Fact Issues Regarding “Relatedness of Claims” Preclude Motion for Judgment on the Pleadings

The United States District Court for the District of Arizona has held that mere reference to a “pyramid scheme” in a prior lawsuit is insufficient to warrant judgment on the pleadings regarding the relatedness of a later claim alleging a pyramid scheme. Hanover Ins. Co. v. Vemma Int’l Holdings, Inc., 2016 WL 4059606 (D. Ariz. July 29, 2016). The court also held that the possibility of reputational and financial harm to an insured individual is sufficient to demonstrate irreparable harm for the purposes of seeking a preliminary injunction for advancement of defense costs.

The Federal Trade Commission (FTC) filed a lawsuit against the insured entity and an insured director alleging, among other allegations, that the insureds had participated in a pyramid scheme. The insureds notified their insurer of the lawsuit, seeking coverage under the company’s directors and officers and entity liability policy. The insurer denied coverage for both the insured entity and the director and filed a declaratory judgment action. The insurer argued in a motion for judgment on the pleadings that coverage was unavailable on the ground that the FTC action was not a claim first made during the relevant policy period because it was related to other claims asserted prior to the policy period. The insureds sought a preliminary injunction for reimbursement of defense expenses.

The court denied the insurer’s motion, concluding that further discovery was needed to determine whether prior lawsuits were based on the same marketing and compensation scheme as the FTC action, and that a previous claim including allegations of a pyramid scheme did not necessarily preclude coverage for a later pyramid scheme claim.

However, the court denied the insured company’s request for a preliminary injunction because the insurer had shown that the insured company might not succeed on the merits with regard to whether the claims were related. Nevertheless, the court granted the insured director’s request for a preliminary injunction for advancement of defense costs, subject to the policy’s allocation provision, because the insurer identified no evidence that any prior claims were brought against the insured individual. The court concluded that the director had demonstrated the likelihood of irreparable harm if the injunction was not granted, as the director had produced evidence of likely reputational harm and the potential for financial ruin in the absence of an insurer-funded defense.