That Escalated Quickly: Pros and Cons of Escalation Clauses in Purchase Agreements

An escalation clause or “escalator” is a provision in or an addendum to a purchase agreement, that allows the buyer’s offer to increase (escalate) the purchase price they have offered up to a maximum amount in the event that the seller receives another offer. 

For example, Zach makes on offer on Mia’s house for $250,000 and adds a clause to his purchase agreement escalating Zach’s offer to $100 more than any offer over $250,000, up to a maximum purchase price of $280,000. Charles then offers $260,000 for the house, which automatically escalates Zach’s offer to $260,100

The following terms are typically included and defined in an escalation clause:

• the “escalating factor”: the amount in excess of a higher, competitive offer; 
• the “cap” or “ceiling amount”: the maximum limit or amount the buyer is willing to offer for a purchase price;
• “multiple escalations”: the buyers acknowledge that there may be multiple escalations, up to the cap or ceiling amount. 

The escalation clause should contain detail regarding the escalation increase procedure(s).  Example options include:

1. the loan amount provided for in the offer shall remain the same, and the buyer shall pay any increase in cash at the time of settlement; 
2. the down payment amount provided for in the offer shall remain the same, and any increase shall be added to the loan amount;
3. the loan amount provided for in the offer shall automatically increase to be ______% of the new sales price of the property; or
4. the loan amount shall not exceed $________ and the buyer shall pay any amount of the increase in sales price which is not included in the loan amount in cash at the time of settlement. 

Escalation clauses also include provisions for termination of the escalation clause, a disclaimer that the buyer holds their agents and their brokers harmless with regard to the negotiation of the sales price, and the procedure for accepting a counteroffer from the seller.  

Escalation clauses have gained popularity since the COVID-19 pandemic has made the real estate market even more competitive. 

Buyers who want to ensure their offer is a winning one are making more use of escalation clauses because it can be a helpful tool when buyers know there will be multiple offers or when the buyer expects to pay an increased price. In the event of a bidding war, a buyer might be inclined to use an escalation clause to help secure the sale. Sellers who want to minimize back-and-forth negotiations appreciate the immediate increased off that escalation clauses inherently provide.  

Full disclosure of a buyer’s maximum offer can be a strategic drawback for a buyer in their negotiations with a seller. Buyers should also consider that an escalation clause on the initial offer in a multistage negotiation could be strategic drawback if that offer is disclosed to other potential buyers. Additionally, sellers may have little incentive to lower a potential counter demand after knowing the maximum the buyer is willing to pay. Buyers should be aware that each scenario is different, and there are incentives and drawbacks to limiting the ability to negotiate their offers. 

Sellers also face risk in receiving offers with an escalation clause. Escalation clauses do not guarantee a better offer for sellers. Offers from other buyers may be more advantageous to a seller, even if the purchase price is lower (i.e., cash offers, no inspection, less seller contribution to closing costs). When discerning between different offers, some with escalation clauses, some without, sellers must carefully evaluate which offer is truly best. 

Another potential disadvantage of escalation clauses for sellers is that a buyer may not make an offer if he knows a previous offer includes an escalation clause. In a recent article, the National Association of REALTORS® (“NAR”) analyzed how buyers are coping in a highly competitive housing market. NAR discussed that among reported buyers who declined to make an offer on a house, 35% of those reported buyers did not make an offer once they knew there were already multiple offers on the property. NAR explained that this could be because the buyers could no longer make an offer that was below the listing price or the buyers anticipated escalation clauses. 

If the escalation clause is drafted poorly and does not require that the competing offer be verified, the buyer risks the seller or others on the seller’s behalf manipulating the purchase price with sham offers to drive the price up. Further, the buyer risks an expensive surprise if the escalation clause fails to include a maximum purchase price amount. The careful drafting of the clause for a thorough analysis of probable outcomes and strategies in the current market is critical to preventing unintended outcomes.