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Best of the Hotline: Price Escalation Addendum

By: Hank Lerner, Esq. on in  | 

PAR first published the Price Escalation Addendum (Form PEA) way back in 2008. The Standard Forms Committee resisted drafting this sort of form for many years, but finally relented after seeing example after example of poorly drafted clauses that were wreaking havoc in local markets. But this form – and even the general concept behind it – is one of the most misunderstood in the PAR forms library. You should review PAR’s guidelines for the form before using it, but let’s review a couple of the most common questions/complaints/misconceptions that we hear on the PAR Legal Hotline.

“The seller didn’t honor our escalation clause!”

This comes up in two contexts:

  • the escalation addendum goes up to $X, but the seller chooses to accept a different offer with a price lower than $X;
  • the escalation addendum goes up to $X, but the seller returns a counteroffer at a set price (we’ll talk more about price below) without invoking the addendum.

Attaching Form PEA is not a magic bullet that somehow overrides all the regular negotiation rules.

There is never a guarantee that the offer with the highest purchase price will be accepted in any transaction. A seller has the right to accept whichever offer they want, and if they don’t want the offer with the escalation addendum, they are free to accept another one regardless of the price.

Nor is there any requirement that a seller unquestionably accept all the terms and conditions of an offer that is presented. The seller can choose to tear up this addendum and counter at a set price in the same way that a seller could counter with a different settlement date or refuse to accept an appraisal contingency.

“How dare the seller counter at my maximum price when I’m sure there’s no competing offer that high?”

Life – and real estate – is a series of trade-offs. In a typical negotiation the buyer puts out their preferred terms, but keeps their “if I have to” terms close to the vest. Not so with this form. A buyer using Form PEA gets the benefit of an automatic escalation without having to do a direct back and forth negotiation, but it comes at the cost of telegraphing part of their strategy. If a seller chooses to not negotiate using the PEA, they can counter at any price they choose.

The first thing buyer agents often say is “It’s not fair to counter at the top price without a competing offer.” But why not? With or without an escalation addendum, if a buyer says “I’m willing to go higher” there’s no reason why the seller can’t ask them to actually go higher. Now…it’s a problem if the seller/listing broker lie about the competition and say they have a competing offer when they don’t, but that’s probably (though not always) why they tore up Form PEA in the first place, so buyers should probably consider that as part of their negotiating position.

“If there are multiple offers using Form PEA, the price automatically escalates to the highest one, right?”

No, sorry. That is not a correct reading of the form. Paragraph 2 says: “If one or more competing offers include similar price escalation terms, this automatic increase will be applied to the maximum escalated sales price of the highest competing escalation term, not to exceed the maximum purchase price stated above.” The key wording there is “the highest competing escalation term….” This doesn’t mean it goes to the highest of all the offers, but that it goes to one increment above the maximum of the second-highest escalation addendum (which is the ‘competing’ offer).

For example, assume there are three offers that would escalate in $1,000 increments to $210,000 – $220,000 – $230,000. If the PEA is invoked here, the sales price would be $221,000 – one increment over the second-highest offer.

“This is hard!”

Yes, it is. This sort of clause is difficult to write, and even harder to implement across all possible transactional variations. Many brokers have told us that they teach their agents to advise clients they should view Form PEA as an indicator of interest, but that it’s often better to just negotiate a clean agreement with acceptable terms (which is why we hear so many versions of the first two questions). This ultimately becomes a practical business issue for brokers, agents and clients to work through, but our best advice – with this form and any other one for that matter – is to educate yourself on how it works and to keep a clear and open line of communication with the other side to ensure that everyone is on the same page throughout the negotiations.

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Comments (6)

Comments

  • Kathy Opperman   September 4, 2020 at 8:47 am

    Hi Hank, thanks for talking about the escalation addendum which we are seeing a lot more in multiple offer situation‘s. Are used to teach the escalation of the offers the way you are stating in this article, however several of my agents have taken classes and have been told that all of the offers escalate to the top number in every offer. So I now teach that they all escalate to that top number. If this is not true like you are saying, then I am requesting we ask the Standard Forms Committee to modify the language for clarity. Currently it doesn’t say the price escalates over one other offer, it says the highest competing. Please consider having this language adjusted as it is causing great confusion in the marketplace. We have used it very successfully in hundreds of transactions by communicating what the seller thinks it means, which is that all offers escalate to the top number, and many buyers have won houses this way when other terms were also acceptable. Thank you!

