Overview of Knock Out Rule
The knock out rule is a legal doctrine applied to contracts when the terms of an offer and acceptance do not align. The contract is then governed by the UCC’s gap-filling provisions. It was established in the landmark case of Solomon v. Royal Globe Ins. Co. to ensure courts avoid interpreting contracts in one party’s favor. The case involved a car accident involving Solomon and Benjamin, who rented a U-Haul truck to transport a pool table.
U-Haul alleged that insurance terms in the contract did not meet the legal requirement for standard coverage . The lower court sided with Bowling and found coverage for personal property existed by operation of law. The Supreme Court of Michigan agreed but on different grounds. It held that both parties’ terms "knock out" each other, leaving only the statutory terms in force. In other words, when conflicting terms are presented by both parties, the knock out rule will reject both in favor of a statutory provision or gap-filler.
The UCC governs the knockout rule in Uniform Commercial Code § 2-207.
Background
The knock out rule was first applied by the United States Court of Appeals for the Seventh Circuit in a case called W.W. Montague & Co. v. Am. & Foreign Power Co., decided in 1963. That decision held that when two merchants exchanged documents relating to the sale of goods, information in one document which was not included in the mirror image version of that information contained in the second document would be deemed to be excluded unless the contract was modified in writing by the parties to include it.
Though the Court almost immediately reexamined its decision and held in its first knock out rule case, Altman & Co. v. C3S Ltd., that the facts of that case required a different result, the idea found in W.W. Montague was echoed in other Courts. By 1972, the California Court of Appeals had adopted the knock out rule, before codifying it into the California Uniform Commercial Code’s version of UCC 2-207. In addition to providing that the formation of a contract in a transaction covered by the UCC will not be impeded by a lack of match between the terms in the acceptance and those in the offer or counter-offer, California’s code version states:
In the event of such a conflict this section and Section 2207 [another name for section 2-207] shall resolve the conflict as provided in subsection (b) thereof in favor of section 2207 [the knock out rule].
(Sec. 2207 is in reference to the pre-code version of UCC section 2-207, which did not contain subsection (b).)
Since 1972, the knock out rule has taken on a more or less canonical status. While many jurisdictions have enacted versions of the knock out rule in their respective codes of civil procedure, such as California, it has yet to be contested in the Supreme Court, and thus has maintained status as a black letter law-type rule.
However, it is also true that while the knock out rule is a near-universal holding in the United States, some courts including in California have recently opened the door to the possibility of a liberalized knock out rule or its complete abolishment.
Knock Out Rule in Practice
Consider the most common form of the knock out rule: offer and counteroffer. In this scenario, you have an offeror, an offeree, a first offer, and a counteroffer. The offeror, with offer intent, sends the offeree an offer. In response, the offeree, with counteroffer intent, makes a counteroffer. Because there is no mirror image, the knock out rule applies. Each of the parties can only get the terms of their last best offer. Importantly, no conduct of either party can change this.
For example, suppose the parties negotiate a lease. The landlord (offeror) offers 20 years at $1500 per month. The tenant (offeree) counteroffers 19 years at $1650. The landlord agrees to all terms except the payment amount. However, the tenant does not agree to the change in payment. The tenant then pays rent on the first of each month for several months. The parties could be presumed to have a contract at $1650 per month for 19 years, but the court enforced the clear terms of the last best offer and held that the tenant breached the contract by paying at only $1500 per month. It does not matter that the tenant was the one who sent the counteroffer. Instead, the important thing to remember is that the intent of the initial offeror is controlling.
Things become more complicated when there are multiple offers and counteroffers. For example, suppose the parties negotiate a complex settlement. In that scenario, the parties intend to make an offer or counteroffer by the making of any settlement proposal, conditional or not, that is passed back and forth. But the recipient does not know that their proposal is considered a counteroffer. After the parties negotiate for two months, they reach an agreement. They later find out that the parties had made and rejected a prior settlement agreement. The parties, not the court, must then decide how to fix the problem caused by the application of the knock out rule to their negotiations.
How the Knock Out Rule Differs from “Battle of the Forms”
Another issue to think about with respect to the knock out rule is that it differs from the more well-known "battle of the forms" scenario. See, e.g., Bobsieller, Inc. v. Seiko Time Corp., 920 F.2d 222, 226 (2d Cir. 1990). The battle of the forms refers to situations in which two merchants exchange forms with differing boilerplate rules in them. The last form exchanged usually wins. In a knock out situation, however, the forms do not differ because they have identical standardized terms and conditions.
