Five Best Practice Tips for an Escalation Clause
May 11, 2018 |
With a tight seller’s market, the use of escalation clauses is on the rise to give buyers an advantage over other competing buyers. Unfortunately, poorly worded escalation clauses can hurt your client and leave you at risk. Below are some tips to consider before recommending your client use an escalation clause.
What is an escalation clause?
An escalation clause is a buyer’s offer to raise the proposed purchase price over that of another competing offer.
Ex: In a transaction without an escalation clause, your client offers $250,000. If another competing offer comes in, at substantially similar terms (financing and inspection contingencies), at $252,000, the latter is likely to get the deal. Now if the initial offer contains an escalation clause offering $3,000 over any competing offer, up to a cap of $260,000, then the offer would escalate to get the house at $255,000.
1. Make Sure There is a Cap
If you write an escalation clause, make sure there is an upper limit to what your buyer is willing to pay. This way your client’s offer does not escalate beyond the upper end of their budget.
2. Include a Benchmark
All offers are different. Some contain commission reductions, others include seller paid closing costs. Consider using the term “net offers” for comparison of purchase offers and then defining what a “net offer” is. This allows the Seller to compare apples to apples and only escalate if the net offer is higher than your client’s offer.
3. Bona Fide Offers
To prevent an inside offer that escalates your client’s offer, make sure to include a provision that requires the other offer to be bona fide or arm’s length and that you be provided sufficient documentation to confirm the other offer.
4. Identify the Starting Point
Make sure you identify what offer is to be escalated, the purchase price or a competing escalated purchase price. If it escalates from a purchase price in increments of $2,000 and a competing offer escalates from the purchase price in increments of $3,000, the higher increment will win. But, if it escalates from a competing escalated offer and has a higher cap, the one with the higher cap will win.
5. Consult with Counsel
In some jurisdictions, drafting escalation clauses may be deemed the unauthorized practice of law. Consider retaining legal counsel to draft form escalation clauses for your practice. This way, you’re best protecting your client and yourself in using these clauses.
The proper use of escalation clauses may just give your buyer clients an edge in this tight market. Consider these tips when discussing and using escalation clauses in a transaction, to avoid confusion and potential liability for poorly drafted clauses.