Understanding an Escalation Clause
An escalation clause is phrasing in a contract that is sometimes used to strengthen a buyer’s position in a multiple offer situation. The basic idea is that the buyer offers to pay a certain amount more than their current offer if there are multiple offers. Often, when we see them, the escalation clause states something along the lines of “buyer will pay $1,000 more than the highest offer if other offers are present.” Obviously, wording may vary, but we see similar wording to this and it’s important to note (as we will explain below).
Escalation clauses are used to shore up an offer by the buyer and try to guarantee that the seller will pick their offer over all others. By putting a monetary figure in there, the buyer is essentially making their offer look better than all others, because they are willing to pay more than anyone else.
The Dangerous Game of an Escalation Clause
While it may seem like a good move to secure the buyer their dream home, an escalation clause has a dangerous side to it that many don’t consider. By agreeing to pay an amount higher than other offers, the buyer is locking themselves into a potential disaster. What if the seller suddenly gets an offer that is $10,000, $20,000, $100,000 more than the buyer’s original offer price? Now the buyer is on the hook for their offer price, plus the other offer’s increase in price, and whatever amount they used in their escalation clause (in our example above, $1,000). That’s a lot of money. Hopefully the buyer elected to have an option period so that they could terminate the contract if they don’t want to spend that much. We’ve even heard of cases where offers were made by friends of the seller in order to bump up the price, even though the friends making the offer have absolutely no intention of buying the home.
The other danger in escalation clauses, is the unlicensed practice of law. In Texas, real estate agents are forbidden from practicing law without a license and the wording of these clauses can be construed as practicing law. This can land an agent in a lot of hot water with the Texas Real Estate Commission. The Texas Association of REALTORS® has even made a video about it so that agents don’t forget.
If you are a buyer and find yourself in a multiple offer situation, the best way to deal with it is to make what we call “your highest and best” offer. It will keep you from being pushed to a higher price than you might be ready for and it will keep your agent from breaking the law.
image courtesy of Nick Harris1
The example used is a terrible example of escalation clause. Obviously if all someone said was they offer $1000 more than all other offers there may be issues. The well written escalation clause includes a cap on how high the buyer is willing to go. A better example is that a buyer offers a certain price, but if other offers are received which are the same or higher, then the buyer agrees to increase their bid in increments of $1000 up to a total offer of $x. Until TREC drafts an addendum for realtors to use with escalations then it looks like our options are limited.
But if attorney drafts an escalation clause for use, I presume it is OK?
Yes and no. There is a bit more info about the circumstances that would need to be answered before a definitive yes or no answer could be given. Check out this article from TREC about escalation clauses in Texas and an attorney’s involvement (PDF file).