It is important to remember that the first buyer’s standard terms and conditions do not defeat the seller’s standard terms and conditions. Conversely, the seller’s terms and conditions that are contained on the preprinted side of the sales order reject and supersede the buyer’s terms and conditions contained on the preprinted side of the purchase order, unless the two documents are somehow expressly made part of the contract, such as by mutual approval, separate reference, or by performance by both parties. In the other words, not only must the last form control, as in the battle of the forms, but the second form must expressly mention the previous form in order for it to be incorporated into the agreement.
Interpretation by Courts
Courts typically interpret the knock out rule as requiring determination of which terms were really agreed to by the parties, and then creation of a contract out of those terms. For example, in Northwest Airlines v. PeopleSoft, Inc., 2006 WL 756200 (8th Cir. March 22, 2006), the Eighth Circuit interpreted Minnesota law to allow a court to decide whether the parties all intended to bargain for the contract terms in the "other" additional terms. The court reasoned that, in Minnesota, the knock out rule, if it applied, would apply only to disagreements about additional terms. In contrast, when original contract language conflicted , the court found that no party had agreed to contract on that term, and no contract therefore was formed on that subject matter.
Decisions like Northwest Airlines show that courts generally do not make the parties’ decision for them by simply declaring certain terms valid or invalid based on some form of judicial "reasonableness." In Northwest Airlines, the court emphasized the factual nature of the inquiry by stating that it could overturn or reverse the district court’s decision "if we come to a different conclusion after considering the objective manifestations of the parties."
Effects on Companies and Corporations
For businesses, the knock out rule can influence how they draft and negotiate their contracts. Since this rule is generally applied only to the terms specified as additional or different from the first document, this means that in negotiation, the party attempting to add terms to a contract would have to review and analyzing the other party’s proposed changes in detail, as it could impact the location and context of their own proposed terms.
If both parties have terms they want to add or replace, the knock out rule automatically removes all instances of these competing terms, which means businesses need to be strategic in their negotiations. A new contract will be formed that excludes not only the replaced term, but also any competing terms added by either party.
In most cases, parties are encouraged to use the counter-offer that excludes any conflicting terms. However, there is nothing prohibiting a party from simply proposing a contract with their terms, without responding to the counter-offer. In practice, many parties will simply respond to the counter-offer by explicitly agreeing, or rejecting, the terms of the other party, then providing their own adjustment, rather than taking the time to create a separate counter-offer that excludes any proposed terms.
Advantages and Disadvantages
The advantages of the knock out rule to one party may come with disadvantages to the other. While one party may benefit from the time and cost savings associated with not having to propose any form of negotiation or acceptance to a counter-offer, the other may be forced into accepting a contract that is substantially different from what was first presented. The inability to bring forth terms to the table for negotiation may also deprive the contracting party from negotiating a more suitable overall deal for himself or herself. As a result, while the knock out rule serves to promote the efficiency in which contracts are entered into, it may also eliminate opportunities for improvement that the parties may have had available to them had they taken the time to express themselves more clearly.
On the other hand, if both parties are aware that their respective forms of acceptance and offer would likely create a materially altered contract, the knock out rule stands to benefit both parties. While the language of both contracts would be rendered void (due to the possibility of a differ to that contract being only a potential acceptance to the original offer), each party, as mentioned before, may be able to save time and money that would have ultimately gone towards the time spent haggling terms back and forth. With this in mind, the knock out rule is an appropriate solution for parties who are all on the same page and would rather save themselves the trouble of spending several weeks moving back and forth with amended contracts.
Conclusion
In conclusion, the knock out rule remains a relevant and significant principle in contract law, particularly within the context of the Uniform Commercial Code (U.C.C.). Its application in every state but Louisiana serves as an essential mechanism for resolving issues of contract formation when the parties’ forms contain conflicting terms. As such, even though the knock out rule has its origin in common law, it has evolved to become critical for uniformity and predictability in commercial transactions.
The wide acceptance of the knock out rule under U.C.C. section 2-207 demonstrates that this approach to dealing with conflicting printed terms in two standard forms is likely to continue in the absence of any specific language addressed to the conflict . The rule also offers the most equitable solution to this common problem, largely because the terms that are not standardized will be of primary importance to the contracting parties. As such, even though the knock out rule may not produce the express intent of the parties, it is the rule that most closely aligns with the purpose and application of U.C.C. section 2-207 in facilitating transactions between merchants. Finally, as businesses become more global in nature and the use of standardized forms as a means of furthering commerce continues to grow, the need for a uniform understanding of which terms apply to a contract agreement—even when that understanding may contradict the express intent of the parties—will be needed to promote a healthy and balanced commercial market.
