Schulz v. Neovi Data Corp., 60 Cal. Rptr. 3d 810 (Ct. App. June 15, 2007)
Schultz alleged that defendant EZ Expo (which wasn’t a party to this appeal) operated an “Internet Matrix” that was really an illegal lottery. Its site promised consumers expensive electronics like plasma TVs for trivial sums. The catch: you only get the prize by paying a fee to enter a “matrix,” and then a sufficient number of other suckers have to sign up after you. In other words, it’s a pyramid scheme.
After dropping over $500 on the site, Schultz asked for a refund and was refused. He sued EZ, along with the other defendants (including PayPal), who offered various ways to pay for the site’s services. Though the court affirmed the dismissal of claims against PayPal and another defendant, Neovi, it remanded to give him a chance to allege facts against two other defendants, Ginix and PaySystems, that would survive the post-Proposition 64 standards.
Schultz alleged that PaySystems and Ginix were “the former and current credit card processing and billing services for EZ.” EZ sent its website to them for their review, and they realized the site was an unlawful lottery and knew EZ was making false claims, but nonetheless allowed EZ to use their payment services, with the knowledge and specific intent of aiding and abetting the lottery. Moreover, they knew that credit cards “‘would lend an aura of respectability’” to the site, “deceive consumers into believing the activity was legal, and make participation easier, thereby generating more revenue.” They contracted with EZ to display their logos and create links to their websites so they could process payments. The orders were actually placed on their websites, and they charged victims’ credit cards, collected the money, deducted processing fees, and then paid EZ. Plaintiff alleged that Neovi’s relationship with EZ was similar to that of Ginix and PaySystems, except customers paid with a “‘virtual check.”
EZ transferred PayPal-using customers to PayPal’s website, where their transactions were completed. PayPal deducted its commissions and paid EZ. Schultz alleged that PayPal reviewed EZ’s site, determined it operated an illegal lottery, and authorized a link with EZ with knowledge and intent to aid and abet similar to that described for the other processors.
Schultz alleged that the defendants were engaged in an unlawful business act or practice under California law. He sued as an individual, as a private attorney general, and as a putative class representative. The complaint doesn’t meet post-Prop. 64 pleading requirements, but he argued that he used Ginix’s payment processing services and can amend the complaint to allege actual injury. The court determined that this should be allowed. Counsel also argued that alternative parties were available to substitute in as plaintiffs who’d used the services of the other defendants, and the court believed this also appropriate, except insofar as the complaint failed to state a claim against any defendant regardless of standing.
The court thus turned to the sufficiency of Schultz’s substantive allegations. Aiding and abetting liability for an intentional tort may be imposed if the person knows the main tortfeasor’s conduct is a breach of duty and gives substantial assistance or encouragement to the tortfeasor.
The court found the allegations against Ginix and PaySystems satisfied these elements. Schultz pled actual knowledge of illegality; his claims did not rely on any duty to investigate a website or monitor its conduct to determine whether it was illegal. The court specifically stated that its conclusion was in accord with public policy: “We do not quarrel with the claim that payment processors provide useful services to consumers. But this does not give them license to aid and abet illegal activity.”
Moreover, Schultz pled substantial assistance or encouragement: these defendants “authorized EZ to configure its site to display their respective logos so that consumers could link directly to their sites to process credit card payments,” with knowledge and specific intent to aid and abet, in order to make more money. After PaySystems ended its relationship with EZ, someone from Ginix “‘personally assured [EZ] that Ginix did not have any problem with the operation of the lottery site and would not freeze funds paid by consumers [as PaySystems had done].... Ginix ... essentially promised it would have a “stronger stomach.”’” These allegations, the court held, showed more than the provision of the usual, legitimate service of processing credit card payments, but went “far beyond” mere processing. Moreover, the allegations were more than merely conclusory, and sufficiently pleaded ultimate facts at this stage of the case. Some California cases suggest that a complaint must allege that an aider and abettor had the specific intent to facilitate wrongful conduct. Even assuming this is required, the court pointed out that Schultz had alleged specific intent.
