De-Escalation Clause

By
Jason Fernando
Full Bio
Jason Fernando is a professional investor and writer who enjoys tackling and communicating complex business and financial problems.
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Updated September 28, 2022
Reviewed by
Robert C. Kelly
Robert C. Kelly
Reviewed by Robert C. Kelly
Full Bio
Robert Kelly is managing director of XTS Energy LLC, and has more than three decades of experience as a business executive. He is a professor of economics and has raised more than $4.5 billion in investment capital.
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What Is a De-Escalation Clause?

A de-escalation clause is an article in a contract that calls for a price decrease if there is a decrease in certain costs. It is the opposite of an escalation clause.

Key Takeaways

  • A de-escalation clause is a contractual provision that allows prices to be lowered after the contract is signed.
  • It is the opposite of an escalation clause, which allows prices to be raised.
  • De-escalation clauses can help ensure that contracts are fair and sustainable for both parties.

Understanding De-Escalation Clauses

De-escalation clauses are designed to ensure that the terms of a contract remain fair even if market conditions change after the contract is signed.

These clauses can be especially useful in situations where there is significant volatility in the price of the goods or services exchanged. For instance, shipping costs may be higher than normal when a contract is signed during times of unusually high oil prices. A de-escalation clause will correct for that by lowering the contracted shipping price if oil prices decline during the life of the contract.

The exact form of de-escalation clauses will differ depending on the industry. For instance, professional athletes might have de-escalation clauses in their contracts that reduce their pay if they do not play in the majority of regular-season games. An equipment maintenance company, on the other hand, might have a clause stipulating that its maintenance fees will be reduced if the value of the equipment being maintained depreciates in value.

Combining Clauses

De-escalation clauses are often used in combination with escalation clauses, to ensure fairness for both parties. For example, a transportation contract might contain clauses for increasing or decreasing the price of shipping based on changes in fuel prices.

De-Escalation Clause Example

For example, suppose a factory agrees to buy a component for $100 per unit at a time when the cost of producing that component is $80 per unit. Both parties agree that a 20% profit margin for the supplier is fair and will allow the supplier to continue honoring the contract for as long as the supplies are required by the factory.

But what if the cost of producing the component falls after the contract is signed, i.e. to $40 per unit? In that situation, the supplier’s profit margin would increase to 60%. The customer may feel that this situation is unreasonably expensive. If no change is made to the contracted price, then the factory could become increasingly tempted to look elsewhere for cheaper supplies.

To mitigate this, the parties can agree on a de-escalation clause stating that, if the price of supplying the components decreases after the contract is signed, some or all of that decrease will be passed on to the customer in the form of lower prices. This can help minimize contractual disputes and keep business flowing smoothly for both parties.