A purchase price escalation clause provides that an offer to buy real estate will automatically increase to exceed any other offer by a certain amount (see examples below). An escalation clause may be an effective way to make the highest bid; however, an escalation clause should be used only in appropriate circumstances and should be carefully drafted to protect the buyer.
Example 1: Escalation Clause Without Buyer Protections
A potential buyer really wanted to ensure her offer would be accepted. The buyer’s agent was eager to help the buyer come out on top in a very competitive market. The offer included the following provisions: Escalation clause $2,000 above highest offer. Non contingent upon inspection. Non contingent upon appraisal.
It is likely that this simple escalation clause would accomplish its purpose: the buyer probably would be the highest bidder.
What could possibly go wrong?
- The escalation clause did not include a cap, so the purchase price would automatically increase to an amount $2,000 above the highest offer, regardless whether the buyer was willing or able to pay that amount.
- The escalation clause was combined with a waiver of inspection, essentially offering to pay any price for the home regardless of its condition.
- The escalation clause was combined with a waiver of appraisal, essentially offering to pay any price for the home regardless of its fair market value.
- If another offer was submitted with an escalation clause, the two escalation clauses would result in the purchase price spiraling upward to $2,000 higher than the cap (if any) in the other offer.
- If the offer was accepted by the seller, and if the buyer was unable or unwilling to close the transaction, then the buyer would be at risk of losing all of the earnest money, or of being sued by the seller.
Thankfully, the buyer obtained legal advice before signing the offer, and chose not to proceed with the proposed escalation clause as written.
Example 2: Escalation Clause for Offer to Purchase Unique Property
All parcels of real estate are unique, but some are more unique than others. A family found an island the family wanted to buy. The island included residential and recreational areas. The family was able and willing to pay more than the fair market value of the island.
The family’s offer included an escalation clause, but the clause also included the following provisions to protect the buyer:
- If the seller received one or more additional bona fide offers with terms acceptable to the seller, but which resulted in net proceeds equal to or greater than the net proceeds payable under the offer, then the purchase price stated in the family’s offer would automatically increase to an amount which would yield net proceeds equal to $_____ in excess of the highest net proceeds under the other offers.
- This provision protected the buyer by taking into consideration not only the purchase price, but also other terms and conditions that would affect the bottom line.
- Notwithstanding any other provision to the contrary, the purchase price under the offer would not exceed $_______ — a specified amount (the “cap”).
- This provision protected the buyer by limiting the maximum amount of the purchase price.
- If one or more other offers caused the escalation of the purchase price, seller must provide buyer with sufficient documentation to justify the purchase price increase.
- This provision protected the buyer by requiring the seller to provide evidence if seller actually received a higher offer that resulted in a purchase price increase.
- The escalation clause also established a process for acceptance of the offer and documentation of the final purchase price, whether based on the initial offer or based upon escalation of the purchase price set forth in the addendum.
- This provision protected the buyer by establishing a framework to nail down the deal terms and prevent the seller from later increasing the purchase price based on an additional offer.
In many cases, an escalation clause is included in an offer to buy real estate because the demand for housing exceeds the supply, not because the property is unique. However, the same care should be used in drafting an escalation clause for an offer to buy a home as for an offer to buy an island. An experienced real estate attorney can assist a buyer with coordinating all of the terms and conditions of the offer to help achieve the buyer’s goals without undue risk.
Please Note: The information in this article is provided solely as general information and not as legal advice. Receipt of this information or its use does not establish an attorney-client relationship. Readers are urged to speak with a qualified attorney when making decisions regarding a specific legal issue. For questions about any issue regarding real estate transactions, please feel free to contact the author.