On Knock-for Knock Clauses and their Optimal Regulation

This article addresses two topics in relation to knock for knock contracts. The first topic is the nature and purpose of knock for knock clauses, and why we observe them in some sectors of the economy and not in others. Why, for instance, do we observe knock for knock contracts mainly in the offshore rather than in the onshore oil and gas sector? I will argue that the answers given in the literature are not entirely satisfactory, although they contain some of the elements for an explanation. Instead, I suggest a simple model that can be used to think about when liability exclusions are optimal.
The other topic is the one raised by Parchomowski and Stavang (2015): when should courts uphold unqualified knock for knock contracts? I broaden this question by inquiring not only what courts but also what lawmakers and public regulators should do to implement an optimal regulatory system. My point will be that civil fines are meant to exactly counteract such shortcomings of parties’ contractual arrangements that may arise when the parties do not adequately take into account the effects of their contracts’ incentive provisions on third parties. Instead of striking down unqualified knock for knock clauses when an injurer has acted with gross negligence, I suggest that fines for such gross negligence should rather be increased. Fines can do as good a job at securing incentives as liability for gross negligence and do not jeopardize the significant savings of dispute costs that are associated with certainty of enforcement of knock for knock clauses.