    Reply to Kathy Opperman
    • Hank Lerner, Esq.   September 4, 2020 at 2:40 pm

      Here’s the simplest way to break it down (in my opinion). The terms of Form PEA can be paraphrased to “I’m willing to beat any other offer by $XXX, up to a maximum.” So no matter how many escalation addenda the seller has in-hand, or the specific numbers that are in each one, if a PEA is part of the final winning offer then the final price can only be $XXX higher than the next highest offer.

      Remember that a “competing offer” is defined in this paragraph as an offer “from another prospective purchaser.” The clause says that “this automatic increase” (i.e., the increase written down on this specific piece of paper that the seller intends to countersign) “will be applied to the maximum escalated sales price of the highest COMPETING escalation term. Since a “competing” term is already defined as one from another buyer it means that the parties look to the highest escalated price SUBMITTED BY SOMEONE ELSE, then apply the $XXX increment from this offer.

      Feel free to send this link to those instructors who are teaching it otherwise, and have them call PAR if they need to discuss further.

      Reply to Hank Lerner, Esq.
  • Doug Byler   September 4, 2020 at 9:54 am

    I some times see “No Escalation Clauses” in the agent comments, and have been told some brokerages have a blanket office policy to not allow offers with escalation clauses. Is that legal/ethical? If an escalation clause is submitted to a listing agent, I thought that it had to presented to the seller, regardless of an “office policy”. Naturally the seller can reject an escalation clause, but can an agent refuse to accept/present the offer based on their office’s policy? If the listing agent claims the seller instructed them not to take an agreement with an escalation addendum, is a buyer’s agent within their right to see that restriction in writing?

    Reply to Doug Byler
    • Hank Lerner, Esq.   September 4, 2020 at 2:49 pm

      This is a tough one, Doug. A broker can have an office policy that they won’t negotiate an escalation clause. But the tricky part is in how that’s implemented. If a broker wants to cut off a legit negotiating technique they’d need permission/instructions from the seller to do so. For example, a listing broker might say: “Before you list with me I need to tell you that you’ll hear about these cool things called escalation clauses and how you can make tons more money with them, but you should know that I consider them evil and I’m not willing to work with any seller who wants to consider them as part of their negotiating strategy. If you want to work with me I’ll need your permission to put ‘no escalation clauses’ in the MLS and an instruction to handle offers accordingly.” If the seller gets that shpiel, understands what it means, and moves ahead with the relationship then the broker is probably OK because the seller has agreed to that as part of the relationship. But if the broker just does it on his own without a client discussion it’s likely going to cause problems.

      Note that the same thing is true on the buyer side. There are plenty of buyer agents who might not want to write an offer with an escalation clause. If that’s worked out in advance then it may be OK, but it’s not going to go well if the agent just says “nope – won’t do it…and by the way you’re still under contract with me even though I’m refusing to use a legal strategy without discussing it with you first.”

      Reply to Hank Lerner, Esq.
  • Montana, Dianne   September 4, 2020 at 3:44 pm

    Hi Hank.. Thank you for another great article.. However, I’m with Kathy on this one! I think I was interpreting the language a little differently and based on what you are saying, I need to know if I am understanding this correctly since the guidelines do not address this. If you have 3 offers and they all have escalation clauses – to keep it simple, lets say increments are all 1,000 and they all max out at 235k. If the offers are 210/220/230.. are you saying that each offer only beats out the next highest offer? So therefore the lowest offer of 210 would only jump to 221k (even though the max is 235k)? I would have figured that in this situation, all offers would basically be tied at 231k! Please advise.. and thank you.

    Reply to Montana, Dianne
    • Hank Lerner, Esq.   September 4, 2020 at 5:13 pm

      Dianne:
      That’s a little different situation. First, if the two (or more) highest offers are ACTUALLY at the same top number (see the next comment), then they do cancel each other out simply because there is no way for either of them to be one increment higher than a competitor when both are at the same maximum. But it gets tougher if some of the offers contain an assist of some sort and others don’t, because the PEA escalates to an increment over the NET purchase price of a competing offer, so two offers with $235,000 as the maximum purchase price could actually be different once the assist is calculated in. One more reason why this isn’t a magic bullet form, and why a straight-up negotiation may be more effective.

      Reply to Hank Lerner, Esq.
  • Andrew Wetzel   September 5, 2020 at 2:06 pm

    There are always creative ways to try to get an edge and they all have pluses and minuses. Know your market. I tell buyers that there is no guarantee that they will get a second bite at the apple. While I won’t tell them how much to offer, I may suggest that they make their “highest and best” if the comps and “selling price to last asking price ratio” demonstrate that that may be needed. However, as a listing agent, you know that some buyers/ agents will do whatever they can to get a contract signed and then scorch the earth with inspection repairs. Let your client know the possibilities.

    Reply to Andrew Wetzel

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