What Is an Escalator Clause?

Daniel Liberto is a journalist with over 10 years of experience working with publications such as the Financial Times, The Independent, and Investors Chronicle.

Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.

Michael Rosenston is a fact-checker and researcher with expertise in business, finance, and insurance.

What Is an Escalator Clause?

An escalator clause is also called an escalation clause and a contract provision that allows for an increase in the agreed-upon wages or prices if certain conditions change while the contract is in effect.

A labor contract may be adjusted based on an increase in the inflation rate. Additional expenses may trigger an adjustment to a business-to-business contract. A landlord may demand an escalation clause in a long-term rental agreement to cover tax increases.

Key Takeaways

• Escalator clauses allow for an automatic increase in wages or prices if certain specified conditions change in the future.
• These clauses allow people to enter into long-term contracts without worrying that changes in business conditions could make the agreement unfavorable.
• An escalator clause is commonly called an escalation clause.

Benefits

An escalator clause allows individuals to commit to long-term contracts without worrying that changes in external circumstances could hurt them. It ensures that contracts remain fair to all parties involved. Escalator clauses are often championed by labor unions, which demand that wage increases in employment contracts be tied to inflation.

Escalator clauses are found in business contracts of companies that supply goods or services with costs that are prone to fluctuations. For example, shipping charges can swing dramatically depending on volatile oil prices.

If rents are increasing rapidly, a landlord may hesitate to sign a long-term rental agreement or lease, since they could lose out on higher rents. An escalator clause allows rent to increase by a specified amount each period, allowing the landlord to benefit from current market conditions and the renter to secure a long-term arrangement.

Escalator clauses may contain de-escalation provisions, which allow for a price decrease if certain costs decline.

Example

In real estate, an escalator clause may be attached to an offer on a home, indicating that the potential buyer is willing to increase the bid should higher offers be received.

If a buyer makes an offer of $400,000, an escalator clause could specify that if a higher offer comes in, the buyer will beat it by $3,000, but only up to $427,000. If an offer of $405,000 is tabled, the escalator clause would trigger a new offer of $408,000. Alternately, if a competing offer comes in at $429,000, the escalator clause would not allow for a new offer adding $3,000 since the clause specifies a cap of $427,000.

What Is an Escalator Clause in a Labor Contract?

A labor agreement may indicate that the agreed-upon wages will increase over time to match an increase in the Consumer Price Index. In other contracts, such as an agreement for a construction project, the current price of building materials will be listed along with an escalator clause indicating that the actual prices may change.

Why Are Escalator Clauses Debated?

The use of escalator clauses in employment contracts is often debated. Unions commonly argue that these provisions are necessary to protect workers against a potential loss of purchasing power over time. Some economists may argue that escalator clauses worsen the inflation they are created to relieve.

What Is an Escalator Clause in a Business Contract?

In a business contract, an escalator clause protects a contractor from unpredictable increases in the prices of the necessary supplies. The current prices of key materials are stated in the contract, with the proviso that actual prices may be different.

The Bottom Line

An escalator clause is commonly called an escalation clause. It is a provision that allows for increases in wages or prices if economic conditions change throughout the contract. This clause is found in labor and real estate contracts.

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