Contract Escalation Clause Example: Everything to Know
A contract escalation clause example provides a framework for including in a contract a language for an increase in payments should material costs increase.4 min read
2. Components of an Escalation Clause
3. Benefits and Drawbacks for Buyers
4. The Role of the Escalation Clause in Offer-Review Process
A contract escalation clause example can provide suppliers and purchasers with a framework for including language in a contract that provides for an increase in payments should material costs increase. As is in the case with any clause existing in a contract, a contract escalation clause is a negotiable item between the parties, and often relies on compromises made by each.
The Escalation Clause in Real Estate
A contract escalation clause does not merely protect the purchaser of goods or products should material costs increase, but can protect the supplier if costs significantly decrease. This is often called a “two-way escalation clause.”
Another example exists in property contract negotiations. In these cases, the escalation clause, also called an escalator, protects an early bidder for a property against being shut out by a later-arriving higher bid, and the property owner from missing out on getting more money for the property. An example might be the early bidder agreeing to pay a set price above the original bid only in the case that the property owner is presented with a late bid higher than was accepted from the early bidder. Both the amount at which the clause kicks in and the amount over the original bid can both be negotiated.
Components of an Escalation Clause
Although an escalation clause appears simple, in practice, the devil is in the details. Regardless of the fine points negotiated between the parties, almost all escalation clauses address the following issues:
- How much is the contract worth as initially negotiated?
- How much will the price be escalated above or de-escalated below any other costs or competitive bids?
- What is the highest price that the original party will agree to or be required to pay, especially in the case of multiple bids?
Benefits and Drawbacks for Buyers
Escalation clauses offer both advantages and disadvantages to a party interested in purchasing property:
- Benefit: Provides a degree of protection when expecting multiple bids. Buyers would pay a negotiated amount at a predetermined rate of increase to meet each new bid.
- Drawback: Reveals the top amount they are willing to offer and thus allow competitors to know how high to set their bid. This may especially be true if the seller has negotiated a 72-hour clause in the agreement and can share the offer with other bidders.
- Benefit: If the first offer is the only offer, the price will not increase.
- Drawback: They may, in a sense, compete against themselves by giving the seller a negotiating upper hand by showing the top price they can ask before the buyer will walk away.
The Role of the Escalation Clause in Offer-Review Process
Depending on the home-buying market, the offer-review process for property can change.
When it’s a seller’s market, the decision-making process often covers the first week after a property has gone on the market, typically Friday to the following Thursday to allow for weekend traffic. With a deadline for a decision, a buyer has an advantage because they know the seller will take all offers and close the bidding. If there is an escalation clause, and the highest bid doesn’t exceed the amount negotiated in the clause, the buyer is protected against losing the property.
However, there is always the possibility that the seller will review all the offers over the first week and then come back to all the buyers who made competitive bids to ask for a final bid, hoping to drive the price for the property higher. Naturally, buyers aren’t in favor of this process because things are in a state of flux and the footing shifts as each potential buyer reassesses how much they want the property and high how they are willing to go.
In this case, an escalation clause with the first offer puts the buyer at a disadvantage when the bidding reopens in the second week. The seller’s agent may legally reveal the top bid of the escalation clause to all potential buyers and thus give all parties a base from which to start their new bids.
Before considering adding an escalation clause into any offer you make on a property, make sure you understand the role of a buyer’s real estate agent and that your agent has a thorough grasp of property values. It would also come in handy if your agent has a history of working with the seller’s agent to gauge the approach that agent may take. Knowing the market cannot only save you money, but also potential heartbreak if you lose a property you cherish.
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