What Is an Escalator Clause? Definition, How It Works and Example

Escalator Clause

Investopedia / Joules Garcia

What Is an Escalator Clause?

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

An adjustment to a labor contract may be triggered by an increase in the inflation rate. An adjustment to a business-to-business contract may be triggered by an increase in expenses necessary to fulfill the agreement. A landlord may demand an escalation clause in a long-term rental agreement to cover any tax increases or a substantial change in market conditions.

The escalator clause is also known as an escalation clause.

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.
  • Escalator clauses are used to guarantee wage increases, protect landlords from missing out on higher rents, or help property buyers to win auctions.
  • Some escalator clauses include a cap on the allowed increases.

How an Escalator Clause Works

The main purpose of an escalator clause is to allow people 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 the rate of inflation. They also are common in the business contracts of companies that supply goods or services with costs that are prone to wild fluctuations. For example, shipping charges can swing dramatically depending on volatile oil prices.

Escalator Clauses in Rental Contracts

Landlords might favor escalator clauses for residential and commercial contracts. 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.

Sometimes escalator clauses include a cap on the allowed increases. Escalator clauses may also contain de-escalation provisions, which allow for a price decrease if certain costs decline.

Criticism of Escalator Clauses

Escalator clauses are not favored by everyone, particularly those that are forced to cover the cost of any increases in wages or prices.

In particular, their use in employment contracts has become controversial. Unions argue that these provisions are necessary to protect workers against a potential loss of purchasing power over time.

Some economists argue that escalator clauses worsen the inflation that they are created to relieve.

If wages automatically keep climbing, central banks can struggle to stabilize prices. Companies that are unable to pass on higher costs to their customers make up the losses by laying off staff. This argues that the provisions can be self-defeating.

Example of an Escalator Clause

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.

For instance, 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 $430,000. This would mean that if an offer of $405,000 is tabled, the escalator clause would trigger a new offer of $408,000. On the other hand, 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 $430,000.

Frequently Asked Questions

What Is an Escalator Clause in a Labor Contract?

An escalator clause in a contract allows for the prices agreed upon to increase if certain market conditions change over the term of the agreement.

The contract may specify the measurement to be used. For example, 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 in the contract along with an escalator clause indicating that the actual prices may change before they are used.

What Is an Escalator Clause in Real Estate?

An escalator clause in real estate states that the price offer will be increased if a higher bid is received. It typically includes a cap on the maximum that the buyer will pay. Proof of a higher offer is usually required to trigger the increase.

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.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Chron. "Escalator Clause in a Labor Agreement."

  2. NAHB. "Escalation Clause for Specified Building Materials."

  3. Rocket Mortgage. "What Is An Escalation Clause And When Is The Time to Use One."