentations were
communicated, and the identity of the parties to those misrepresentations.
Specifically, it is alleged that on a monthly basis between 2005 and 2012, and in
each years’ annual reports, Defendants Walters and Morris, through the
enterprise of their LLCs, mailed financial statements and limited partnership
production distribution reports which were false in that they did not contain
actual “operating expenses” for each well, the amount of oil sold, and the
amount of revenues. While these allegations do not contain precise dollar
amounts for the revenues or expenses, or the precise amounts of oil
misrepresented, that information is clearly only within the control of the

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Defendants. Paragraph 201 specifically pleads that these misrepresentations
were sent via mail and wire on a monthly basis during the time periods specified
and were generated by Defendants Walters and Morris and received by all the
investors in these partnerships, specifically including the Plaintiffs. The Rule 9
heightened pleading standard is applied less stringently when specific factual
information about the fraud is peculiarly within the Defendants’ knowledge or
control. U.S. ex rel. Russell v. Epic Healthcare Management Group, 193 F.3d 304,
308 (5th Cir. 1999).
Count I
As the district court discusses in Kalbfleisch ex rel. Kalbfleisch v. Columbia
Community Unit School Dist. No. 4, 644 F.Supp.2d 1084, 1090 (S.D. Ill. 2009),
there are a limited number of cases under which, even if state law creates the
cause of action, some substantial, disputed question of federal law is a
necessary element of one of the well-pleaded state claims. Specifically, a case
may have a “substantial federal question for purposes of subject matter
jurisdiction, even though no issue of federal law appears on the face of the
complaint. See Grable & Sons Metal Products, Inc. v. Darue Engineering & Mfg.,
545 U.S. 308, 312-20, 125 S.Ct. 2363, 162 L.Ed.2d 257 (2005). Here, the
Plaintiffs’ state law claims of breach of contract and implied covenant of good
faith and fair dealing raise a substantial question of federal law because the
vindication of the Plaintiffs’ rights turns on the construction of the Privacy Act, 5
U.S.C. § 552(a). Because Defendants have refused to produce partnership

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information based upon a citation to federal privacy law, a resolution of whether
that federal privacy law does in fact apply is essential to the determination of the
underlying state court claim. For this reason, there is federal question
jurisdiction to consider this case under Count I.
Counts XII and XIII
Because this court will have concluded that federal question jurisdiction
does exist under Counts XIV and I, the court need not address at this time
whether there are violations of federal securities law by failing to register these
investments, or whether there have been deceptive trade practices. The parties
dispute the appropriate statute of limitations to be applied to these claims. In
Merck & Co., Inc. v. Reynolds, 130 S.Ct. 1784 (2010), the United States Supreme
Court concluded that “[c]onstruing this limitations statute for the first time, we
hold that a cause of action accrues (1) when the plaintiff did in fact discover, or
(2) when a reasonably diligent plaintiff would have discovered, ‘the facts
constituting the violation’ . . . include the fact of scienter, ‘a mental state
embracing intent to deceive, manipulate, or defraud.’” Id. at 1789-90.
The question of whether Plaintiffs were reasonably diligent and, in fact,
discovered facts involving “scienter” requires the exploration of facts that are not
before the court at this time. Those facts may be developed before the arbitrator
and resolved as a part of any arbitration proceeding.

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Recommendation
The Magistrate Judge RECOMMENDS that this court deny the
Defendants’ Second Motion to Dismiss because: (1) there is an appropriately
pled claim under 18 U.S.C. § 1962; (2) a federal question concerning the
applicability of 5 U.S.C. § 552(a) to the resolution of underlying state court
claims; and (3) potential remaining federal claims subject to more full factual
development to determine whether they have been brought within an appropriate
limitations period. Together these matters establish an appropriate basis for
federal question jurisdiction.
SO RECOMMENDED this 26th day of April, 2013.

__________________________
William G. Hussmann, Jr.
United States Magistrate Judge
Southern District of Indiana

Served electronically on all ECF-registered counsel of record.

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