Exploring the Knockout Rule Contract: A Legal Professional’s Guide

What is a Knockout Rule Contract?

Knockout rule contracts are a specific type of contract utilized in various industries, most notably in the financial sector. Within the insurance industry, the most common example of a knockout rule contract is the multi-policy discount. A multi-policy discount contract offers reduced premiums for additional policies purchased by the same insured. In other words, if a buyer purchases both a home and auto insurance policy from the same insurance company, as opposed to buying both a policy from separate insurers, the buyer will receive a discount on the insurance premium for both policies. The discount on both policies can be considered a knockout rule contract. In addition to the multi-policy discount, there are other facets of knockout rule contracts that legal practitioners should be aware of. For instance, some contracts provide valuable information regarding the formation of contracts. Sometimes a knockout rule contract will expressly incorporate extrinsic materials by reference. If this is the case, then the incorporated material must be read side-by-side with the knockout rule contract to be given full legal effect. The most common example is the incorporation by reference of a tariff or other tariff-related materials. The tariff contains all of the essential terms of the contract and becomes a part of the contract, essentially superceding any contradicting language within the knockout rule contract. The incorporation by reference of extra-contractual terms has been explained as follows: That is, a contractual obligation may be based not only on the terms of the contract but also on other materials including some which, if the contract is viewed in isolation , would appear to contradict it . . . [C]ertain tariff publications may ultimately be incorporated into a contract. These extra contractual items do not operate to ‘amend’ a contract; we consider them indispensable items which may be required for the contract’s performance. More simply, application of the doctrine is warranted when an ‘agreement’ cannot be identified from the contract alone, but must also be gathered from surrounding circumstances. Another example where a knockout rule contract refers to extrinsic sources contains the following boilerplate: If your representatives do not sign this contract, it will nonetheless be effective and binding upon full payment of all premiums. Modifications in the language of the policy, which are agreed upon by the named insured and the company, shall not be binding unless specifically approved by an authorized representative of the company. Any changes that alter the premium, coverage, or the total amount of insurance cannot be binding unless made in writing by an authorized representative of the company. Further, any amendment to the Capabilities Document, or any online content relating to this contract are subject to the pricing criteria used by the company and its affiliates, and are not binding unless agreed to by the company. In this example, it is clear that the Capabilities Document and some online content are incorporated into the contract. There are many examples like the one above, and if you are an attorney involved in litigation, the referral to extrinsic sources could be helpful. Overall, a knockout rule contract does not have to be as lengthy as the one above, it can also be few sentences. However, it can still be useful to understand the concept for legal practitioners working in the insurance industry and beyond.

Knockout Rule Legal History

The historic origin of the knockout rule can be traced to the Uniform Commercial Code (U.C.C.) as adopted in some states. Article 2 of the U.C.C., which governs the formation and performance of contracts for the sale of goods, provides for a "battle of the forms" and indicates that when an acceptance contains terms that differ from those contained in an offer, these "different" terms become part of the contract that exists between the parties. U.C.C. § 2-207; see D&H Therapy Associates, LLC v. Triple Point Techs., Inc., 2011 WL 231359 (D. Or. Jan. 20, 2011) (discussing the U.C.C. "battle of the forms"); see also Club Com, Inc. v. Pivotal Corp., 2005 WL 1241908 (Mass. Super. May 11, 2005) (noting that the knockout rule has its origin in U.C.C. § 2-207). The U.C.C., like the Restatement, is not limited to sales of goods but is uniformly applied throughout the United States in all areas of contract law. Although many jurisdictions have adopted the U.C.C., the U.C.C.’s "battle of the forms" and variation of the common law mirror one another and courts have applied both types of such rules interchangeably. See, e.g., Harrison v. George Wash. Univ., 919 F.Supp. 823, 827 (D.D.C. 1996) (holding that while the knockout rule is applied when the U.C.C. applies, the rule is also applied "independent of the Uniform Commercial Code"); see also American Int’l Specialty Lines Ins. Co. v. Continental Cement Co., 2003 WL 22917706 (Mo. Ct. App. Dec. 16, 2003); Kahn Lucas Lancaster, Inc. v. Keystone Constructors, Inc., 433 Pa. 180, 249 A.2d 556 (1969); Florida v. Glades Elec. Co., 984 So. 2d 1272 (Fla. Dist. Ct. App. 2008); Williams v. Walker-Thomas Furniture Co., 371 F.2d 398, 403 (D.C. Cir. 1967). Requiring that agreed-to material terms be enforced and not overridden by contrary boilerplate in an offer or acceptance is not a new concept. See Club Com, Inc. v. Pivotal Corp., 2005 WL 1241908, at *2 (Mass. Super. May 11, 2005) (recognizing that the knockout rule originated from the longstanding principle that only those provisions which are essential to an enforceable contract are included in the agreement). However, even in jurisdictions where this concept was not established as a "rule" until the adoption of the U.C.C., practices that use the knockout rule in commercial transactions are now widespread. See Cincinnati Ins. Co. v. PVR Transp., Inc., 2010 WL 3001106, at *3 (Ohio Ct. App. July 30, 2010); American Fed. Bank, S.C., v. Jersey Ventures, Inc., 895 F. Supp. 1234, 1240 (E.D. Wis. 1995); St Paul Fire, 977 A.2d at 291.

