Calling the local real estate market red-hot is like calling a bonfire
a campfire. Properties can sell within hours of going on the market. Some
properties sell for more than the listed price. Multiple offers are common.
What’s a buyer to do? Not wanting to be outbid, some buyers want
to use an escalation clause. How does that work, you ask?
An escalation clause is a provision in an offer which states the offer
will increase above the starting price if the seller gets another offer
higher than the starting price in the first offer. Escalation clauses
often contain other terms. The amount to be added above the competing
offer is usually one term. Many include a cap, above which the original
offer will not escalate
That may seem simple enough. A buyer can offer $100,000 with a clause that
says if the seller gets an offer higher than $100,000 the buyer agrees
to pay $500 more than the competing offer, but not to exceed $120,000.
The buyer thinks that will allow a lower offer than the buyer’s
top dollar but keep the buyer in the game if another offer comes in. How
does that look to the seller?
To the seller, an escalation can look like a game. The buyer is not willing
to make a top dollar offer even though it is a hot market. The buyer is
trying to get the property cheaper. That may not look like a buyer the
seller wants to work with. The seller might think, “the buyer is
a sharp operator and that worries me.”
The seller may have a hard time comparing offers. Closing costs, mandatory
repair clauses, a contract clause allowing a buyer to terminate the contract
and other provisions may not be identical in competing offers. For that
reason, some using escalation clauses provide that the offer will increase
to net the seller more than a competing offer. That means the seller has
to calculate “net.” More than a few sellers will be uncomfortable
making that calculation. It may be impossible to calculate, as when repairs
can be required.
A seller considering accepting an escalation clause offer has more to worry
about. Will the buyer agree the competing offer was bona fide? If not,
the escalation clause buyer may sue the seller and tie the property up
for months or years while the litigation proceeds. The seller pays thousands
of dollars in attorney fees and might ultimately win. If the buyer refuses
to close, most contracts limit the seller’s damages to the deposit.
If the seller tries to collect attorney fees from the buyer, the seller
might find the buyer is uncollectible. Even if the seller collects attorney
fees, the property has been off the market for months, the market may
have cooled in the interim and getting the deposit is nowhere near the
seller’s actual loss.
Some sellers focus on the escalation clause to the exclusion of other aspects
of competing offers. There may be a stronger offer on the table, albeit
for a little less money. In an effort to get a contract at the highest
price, the seller may come to regret passing on a stronger offer from
a more qualified buyer. That can be a problem for both parties.
A lot of sellers will not accept an escalation clause offer and many attorneys
counsel their clients to refuse them as well. They may seem like a good
idea to a buyer in a hot market, but escalation clauses also bring problems
One potential problem is being “gamed” by an unscrupulous seller
who provides a fake offer as the competing offer. How will the buyer know
if the offer the buyer outbid is really an offer? The buyer already told
the seller the buyer’s maximum price via the cap in the escalation
clause, so an unscrupulous seller might be tempted to create an offer
just below that cap.
Including a cap in an escalation clause tells the seller the buyer’s
top price. That does not leave any room for negotiation. It may allow
the seller to simply counter at that top price. In any event, the buyer
may be paying more than the seller would otherwise accept through a fixed
price offer. An escalation clause may also tell the seller the buyer is
committed to purchase and is not willing to walk away. That may hamper
future negotiation if the escalation clause offer is not accepted but
the parties continue to talk.
Escalation clauses can help create a contract. Escalation clauses can also
create problems and in some cases interfere with creation of a contract.
Before using an escalation clause, a buyer (and a seller) should consider
all aspects of the situation and make sure he or she understands pros
and cons of the clause. Because escalation clauses are more complex than
they appear at first blush, this could be one time where consultation
with an experienced real estate attorney is priceless.
Escalation clauses are not necessarily the best course in a hot market.
If used, they should be used with caution.
William G. Morris is the principal of William G. Morris, P.A. William G.
Morris and his firm have represented clients in Collier County for over
30 years. His practice includes litigation and divorce, business law,
estate planning, associations and real estate. The information in this
column is general in nature and not intended as legal advice.