Escalation Clause Insurance: Everything You Need to Know
Escalation clause insurance is a method of protection against any major changes or other financial matters referred to in a contract or other type of agreement.3 min read
Escalation clause insurance is a method of protection against any major changes to costs, interest rates, or other financial matters referred to in a contract or other type of agreement.
What Is an Escalator Clause?
One of the provisions that may be included in a contract is called an "escalator clause," which allows one party to increase the prices or wages specified in the contract. This clause is often found in a labor contract, which may tie the increases to the rate of inflation. An escalator clause is also referred to as an "escalation clause." You can find escalator clauses in many different formats, allowing individuals to enter into long-term or large contracts with accommodations for shifts and changes within the market.
For example, a landlord might not wish to provide a long-term lease or rental agreement if rent prices are increasing in the area. By allowing a tenant to sign a long-term agreement, the landlord could lose out on property appreciation and higher rent potential. If the agreement included an escalator clause, the landlord can specify potential rent increases over each period and benefit from the existing market conditions. This agreement also benefits the person signing the agreement since they can secure a living arrangement on a long-term basis.
Some escalator clauses include caps on the increases that will be permitted. This type of clause may also include provisions for de-escalation.
Definition of De-Escalation Clause
If a contract includes a de-escalation clause, this section will outline how prices will go down for specific goods or services as the result of decreases in costs of materials, labor, or other factors. A de-escalation clause could include a stipulation around the reduction of maintenance fees if the item experiences a depreciation in value.
A de-escalation clause serves as the opposing factor to an escalation clause. This type of clause can offer protection for consumers to prevent them from paying extremely high prices during the terms of an agreement that may have been signed under different circumstances or conditions.
For example, when gas prices are high, transportation and shipping costs go up. If a contract was signed during a time with higher gasoline prices, the shipping costs might be higher than usual. Including a de-escalation clause in that contract example would allow the parties to lower the shipping rate as the prices of gas go down.
Escalator Clause in Real Estate
In a real estate agreement, you might see an escalator clause in a purchase agreement. In this application, the clause indicates that the potential buyer will increase their initial offer if any other offers are received. This clause would often include a cap on how high the increase will go.
For example, a potential homebuyer offers to purchase a house at a price of $300,000 but includes an escalator clause that they will increase their offer to beat out any other higher offers by $5,000. The clause also outlines the cap of $350,000, which means that buyer will only increase their offer up to $350,000. If another offer came in at $348,000, the terms of the clause wouldn't allow the buyer to add the $5,000 because that would take the price beyond the cap of the escalator clause.
Escalation Clause in the Construction Business
In the construction industry, escalation clauses in contracts refer to the cost of the materials for the project. If the costs rise to a certain point beyond what was originally agreed upon, the costs may be able to be passed to the owner of the project. In long-term and large construction projects, these types of clauses have been used for years. In the recent past, costs of construction materials have been steadily increasing, so many contractors are now using escalation clauses in all types of projects. These might include commercial mixed-use developments, single-family homes, and apartment buildings.
- One of the major factors causing the increase in construction material prices is a boom of building across the globe, especially in China.
- Another factor is related to the environment, as the loss of forest areas has driven up prices for lumber.
- Transporting the construction materials is also expensive, especially when fuel prices are high. With these potential fluctuations in pricing, escalation clauses are important in the construction industry.
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