Essential Features of the Knockout Rule

Knockout rule contracts are some of the simplest forms of employment agreements to understand, as they typically consist of a very short list of terms that are plainly stated. This is not the type of contract where you are likely to find a lot of complex legal jargon or technical expressions. The terms will typically be presented in a simple, straightforward manner and will generally be limited to the following:
A clear statement that the employee’s work is at-will
A statement that any employment or noncompete contract that was previously signed by the employee is null and void
A statement that the employee understands and agrees to the contract’s terms and releases the employer from any liability resulting from a potential breach of an agreement previously signed by the employee
As you can probably infer from the above, all three of these clauses are meant to provide a very clear statement to both the employee and employer about their intentions with regard to employment status. These terms are designed to protect the employer from any legal challenges based on the fact that more than one contract was signed by the employee (whether intentionally or unintentionally) or the idea that the employee had a right to enter into a binding contract and thus the former contract should remain valid. That is, the purpose is to remove any potential legal liability from the employer by eliminating the possibility that the employee could claim a previously-signed contract should remain valid due to a lack of understanding about signing a second one.
The clear wording and brevity of these clauses is what sets knockout rule contracts apart from other employment agreements.

Pros and Cons

Knockout rule contracts have a number of advantages to both clients and law firms. From the client’s perspective, they present an opportunity for significant cost savings. Clients are guaranteed costs up front, as no additional costs may be incurred if the law firm fails to beat a competitors’ price. In addition, because it is an exclusive agreement, it guarantees more work for the law firm than a traditional retainer agreement might. Finally, the knockout rule also encourages law firms to perform their work in a more effective and economical manner. If a law firm is able to reduce the time it spends on each case, it increases its own value proposition by delivering the same services, faster and more cost effectively.
For law firms, knockout rule contracts present the opportunity to guarantee a steady stream of income for the duration of the agreement, which can radically alter cashflow for the positive. Because knockout rule contracts are also exclusive, they allow law firms to be certain about how much work they can allocate for the upcoming weeks or months. Knockout rule contracts can also be beneficial for law firms that need to clear the books of older inefficient work as they bring in new, volume clients.
There are some potential disadvantages to knockout rule contracts that both law firms and clients should consider before agreeing to one. For clients, while guaranteed pricing can be very good, it can also lead to problems if the volume of business is lower than expected. As mentioned above, if a client receives a batch of less than ideal hearing dates, it could find itself paying a premium per hearing (a hearing cost that is higher than their current hourly rate).
Law firms can also find some disadvantages to knockout rule contracts. For example, agree to one rate across the board could end up being bad for your most profitable clients if other law firms are bidding lower. By guaranteeing rates for the next year or two, it may prevent your law firm from being able to respond similarly if the market rate for similar services dip.

Common Misconceptions and Issues

Knockout rule contracts are not without challenges and misinterpretations. Practitioners must first be aware of several possible pitfalls. While this practice is still relatively young, it is very dynamic. As a result, future litigation may prove how specific State courts will ultimately respond to knockout rule contracts. For example, some jurisdictions may see these contracts as all or nothing propositions. That is, if a knockout rule has not been clearly drafted as applying to various stages of the dispute process, such contracts may be rejected altogether by some courts. If not sufficiently narrow in scope and outline, judicial officers may find the language too ambiguous to be interpreted in a fair manner. Conversely, if the language is too specific, the potential application of the negotiations process (as opposed to pure litigation) may be severely limited. Currently, the debate focuses on what types of matters are appropriate for knockout rule contracts. Should the contracts apply only to civil actions (which could then save litigants and courts a huge amount of resources)? Or should the contracts also apply to administrative matters and non-litigated claims, such as arbitrations? As the Supreme Court in Martin v. Heinold Commodities, Inc., 643 N.E.2d 734, 736 (Ill. 1994) stated, "the question does not appear to have been conclusively resolved." In that case , the Supreme Court of Illinois declined to adopt the Uniform Arbitration Act’s (810 ILCS 5/1 et seq.) guiding principles for arbitration. The Supreme Court ruled that it was unnecessary and more appropriate for the Illinois Legislature to resolve this issue regarding the applicability of statutes. Through consolidation and law revision, the Illinois Legislature could provide guidance to courts and practitioners concerning the phrase "civil actions" and the potential breadth of the law. Over the past two years, we have seen an increase in support for the use of knockout rule contracts throughout the judiciary. However, with such support, there are always dangers. One of the possible pitfalls in discussing and drafting a knockout rule contract may arise from the exchanges between parties during negotiation. That is, in order for parties to potentially come to an amicable agreement, they will more than likely go slow and build trust with each other over time. This can be a long process. It may be very tempting for those involved to make seemingly innocuous comments that really are meant to bind the parties. Yet, those types of comments can cause yet more uncertainty in the law due to the fact that the parties are bound by the confidentiality of their discussions. Proper drafting of knockout rule contracts is essential to avoid such problems. All too often, parties attempt to craft such agreements on the rear of a napkin during lunch!

