When Is an Escalation Clause Beneficial?

Buyers' Training
June 20, 2013 — 1,888 views  
Become a Bronze Member for monthly eNewsletter, articles, and white papers.

When a contract includes a provision to adjust prices in the occasion of fluctuation in certain costs, it is known as an escalation clause. This clause is also known as “rise and fall” and it allows your offer price to automatically rise by a particular amount in case another offer or bid is given that is more than the one given by you.

When is it Necessary

The escalation clause becomes quite necessary in dredging contracts where there exists a risk of fluctuations in prices or labor, steel, and fuel. The price of steel has seen a stark rise since 2004. It is quite an essential factor in dredging prices, as steel is used by contractors to construct new vessels.

Fuel is also another major factor covered by the escalation clause. The price of fuel tends to be very volatile due to the political unrest in the Middle East and parts of North America. Even the slightest rise or fall in the price of fuel can affect a dredging contract. The same goes for labor costs. An increase in the employment cost index indicates increasing pressures of inflation. This is because companies usually pass on the increased labor costs on to the clients by way of higher prices.

While preparing the tender, the dredging contractor needs to estimate the cost of wages, steel, and fuel. The contractor also evaluates the relevance of an escalation clause that can protect against the fluctuation in prices during the term of the contract.

Apart from dredging contracts, the escalation clause also can be necessary for real estate deals, especially in multiple contract situations. Escalation clauses give you a chance to compete with other offers on the same purchase and win them as long as your offer is the highest.

The Underlying Benefits

This clause is especially useful when a buyer is expecting to compete with other possible offers. The escalation clause says that the individual making the purchase is ready to outdo a counter offer by another potential buyer by a certain amount. A bid situation, where you obviously expect other buyers to compete for the purchase is the best scenario in which the escalation clause can be useful.

By using this clause, the buyer can bargain for the purchase and he also gets to spend the amount he intends to – not more. The need for an escalation clause must be carefully evaluated by the buyer in a given situation. Investigate the kind of competition you are up against with the listing agent. Other factors that can help you decide are available finances, risk factors, market value, and competition.

The escalation clause is very common today especially in dredging contracts. It helps cover unexpected price fluctuations in obscuring labor, fuel, and raw materials while a construction project is going on. It is advisable to have an escalation clause in a dredging contract that is expected to last for more than a period of 3-6 months. This can take off the speculation from the contractor’s tasks and help concentrate on the proposed work instead.

Buyers' Training