Every market goes through ebbs and flows of being competitive. And when these competitive markets occur, the WRA legal team often sees creative and sometimes risky contract drafting so buyers can present a competitive offer.
For example, a buyer wants to write a competitive offer without including an Inspection Contingency. Obviously, a buyer’s decision to proceed without an Inspection Contingency is a big deal. Therefore, the firm would be wise to have written acknowledgment from the buyer that indicates the following:
- The buyer directed the agent not to include an Inspection Contingency in the terms of their offer.
- The buyer understands the firm is not held to the same standard as a home inspector.
- The buyer is responsible for understanding the condition of the property without the help of an inspector by deciding not to include an Inspection Contingency in their offer.
Other examples of competitive and sometimes risky contract drafting in competitive markets include writing cash offers or offers that are not contingent on financing, offers without an Appraisal Contingency, or offers that include a price escalation clause.
In a competitive market, a price escalation clause would likely be included in the buyer’s offer when the buyer says to the agent, “I am willing to pay up to $X for this property, but I don’t want to offer it right out of the gate. If I end up in competition with another buyer, is there a way I can automatically increase the price of my offer up to a certain amount?”
There are different strategic theories as to why a price escalation clause is included in a buyer’s offer. Regardless of the theory, however, the WRA legal team is often asked about price escalation clauses, and so we offer the following 10 tips to help.
Tip 1
There is no standard form or language for an escalation clause, so there are often different versions of escalation clauses out there.
Tip 2
Escalation clauses are also sometimes called acceleration clauses.
Due to the fact that acceleration clauses are more commonly associated with mortgage documents, the WRA legal team has a tendency to refer to the clauses in real estate transactions as price escalation clauses.
Tip 3
There is one shared element to every price escalation clause: the buyer agrees to pay more for the property if the seller receives another equal or higher offer.
Tip 4
The basics of a price escalation clause include:
- Using only another bona fide offer to determine price.
- The maximum price to be offered.
- Requesting the seller provide copies of other offers directly to the buyer.
- Setting a time limit on when a clause may be used.
- Clarifying whether the price can increase multiple times or if it’s a one-time increase only.
- The timing allowed for other offers to be used to set the buyer’s price.
Tip 5
The seller can counter out escalation clauses.
The seller may not want to entertain offers with price escalation clauses and instead may choose to tell buyers to write their highest and best offer.
Don’t forget, listing agents must still present the offers unless the seller has provided specific instruction, preferably in writing, that they don’t want to entertain any offers with certain terms.
Tip 6
The seller may choose to respond with multiple counter-proposals when they receive multiple offers with escalation clauses.
For example, the seller may counter all buyers using a WB-46 Multiple Counter-Proposal to set a fixed price and remove the references to each buyer’s respective escalation clause.
Tip 7
If sellers and listing agents don’t understand how the price escalation clause works in a buyer’s offer, then they should either counter clarifying the terms or not accept the offer terms.
When an escalation clause is included in the terms of a buyer’s offer, the most common point of confusion sellers and listing agents complain of is whether the buyer’s price may escalate more than once. Again, if the seller and listing agent are unsure of how the escalation clause functions if the terms are accepted, then the language should be clarified via a counter-offer or multiple counter-offers, depending on the circumstances of the situation.
Tip 8
Agents should draft offers to purchase as instructed by the buyer.
When a buyer has asked the agent to include language in the offer that allows the buyer’s offered price to increase in certain circumstances due to a competitive situation with other offers, the agent would be able to explain the potential inclusion of an escalation clause. However, agents who do not have a full understanding of how escalation clauses work should be careful to offer this opportunity to the buyer. Additionally, the agent should speak with their supervising broker to see if the firm has a tried-and-tested escalation clause they have used in these circumstances.
Tip 9
The WRA offers the following example of an escalation clause:
“If Seller accepts this offer and receives one or more additional bona fide offers to purchase the Property with terms acceptable to Seller (Other Offers), prior to __________ (date) which result in Net Proceeds of Sale (purchase price minus any monetary contributions by Seller) payable to Seller equal to or greater than the Net Proceeds of Sale payable to Seller under this Offer, then the purchase price of this Offer shall automatically increase to an amount which generates Net Proceeds of Sale to Seller $ __________ in excess of the highest Net Proceeds
of Sale generated in such Other Offers.”
“The Purchase Price of this offer may be increased [ ] once [ ] more than once [CHECK ONE] (“once” if neither is checked) based on one or more Other Offers.”
“The purchase price of this Offer shall not exceed $ __________.”
“If the purchase price of this Offer is increased based on one or more Other offers, Seller shall, no later than __________, submit to Buyer a signed amendment to the Offer reflecting the adjusted Purchase Price and a copy of any Other Offers that resulted in, and were the basis for the increase to the purchase price of this Offer.”
“Buyer agrees to accept the amendment and deliver it back to Seller according to the delivery terms in this Offer and by the deadline for acceptance in the amendment.”
“Wis. Admin. Code § REEB 24.12 prohibits a licensed real estate agent from disclosing any of the terms of one prospective buyer’s offer to purchase, exchange agreement or option contract proposal to any other prospective buyer or to any person with the intent that this information be disclosed to any other prospective buyer. Accordingly, delivery of Other Offers must be conducted solely between Buyer and Seller or their attorneys and cannot involve their respective real estate agents.”
“[ ] Appraisal. If the appraised value of the Property is less than the amended purchase price but is at least $ __________, the amount financed shall remain as stated in any financing contingency in this Offer and Buyer will pay the difference between (i) the appraised value plus $ __________, and (ii) the amount financed in the financing contingency in this Offer. If the appraised value is less than $ __________, this Offer shall be null and void.”
Tip 10
The WRA has the following resources relating to escalation clauses:
Cori Lamont is Senior Director of Legal and Public Affairs for the WRA.