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Some prospective buyers may encourage their agents to add escalation clauses in their offers in order to obtain a competitive advantage. A prospective buyer announces their willingness to pay a particular amount more than the highest competing buyer in an escalation clause. The escalation clause may or may not specify a maximum price that the buyer is ready to pay.
Escalation provisions are discouraged by the Commission, although they are not prohibited. “A broker shall not reveal the price or other material terms contained in a party’s offer to purchase, sell, lease, rent, or option real property to a competing party without the express authority of the offering party,” according to Commission Rule A.0115. In the uncommon occasion that a buyer agrees to enable a broker to disclose the price and terms indicated in their offer with another prospective buyer, the broker may do so then and only then.
Escalation clause pitfalls:
If a buyer submits an offer with an escalation clause without knowing the price and terms of the other offers or stating a limit price, the buyer may end up paying far more than anticipated for the property.
If a buyer specifies a maximum price in an escalation clause, the seller will know the buyer’s top price right away, thereby jeopardizing the buyer’s negotiation position.
An escalation provision in an offer may not be enforceable until a specific price is written into the contract and the buyer sees the price that the seller has stated.
For a buyer who applies an escalation clause, the seller may construct a phony bid in order to drive up the sales price.
Escalation clauses cannot be written by real estate brokers since doing so would be considered the unlicensed practice of law. It is advised that the buyer hire an attorney, however this will increase the buyer’s fees. To safeguard the seller’s rights, an offer with an escalation clause should be reviewed by an attorney.
A bidding war could ensue if many purchasers include escalation clauses in their contracts. No contract is ever formed and no property is ever sold if no buyer is willing to commit to a fixed price.
Because the introduction of an escalation clause implies that a potential buyer is willing to pay more than other bidders, it may encourage sellers to seek higher prices, which is a disadvantage to the buyer.
While the usage of escalation clauses may result in higher sales prices, which is beneficial to sellers, they may also dissuade purchasers who do not want to employ them. Escalation clauses can lengthen the negotiation process, which can be a disadvantage for both sellers and purchasers.
A buyer who loses a deal because another buyer invoked an escalation clause may believe they were treated unfairly. The buyer’s sense of unfair treatment may deter him from buying property in the future, and he may submit complaints against the brokers involved in the transaction.
The Commission may take disciplinary action against a broker who reveals the price/terms of an offer without the buyer’s approval or otherwise provides one party an unfair advantage over another.
In a multiple offer situation when one or more buyers are employing an escalation clause, a seller’s best approach is to ask all purchasers to submit their highest and best offers. This allows each buyer to purchase the property at the price and terms that he or she is prepared to pay, and the seller to receive the best offer from each buyer rather than an incremental offer from a buyer who wishes to offer slightly more than a competing buyer.
Price is usually the focus of escalation clauses. When advising seller-clients to consider more than the sales price in an offer, listing agents should be cautious. A lower-priced offer from a well-qualified buyer may be preferable to a higher-priced offer from a less-qualified bidder. Similarly, a buyer who has seen the property before making an offer may be favored over one who offers a high price before seeing it.
Brokers should exercise considerable caution when using escalation clauses. Even without such stipulations, real estate purchases are complicated. Real estate transactions can be even more frenetic in hot markets with minimal inventory. Confusion, worry, annoyance, and fraud may result from the use of such phrases. For these reasons, the Commission discourages their use and the disclosure of competitive offer terms, even when buyers have given permission.