Defendants relied on Emery v. Visa Internat. Service Assn., 116 Cal. Rptr. 2d 25 (Ct. App. 2002). In Emery, the plaintiff brought state claims based on solicitations to participate in illegal lotteries that allowed payment with Visa cards. The defendant was a clearinghouse whose members either contracted with merchants to accept Visa for payent or issued credit cards to consumers. The defendant didn’t issue cards, transfer funds, bill cardholders, or receive any fees based on particular transactions. Plaintiff alleged that defendant’s “advertising, licensing of its logo, and utilization of its payment system create[d] either an actual or ostensible agency relationship with its merchants” and that defendant aided and abetted the lottery by failing to police the exploitation of its logo and repudiate lottery-running merchants.
The court distinguished Emery because here, Schultz alleged that Ginix and PaySystems, “with prior knowledge of its operations, contracted directly with EZ and received payment based on their activity” (emphasis added). Schultz was not pleading liability from failure to police; rather, he alleged that defendants “had a direct stake in the success of the website and contracted for use of their services to encourage participation and make more money.” When an aiding and abetting allegation is based on failure to stop lottery solicitations, making a credit card available for payment is not itself sufficient; the Emery court found no evidence that the defendant knew of the solicitations, facilitated their distribution, or in any manner helped with an intent or purpose of facilitating violation of the law. Here, the allegations of the complaint supplied what was missing in Emery.
The Emery plaintiff also relied on the defendant’s use of the Visa logo, arguing that it implied the truth of merchants’ statements. But the Emery court considered this no more than an extension of the “failure to police” claim. By contrast, the allegation here was not merely licensing the use of the logo to bad actors. Rather, Schultz pled that defendants, “with full knowledge of the alleged illegal website, actively participated in processing payments, hoping use of the direct link from EZ's site to their sites would generate more revenue.”
As to PayPal and Neovi, however, the court found the complaint insufficient. Plaintiff pled only PayPal’s knowledge that EZ was running an illegal lottery and agreement to allow EZ to use its system because it would be profitable for PayPal. The allegations against Neovi were similar – knowledge of illegality plus knowing and intentional aiding and abetting by providing a payment system. Such conclusory allegations were insufficient to allege knowledge of the illegal lottery or “substantial assistance or encouragement.”
Discussion: This case suggests that Kozinski’s dissent in the recent Perfect 10 case might have merit as to the state claims, since it makes distinctions similar to his. Assuming reconsideration would be justified, it seems to me that preemption is a separate barrier to many of the state-law claims. Perfect 10’s claims are mainly about aiding and abetting copyright infringement, though it has a potpourri of other allegations. Here’s the Perfect 10 district court’s description of the factual allegations supporting the state-law claims: “The misconduct, all perpetrated by the allegedly infringing websites or unidentified ‘webmasters,’ includes selling misappropriated content, deceiving customers as to the origin of their content, misrepresenting the amount and scope of material on the websites, falsely claiming their websites are free, selling access to unauthorized passwords, and running websites that promote rape and incest, illegal downloading, and stealing cable television services.” The only thing left out, it seems, is tortious failure to repair the kitchen sink.
The first item on the list, selling misappropriated content, is clearly preempted, and the next two might be as well depending on the facts – deception can be an extra element, but if the alleged deception comes merely from failing to identify Perfect 10 as the source of the images, that’s just infringement. (See also Dastar.) False “free” claims and selling unauthorized passwords are possibly valid claims, as long as Perfect 10 can allege standing under state law, which it probably can as a competitor of these sites and of sites for which the bad guys sell passwords. As for promoting rape and incest, illegal downloading, and stealing cable – there, not so much hope with the standing requirement. How do those bad behaviors harm Perfect 10 exactly? Separately, unless the sites meet the rigid requirements for incitement under the First Amendment, which I highly doubt, promoting rape and incest isn’t illegal, just disgusting. Illegal downloading and stealing cable raise preemption questions again, not to mention the kind of tertiary liability issues – liability for aiding a site that itself promotes infringement by others – that might make even Kozinski nervous.
All told, the only plausible sources of state-law liability – defendant’s involvement in the bad guys’ actual misrepresentations about the costs or benefits of paying for bad-guy sites, which cause Perfect 10 to lose business to the bad guys – are limited, but maybe Perfect 10 should get the chance to offer facts in support of them. The scattershot presentation of allegations doesn’t inspire much confidence, though.