Prevent Rising Costs with a Solid Escalation Clause

Buyers' Training
December 5, 2012 — 1,217 views  
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Prevent Rising Costs with a Solid Escalation Clause

An escalation clause is a device used in contracts to provide for situations where costs rise. In purchase contracts, both the seller and buyer anticipate that the cost of the product may increase in the future. The escalation clause provides a means of dealing with that potential rise in cost. Both parties are seeking protection and a properly drafted escalation clause can meet the needs of buyers and sellers.

For the professional purchaser, the concern is an increase in the cost of goods. For example, the contract may state that the cost of the goods is based upon some factor, like the wholesale price that fluctuates. This creates a situation where the costs of goods can increase to a potentially unsustainable price for the purchaser. The answer is an escalation clause that limits price increases or voids the contract if the price increases beyond a certain amount. Of course, the seller is going to want those price increases in order to maintain profit. Like all contracts, negotiation of the terms of escalation clause is essential to protecting one’s rights. The professional purchaser is no different.

Sellers only think about price increases and how to pass them on to purchasers in order to protect profits. Purchasers have to consider those increases but also need to think about price decreases. Many people think prices only go up but that is not true. A seller’s costs can go down and there needs to be a means for the purchaser to share in that decrease. A well-drafted escalation clause that spells out clearly and distinctly what happens in that circumstance protects the purchaser. Whether you are buying fruit for a grocery store or office supplies for a large corporation, a good purchaser seeks the lowest price. An escalation clause helps reach that goal by providing for the contingency of a price decrease at the wholesale level.

Negotiation of an escalation clause is an example of the art of compromise. Neither side will get all they want unless there is only one seller of a product or one buyer. Think through all the possibilities when drafting the escalation clause, no matter how remote the possibility. Most contract clauses only come into play in unusual situations so prepare for every contingency. Be prepared when a strike somewhere raises costs or an oversupply of a product decreases them. Make the escalation work for the purchaser and not the seller.

 

Buyers' Training