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Escalation Clauses in Real Estate Contracts

Legal Advice from NAR & the State Legal Counsel

 Legal, Tennessee Real Estate Commission, Tennessee REALTORS®

Published Saturday, October 3, 2020

Model House in Foreground with Blurred Gavel and Block in Background

When you're deciding on what price to offer on a home, the situation may call for a single price or, in some cases, an escalation clause. But what exactly is an escalation clause? We answer that question here for you in this primer.

The Tennessee REALTORS® Legal & Ethics Hot Line and have both provided members with advice regarding escalation clauses in real estate dealings.

For our members' convenience, we've compiled many frequently asked questions pertaining to escalation clauses. You may click the links below to skip to a specific question.

Escalation Clauses

First things first, what is an escalation clause?

An escalation clause is a real estate contract, sometimes called an escalator, that lets a home buyer say: "I will pay x price for this home, but if the seller receives another offer that's higher than mine, I'm willing to increase my offer to y price."

In theory, an escalation clause is fairly simple. In practice, there are a lot of details involved with this clause.

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How does an escalation clause work?

While escalation clauses vary significantly, the general escalation addendum has a few basic components:

  • What is the original offer of purchase price?
  • How much will that price be escalated above any other competitive bid?
  • What is the maximum amount that the purchase price can reach in case of multiple offers?

For example, buyer Brown offers $100,000 for a home or piece of real estate. Her REALTOR® adds an escalation clause that, in the case of a higher competing offer, will increase Brown's offer in increments of $2,000 above the competing offer. Her escalation clause goes up to a maximum of $110,000. If no other offers are submitted, Brown's offer remains at $100,000.

If buyer Green offers the seller $103,000, then Brown's offer would automatically escalate to $2,000 above that, bringing Brown's offer to $105,000. If buyer Orange offers $111,000 for the home, then Brown's maximum of $110,000 will be exceeded, and Orange will have the top offer.

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Will the seller accept an escalation clause?

Some home and real estate sellers simply state that they will not accept an offer with an escalation clause. They would prefer that every buyer submits exactly what they're willing to pay for the home or real estate. Sellers sometimes prefer this method, because it motivates buyers to outbid one another on the first try. It also streamlines the contract paperwork and the decision-making process.

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Will there definitely be multiple offers?

Escalation clauses should only be used when the buyer is fairly confident that there will be multiple offers, or when the buyer expects to pay an increased price. Buyers who submit an offer with an escalation clause are laying all their cards on the table: The seller knows immediately how far the buyer will go to secure the home. If that offer ends up being the only offer submitted, it technically remains at its original price.

A REALTOR® representing the seller will know, however, to counteroffer to the buyer at a higher, escalated price, since the buyer is clearly willing to pay more. While there's no guarantee that the buyers will agree to the higher price, it is likely that they will. A buyer gives up a lot of negotiating power and potentially leaves money on the table when using an escalation clause that goes unmet by a competitor.

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How should you handle an offer with an escalation clause?

The Tennessee REALTORS® Legal & Ethics Hot Line received the following question in 2013:

"Now that the market has heated up again, I have received multiple offers on a property I listed. One of these offers includes a clause stating that the prospective buyer will pay x over any other offer I receive. How should I handle this and what should I advise my seller-client? I've heard these kinds of offers are common in other parts of the country, but this is the first one I’ve dealt with."

The answer from Counsel is as follows:

"This is most often called an "escalation clause" …involving a fixed-price offer, but an additional statement that, if other offers are received, the buyer will exceed any other offers by a certain amount, often up to a "ceiling" price.

The type of offer to which you refer is difficult to handle appropriately. In order to accept an offer that is x percent (or x amount) over the highest bid, the purchaser will probably want proof as to what the highest price is (in a bona fide third-party offer) if such a price plus percentage offer were accepted and the listing broker then informed the offeror what the actual price would be after the addition of the percentage. To reveal this information to the potential purchaser making the offer with the escalation clause could place the listing broker in a possibly illegal and unethical position.

This is due to various statutes, the National Association of REALTORS® (“NAR”) Code of Ethics and an opinion from the NAR Membership Services department. First, the Tennessee Code Annotated ("T.C.A.") 62-13-402(3) indicates that information received by any licensee involved in a transaction (including the licensee on the opposing side of the transaction) that might be considered confidential is to remain confidential. Since the price offered by a prospective purchaser could reasonably be deemed confidential as to third parties, it should remain confidential.

Additionally, T.C.A. 62-13-402(4) states that a licensee has an obligation to treat all parties to the transaction with honesty and good faith. Therefore, it very well may be a violation of the cited statute for the listing broker to reveal to one potential purchaser what a different potential purchaser offered. Even if the identity of the buyer making another offer is "shielded," the very fact that one buyer’s offered price is revealed to a different prospective buyer, the latter statute above (62-13-402(4) could be interpreted to require that a listing broker then go back to all prospective buyers and reveal what other buyers were offering.

A much better and safer approach would be for a listing broker—who receives multiple offers, one of which has an escalation clause—to request that all buyers make their highest and best firm price offer or to counter the offer with the escalation clause at a firm dollar amount. The Tennessee Real Estate Commission has also, in the past, frowned upon escalation clauses."

NOTE: MAAR advises that you consult an attorney. If you do choose to use an escalation clause, have your attorney draft one.

SOURCE: Tennessee REALTORS® Legal & Ethics Hot Line. ↑ Back to Top ↑

Are escalation clauses illegal in Tennessee?

No, escalation clauses are perfectly legal however, it can be dangerous for a listing agent to do correctly. This can encourage a bidding war and an agent runs the very real risk of one of the offerors claiming that he "played favorites" with one over the others.

As an agent, you have a duty to "diligently exercise reasonable skill and care in providing services to all parties to the transaction" (Tenn. Code Ann. § 62-13-403(1)) and to "provide services to each party to the transaction with honesty and good faith." (Tenn. Code Ann. § 62-13-403(4)).

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If an agent submits an offer containing an escalation clause, can I refuse to submit it to my seller?

No. The Broker's Act states, "Unless the following duties are specifically and individually waived, in writing by a client, a licensee shall assist the client by receiving all offers and counter-offers and forwarding them promptly to the client." Tenn. Code Ann. § 62-13-404(3)(A)(ii).

TREC Rule 1260-2-.08 states, "A broker or affiliate broker promptly shall tender every written offer to purchase or sell obtained on a property until a contract is signed by all parties." Therefore, an agent must present all offers to the client unless they have instructed them not to do so in writing and signed by the seller.

Further, under Standard of Practice 1-6, "REALTORS® shall submit offers and counter-offers objectively and as quickly as possible." Standard of Practice 1-7 states in pertinent part, "When acting as listing brokers, REALTORS® shall continue to submit to the seller/landlord all offers and counter-offers until closing or execution of a lease unless the seller has waived this obligation in writing."

SOURCE: Tennessee REALTORS® Legal & Ethics Hot Line. ↑ Back to Top ↑

Does Tennessee REALTORS® provide language for an escalation clause in the forms library?

No. The forms committee through the years has decided that escalation clauses are too difficult to create standard language since each situation where an escalation clause would be used may be different.

For all Tennessee forms, visit Tennessee REALTORS®' Forms on the Fly page (login required).

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