Knockout Rule in Practice: Case Examples

The practical application of the knockout rule is perhaps best illustrated in the case of Chukwuma v. 645751 Ontario Limited, 2004 CanLII 42211. This Ontario decision involved a proposed class action of employees against their employer alleging they were not given the minimum notice of termination of employment in accordance with the Employment Standards Act, 2000 ("ESA"). At the motions stage of the action, the employer brought a motion for security for costs. The employer argued that because its employees had received much more than the minimum notice of termination under the ESA, their claims were "worthless" therefore security should be ordered. The court refused to order security, finding that, generally, courts should refrain from determining the success or failure of a case at the motion for security for costs. At trial, the employer would have to establish that the employees did not suffer any damages. The court went on to find that: "where the minimum notice period is reasonable in the circumstances, the payment of such notice to an employee will result in a complete bar to the employee’s right to claim wrongful dismissal, irrespective of the wording of the contract between the parties." In short, the court would rely on the knockout rule to eject the plaintiffs’ claims where the employer could prove that the minimum notice period was reasonable.
This case is interesting in that it provides a judicial affirmation that the knockout rule applies to employment contracts even when the standard clause is not expressly included in the agreement. In fact, this case goes on to suggest that the knockout rule cannot be contracted out in the employment context, given that an employee cannot contract out of his/her statutory rights under the ESA. The court offered that the employer could not contractually reduce the notice of termination owed, but it could mitigate its damage exposure by paying slightly more than the ESA minimums (which is exactly what happened in this case).
A more recent decision, Byers v. MNP LLP, 2019 ONSC 1661, is another example of how the knockout rule can be applied in the commercial context. In this decision, the plaintiff contractor provided a construction target cost budget, which MNP LLP ("MNP") used as the basis of its proposal. After accepting the bid and awarding the contract, MNP brought an action against the contractor, claiming that the contractor failed to properly cost the project which caused MNP to suffer damages. The contractor sought summary judgment in its favour arguing that MNP contractually agreed to use its target cost budget and received value for these costs. At the motions judge level, MNP’s claim was dismissed, and the case was brought by MNP to the Divisional Court on appeal. In its affirment of the motions judge decision, the Divisional Court relied on the knockout rule in determining that MNP could not claim damages beyond what had been allocated in its target cost budget.

Future Considerations and Trends

As businesses continue to evolve and adapt to the ever-changing corporate landscape, the potential application and implications of knockout rule contracts will likely shift in response. As more companies embrace technology, such as automated platforms and artificial intelligence, the nature of knockout rule contracts and their enforcement may become an even more complex area to navigate. For instance, the proliferation of new technologies, such as blockchain, may lead to re-examination of whether parties can contractually bind themselves to a privately administered forum or arbitrator. Further, the potential for increased cross-border transactions may strain already limited discovery processes, thereby impacting the ability of parties to develop a factual record necessary to present their cases, potentially raising questions as to whether such contracts run afoul of public policy.
The potential impact of evolving business practices on knockout rule contracts is particularly significant when viewed against the backdrop of a growing economy marked by high-tech companies and social media, both of which were not prevalent when knockout rule contracts first emerged decades ago. Because of their relatively recent adoption, "technology" contracts and "social media" contracts are largely untested in judicial and arbitral contexts. For example, many technology contracts (including those relating to IT services and SaaS) include arbitration provisions that mandate the exclusive use of electronic communication to settle disputes, while social media contracts often bind users to private social media courts administered by social media companies. These online dispute resolution ("ODR") forums have proven to be especially convenient for the resolution of disputes, as the parties need not incur any travel costs and can access relevant materials and facts via their smartphones . Among other drawbacks, however, ODR forums also mean that courts cannot (and will not) review the arbitral award, thereby making it difficult for parties to appeal the award and secure an impartial adjudication. Given that knockout rule contracts often involve valuable intellectual property and trade secrets, an unsatisfied party may choose to seek relief in court rather than on an ODR forum. Yet, as the need for physical travel within the context of dispute resolution increasingly dissipates, ODR forums will likely continue to be amended and refined to account for technological advancements. Further, as multinational corporations and cross-border transactions increase and become more complex, similar in-person limitations will likely constrain the ability of the parties to fully participate in a traditional format used for dispute resolution. In this regard, ODR forums remain an efficient and effective method for resolving disputes arising out of knockout rule contracts, especially given that some courts have recognized that online contracts form the basis for the validity of electronic arbitration awards.
Other future trends and considerations may be less related to new technologies. Rather, the future of knockout rule contracts may be more heavily influenced by the efforts of new competitors to take market share from incumbent online providers of services or technology. For instance, at the time of this writing, several new entrants, such as the Consumer Financial Protection Bureau ("CFPB"), have taken aim at various industry practices with the goal of providing competitive alternatives to incumbent services. The efficacy of the CFPB’s efforts to enact such changes remains to be seen, though if fully enacted, the CFPB’s recent proposal to amend its arbitration rule may ultimately impact existing and potential knockout rule contracts in the consumer finance sphere.