What is Escalation & De-Escalation Clause?

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An Escalation clause (also known as Escalator Clause) is a clause in a contract that guarantees a change in the agreement price once a particular factor beyond control of either party affecting the value has been determined. Because of increasing prices, it has become common to insert an escalation clause in the contracts.

If the prices of material, plant, labor & equipments etc increases beyond the point 5% or 10% etc. the clause authorizes the contractor to claim higher value for the contract. This clause is used both when a settled price is quoted for the contract as also when a cost-plus contract is entered into.

Escalator clauses are quite common in construction contracts to cover unexpected costs due to fluctuations in the prices for raw materials, fuel, and labor during the course of the construction project.

Example: A provision in an agreement in which rent will increase from time to time when the cost of living index goes up.
Or changes in the economy result in a period of inflation that causes the costs of raw materials used to produce goods or services to increase over a certain amount.

The inclusion of an escalation clause is to benefit both the customer and the company providing products to that customer. For the company, the clause makes it possible to avoid situations in which goods or services must be supplied to the customer at below cost after some change in the economy increases the cost of raw materials or other expenses that are essential to the production process.
The customer benefits since providing a means for price increases under certain circumstances means there is not likely to be an interruption in the delivery of those contracted products, allowing the customer to make use of those products in whatever manner is considered desirable.

 Escalation Graphic

De-escalation Clause
De-escalation clause is the opposite of an escalation clause. De-escalation Clause in a contract calls for a price decrease if there is a decrease in certain costs. The rationale behind the de-escalation clause is that if the provider of the goods and services does not have to utilize as many resources in order to service the general provisions of the contract, the client should realize a portion of that decrease.

Example: Shipping costs may be higher than normal when a contract is signed due to the prices on gasoline. A de-escalation clause will correct for that by lowering the contracted shipping rate as gasoline prices drop. A de-escalation clause may stipulate that maintenance fees will be reduced if the item being maintained depreciates in value. If the price of raw materials that are used to fulfill the contract decreases then cost to the customer also decreases. A de-escalation clause can protect consumers from paying high prices over the life of a contract that was signed during a time of unusual circumstances.

A Personal Finance enthusiast, Karan is the founder of charteredclub.com and loves to discuss about Money related matters.