Escalation Clause in Offer?

 Posted by at 7:49 am
Oct 232012
 

Every so often an idea will surface that sounds good at first, but deserves some critical thinking. A recent question from a student regarding an “escalation clause” in an offer to purchase serves as an example.

The student’s client had been advised to insert an escalation clause into her offer. For those unfamiliar with the concept, the escalation clause states that the buyer will offer $1000 (for example)  above any other offer the seller receives. The buyer (hopefully) “caps” this with a specific amount. The buyer was tempted to do this because she is in a “bidding war” with multiple offers being made on the property she wants to purchase. This approach might at first glance seem to guarantee she will “win” the war.

As the student correctly analyzed, a fundmental problem with this is it could require the seller’s agent to reveal terms of competing offers. Under Maine License Law and Rule, this would not be permitted without the permission of those other buyers.

Another interesting twist on this: what would happen if two buyers used the same escalation clause?

But beyond that and more importantly, it’s simply bad strategy.

If the buyer uses an escalation clause to effectively tell the seller “I will pay $1000 more than any offer you receive up to $100,000,” an astute seller would either negotiate accordingly or simply respond, “I’ll accept your offer of $100,000.” The seller is under no obligation to justify his or her offer based on receiving other offers.

One of the discussions I often have with buyers is that while negotiation is part of the process, we need to remember this is about purchasing a property–not about proving who is the best negotiator. In the example we are using, the buyer has established what the property is worth to him or her and announced it to the seller. Why not just offer what the property is worth right at the start?

Reverse the situation and it becomes obvious this is an ill-advised tactic. I do not know too many sellers who would inform a buyer, “The lowest offer I will accept is $100,000, but if you’d like to make a higher offer I’ll take that one.” An escalation clause with a cap equates to “The highest I will go, but if you’d like to accept less, I’ll do that.”

Even when there are multiple offers on the same property, this is not truly a “bidding war” because we are not conducting an auction. We simply have several buyers competing to purchase the same property. Also, the seller is under no obligation to accept the offer with the highest price–he or she might well consider accepting an offer with a lower price but better terms. For that matter, the seller is under no legal obligation to accept any of the offers.

If you are buying or selling property, ask the agent representing you to review all of the options both parties have in the negotiating process and remember what you are trying to accomplish.

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