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Escalation Clause (What It Is And Why It’s Important)

What is an Escalation Clause?

How do you legally define it?

What are the essential elements you should know!

Keep reading as we have gathered exactly the information that you need!

Let’s dig into our contracts and contracting knowledge!

Are you ready?

Let’s get started!

What Is An Escalation Clause 

An escalation clause, also called an escalator clause, is a contractual provision allowing the contracting parties to increase, adjust, or alter the price when certain conditions are met.

For example, a contractor may enter into a contract to build a property by including an escalation clause allowing it to increase prices should the cost of material goes up or for inflation.

Another example could be escalation clauses included in commercial lease contracts.

In a long-term commercial lease, the landlord may want to include an escalation clause allowing the rent to be adjusted based on an escalation rate or price increase factor.

Having an escalation clause allows for the contracting parties to aim for a much longer contracting term and ensure that the contract fees, prices, rates, or other financial considerations remain fair over the entire span of the contract. 

When the “escalation” conditions are met, the contract price will automatically get adjusted to the required rate.

In some cases, to avoid a perpetual increase in prices, the contracting parties will agree to an escalation cap or a maximum limit beyond which the escalation provision will no longer take effect.

Once the cap is reached, the price will no longer get adjusted or get increased over time.

Escalation Clause Definition

According to Investopedia, an escalation clause is defined as follows:

A provision allowing for an increase in wages or prices.
Author

As you can see from this definition, the escalation clause is a type of contractual clause allowing the parties to:

  • Increase wages
  • Increase prices 

In other words, the contract provides a mechanism allowing the contract price to be adjusted if certain conditions are met.

Escalation Clause Example

What are some price escalation clause examples that we can consider to better explain the notion of escalation provision.

Depending on the nature of the contract, escalation provisions can take many different forms.

Let’s look at a few different types of agreements.

Lease Agreement

In a lease agreement, the lease escalation clause or rent escalation clause can stipulate that the tenant will pay the landlord a higher amount of rent, starting from the anniversary of the agreement, adjusted for inflation plus 3%.

For example, if the tenant agrees to pay $10,000 in rent this year, then next year, the tenant must adjust the rent by inflation (say inflation was 3%) and an additional 3% totaling a 6% adjustment.

This means that the rent for next year will be $10,600.

Then, the year after, the same exercise will be done.

Collective Bargaining Agreement

Labor unions can use the escalation clause to contractually provide for the increase of the employee wages during the term of the bargaining agreement.

In other words, if the labor union and the employer agree that the employees’ wages will increase by 5% every year, we can consider this to be an escalation provision allowing for the increase of the employee wages.

Long-Term Construction Project

A contractor looking to work on a long-term construction project may want to include a clause to escalate price in the event of volatility or fluctuations in the cost of the material.

In other words, if the contractor has estimated the project cost based on today’s material cost, he or she will put an “escalation” clause allowing it to charge the client more to reflect the increase in the price of the material.

In construction projects where the purchase of the material represents a significant factor, this clause may end up saving the contractor in case of wild fluctuations in costs.

Escalation Clause Real Estate

What Is An Escalation Clause In Real Estate

An escalation clause in real estate works in a slightly different way than in general contracts.

An escalation clause in real estate is a type of clause a buyer may include in a purchase offer informing the seller that he or she is prepared to pay a higher purchase price should the seller receive another competing offer.

Typically, the real estate escalation clause will establish by how much the buyer will want to increase the offer should a competing offer be received by a seller and there is usually a maximum cap that is established.

The maximum cap represents the highest price the offeror is willing to pay to purchase the property when there are multiple bids.

Real estate escalation clauses are quite useful in sellers’ markets as you will have many buyers competing for the same property.

When that happens, the buyer who really wants to acquire the property (or win the bid) will need to find an expedited process to have the offer price “escalate” to match and even slightly exceed the highest bidder.

How Does It Work

The real estate escalate clause will generally include:

  • An escalating factor
  • A cap
  • Disclosure of information
  • The number of escalations possible

This means that the offeror will include in the purchase offer a provision allowing the offered price to be escalated by a certain factor or based on a certain formula.

For example, the buyer can say that he or she will match the highest bid and increase it by $5,000.

The second element is the escalation cap establishing the highest possible price at which the buyer is willing to buy the property.

The third element is the seller’s disclosure of a bona fide third party offer.

This means that the seller cannot just claim that another person has made an offer but will have to disclose or prove that a competing offer has been received (proof of a bona fide offer).

The fourth aspect is the number of times the buyer is willing to trigger the escalation factor.

In some cases, the buyers will only want to escalation provision to get triggered only once while in other cases they may allow for multiple escalations.

Key Considerations

There is no doubt that in hot and booming markets, a buyer may find it useful to leverage escalation clauses to increase the odds of winning a bid, particularly when 10, 15, 20 other bidders are all engaged on the same property at the same time.

There are many benefits and drawbacks in using legal tools such as an “escalation clause”.

Here are some of the key factors and considerations you should keep in mind:

  • Will the seller accept an escalation clause or reject your offer?
  • Are there multiple offers on the property requiring that you use an escalation provision?
  • By including an escalation factor, will your offer stand out?
  • Do you have the funds necessary to purchase the property if the price is escalated?
  • Do you have enough cash to fund the appraisal gap?
  • Will your escalation clause keep you within your anticipated budget?

Escalator Clause Takeaways 

So, what is escalation clause?

How does an escalation clause work in real estate?

Let’s look at a summary of our findings.

Define Escalation Clause

  • An escalation clause, also referred to as an escalator clause, is a contractual clause allowing the parties to adjust certain financial elements of the contract
  • For example, an escalator provision can allow a landlord to increase rent over time, an employee to be entitled to a higher salary over time, a contractor to charge more for fluctuations in the cost of material, supplier to charge more based on increases in the cost of goods, etc
  • In real estate, the escalation clause allows a buyer to place an offer on a property and allow for the offered purchase price to be automatically adjusted as a means to beat the competition in cases where multiple offers may be received by the seller 
  • Depending on the nature of the contract, you’ll need to assess whether the use of the escalation clause is worth it or not and ensure that the clause contains the proper elements to give you the desired outcome 
Acceleration clause 
Coinsurance clause
Contingency clause
De-escalation clause 
Defeasance clause 
Due on sale clause
Force majeure clause 
Gold clause 
Grandfather clause 
Habendum clause
Hammer clause 
Hold harmless clause 
Loss payee clause
Military clause
Most favored nations clause
Nondisturbance clause
Nonforfeiture clause
Release clause 
Safety protection clause 
Set off clause 
Subordination clause 
Subrogation clause
Author
Appraisal contingency 
Asset value vs market value 
Buyer’s remorse 
Contingency vs pending 
Dual agent in real estate 
Preapproval letter 
Private mortgage insurance
Purchase offer 
Real estate agent 
Real estate assumption 
Real estate contract
Right of first refusal 
Seller financing 
What is a buyers’ market
What is a counteroffer 
What is a sellers’ market
Author

Editorial Staff
Hello Nation! I'm a lawyer by trade and an entrepreneur by spirit. I'm passionate about law, business, marketing and technology. On this blog, I share my experiences, provide you with golden nuggets of information about business, law, marketing and technology. Enjoy!

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