The South Dakota Supreme Court recently ruled that a sweeping exclusion for continuous injuries that start before a policy takes effect did not violate public policy, but with Colorado's decision to ban the exclusion in policies covering construction, other courts may be more critical of the unusual policy language.

The state high court agreed with Employers Mutual Casualty Co. that it did not have to reimburse Amco Insurance Co. for a share of the roughly $467,000 in defense costs and damages paid to a school district that claimed subcontractor Steven Thomas & Sons LLC negligently carried out excavation and compaction work while working on an addition to a school building.

It ruled on April 16 that nothing in South Dakota's public policy prohibited EMCO's exclusion, which eliminated coverage for property damage or injuries that allegedly started before the policy period began and continued into the policy period. The exclusion applies regardless of whether the policyholder knew or should have known about the injuries or property damage at the time the policy period began, according to the decision.

South Dakota — like nearly every other state — has not specifically tackled the question of whether public policy forbids an exclusion for a continuous injury that is unknown to the policyholder, according to the decision.

“We've seen exclusions like this, but they are very new,” said David Wood, a shareholder at Anderson Kill PLC.

Far more courts have weighed in on a narrower exclusion that nixes coverage for continuous damage a policyholder knows about before a policy goes into effect, Wood says.

And Wiley Rein LLP partner Laura Foggan points out that policies that specifically provide coverage for pollution liability also have exclusions for progressive or ongoing injuries.

In the South Dakota litigation, Amco argued that the exclusion in EMC's policy ran against public policy because commercial general liability coverage must insure against risks that are outside of the policyholder's control and protect policyholders from unknown events.

Amco insisted that EMC's exclusion was “antithetical to the nature of insurance, excludes coverage for no purpose other than EMC's profit, and leaves EMC's insureds without indemnity coverage in all cases involving continuous injury beginning before EMC's coverage.”

The state high court acknowledged that Colorado's legislature had passed a law outlawing such provisions in policies issued to construction professionals. But it stressed that the South Dakota legislature had not enacted a similar measure and that insurers were increasingly restricting coverage for continuous and progressive injuries, leading it to side with EMC.

According to Foggan, the South Dakota Supreme Court was right to reject the public policy argument. It's been challenging for insurers over the past few decades to manage coverage for ongoing or progressive damage, which, in the asbestos and pollution contexts, have led to staggering costs, she says.

“Not only is it not against public policy, it's a natural working of the insurance marketplace,” Foggan said. “The ability to shape the coverage and restrict what risk would be assumed is really critical to the market being able to offer these types of coverage.”

But Rene Siemens, a partner at Pillsbury Winthrop Shaw Pittman LLP, told Law360 that the exclusion in EMC's policy was so broad it nearly eliminated the value of the general liability coverage offered.

“Insurance is for the purpose of covering matters that may have already happened, as long as they're not known about,” Siemens said. “Most states have a variety of statutes and bodies of case law that recognize that that's the purpose of insurance.”

And Wood argues that EMC's policy language presents a major trap for policyholders. To wipe out the insurer's duty to defend, the exclusion requires only that there be an allegation that the loss at issue occurred before the policy took effect. That encourages insurers to deny defense coverage, even if their duty to provide a defense is generally broad, Wood says.

“That's one of the big issues that I see with this kind of exclusion,” Wood said. “The South Dakota Supreme Court doesn't get anywhere near dealing with that.”

Wood says the decision could have come out differently if the case had involved a battle between a small business and an insurer, rather than two insurers. Courts can consider a policyholder's reasonable expectations about coverage under a policy.

And courts in other states that lack laws like Colorado's may nonetheless be willing to hold that the exclusion violates public policy, he says.

“While it's generally correct that the public policy of a state is articulated by the legislature. ... It sounds, from the South Dakota Supreme Court's analysis, that it can only be articulated by the legislature,” Wood said. “Courts ... articulate their own public policy all the time.”

Wood added that insurance brokers should pay attention to the South Dakota ruling because small businesses that can't score coverage because of exclusions like the one in EMC's policy might target them next to try to recoup their losses.

Siemens recommends that policyholders shop around if insurance carriers try to insert similar exclusions in their policies.

“I would be surprised if the insurance industry uses this broadly,” Siemens said. “Because I think they would get a backlash from the policyholder world."

Attorneys involved in the case did not immediately respond to a request for comment.

Amco is represented by James Moore and Cheri Raymond of Woods Fuller Shultz & Smith PC.

EMC is represented by Timothy Gebhart and Justin Clarke of Davenport Evans Hurwitz & Smith LLP.

The case is Amco Insurance Co. v. Employers Mutual Casualty Co., case number 2014 S.D. 20, in the Supreme Court of the State of South Dakota.