Beware The Escalation Clause! – Toronto Realty Blog
June of 2017 seems like an eternity ago, doesn’t it?
I know we’re all in that ho-hum mindset and have been for the last fourteen months, but even if you think back, pre-pandemic, doesn’t it just seem wild?
June of 2017.
In June of 2017, I had half as many children as I do now.
In June of 2017, I’d had one fewer Coronavirus vaccines. Oh wait, we weren’t going to talk about that…
In June of 2017, it had only been fifty years since the Toronto Maple Leafs had won the Stanley Cup, rather than the fifty-four years the tally is currently up to…
In June of 2017, I wrote about “escalation clauses” on TRB, but to that point, I had never actually seen one in an offer as a listing agent.
Its’ now been almost four years since I wrote that post.
How many escalation clauses have I seen since then?
One.
Here’s the post from June of 2017:
What Is An “Escalation Clause?”
I wrote this blog in response to a Real Estate Council of Ontario (RECO) bulletin that had been sent out about the use of escalation clauses, and that bulletin was sent because most of the agents in the industry at the time had no idea what an escalation clause was or how to deal with one on the buy-side or the sell-side.
Fast-forward four years and most agents still don’t know what to make of them.
I spoiled the surprise in the home-page excerpt already, but know this: escalation clauses are not illegal, but the use of one forces a party to do something that is not permitted in the eyes of RECO.
What a conundrum, right?
RECO tells us that escalation clauses are not illegal, but the Real Estate Business Brokers Act (REBBA), which was uselessly updated in 2020 as the Trust In Real Estate Services Act (TRESA) contains a code of ethics that make using an escalation clause impossible.
Let me water this down even more:
RECO has no problem with escalation clauses.
RECO enforces REBBA which has a problem with escalation clauses.
Well, what else should we come to expect from the provincial government?
As a refresher, I suppose we should discuss what an escalation clause actually is?
Let’s say there’s a house listed for sale for $999,900.
Five offers are submitted on the house as follows:
$1,050,000$1,212,000$1,275,000$1,290,000$1,310,000
The buyer with the offer of $1,275,000 has the following clause in his offer:
Buyer offers to pay $1,275,000 for the property, but if the Seller receives a bona fide offer that is higher, buyer will increase the price to $10,000 above the amount of the other offer.
In theory, and I say “in theory” because there are so many issues with escalation clauses, and I don’t believe agents are working with them, but in theory, the buyer with the $1,275,000 offer price now “wins” the house for $1,320,000.
Easy enough, right?
Except that in practice, there are so many problems with a simplistic view of how an escalation clause works. There are logistical issues, legal issues, contract law that needs to be adhered to, and of course, breaches of ethics that we’ll get to toward the end.
Here are the most obvious issues…
1) Other Terms?
This is the very first thing that should cross your mind when attempting to make sense of the escalation clause.
The escalation clause above assumes either that the offers are all identical, or that only the price matters, or both.
What if the closing dates are different?
What if the deposit amounts are different?
What if one buyer has a bank draft in hand, but others don’t?
What if there’s a condition in an offer?
That simplistic clause above has absolutely no bearing on a typical offer process where every offer has different terms and conditions since a buyer can’t merely assume, or contract to purchase a property, via the escalation clause, when he or she might not have satisfied a slew of other tenets of the offer.
My biggest objection to the
2) Offer & Acceptance
In order for a completed Agreement of Purchase & Sale to exist, there must be an offer and an acceptance.
Including an escalation clause does not automatically result in an acceptance.
There is no “winning” with an escalation clause.
In the situation above, if the $1,275,000 bid automatically was elevated to $1,320,000, what would the seller do if that $1,320,000 offer was conditional? Can the buyer insert the escalation clause and assume he’s “won?”
Alright, let’s say there’s no condition, but the closing date is two months longer, and the deposit amount is for half as much. Does the buyer “win?”
Let’s face it: the buyer never “wins.”
The buyer is simply stating his intent in the original offer, in my opinion, and nothing more.
Because…
3) Signing-Back & Re-Submitting
Let’s continue with the above example and all the terms and conditions are the same. The deposits are the same, the closing dates are the same, no offers have conditions.
The offer of $1,275,000 “escalates” to $1,320,000 due to the clause.
Now what?
Now the buyer “wins?”
No.
Now the buyer has to re-submit at $1,320,000 so the seller can accept.
Or, the seller signs back the offer at $1,320,000 so the buyer can accept.
Either way, aren’t we really just negotiating here? Does this clause have any real clout?
4) Trust
“Hey Jimmy, great news! You won! Yeah, the highest bid was $1,375,000 so you’ve won at $1,385,000. Let’s sign this up!”
Can you see the problem here?
What’s to stop an agent from just telling the agent with the escalation clause that the highest bid was XXX and then expecting them to add the amount specified in their escalation clause?
Oh, but wait…
5) Stick A Pen In Their Hand…
Is an escalation clause legally binding?
Is it irrevocable?
If the buyer who offered $1,275,000 with an escalation clause is told he “won” at $1,320,000, does he have to sign?
Sign what?
Wait, where are we? Are you as confused as I am?
Is the seller signing back? Is the buyer re-submitting?
What if the buyer changes his or her mind?
Should we go back to Point #1 again now too?
All these points and all this talk simply comes down to one thing at the end of the day: the buyer and seller still need to agree on a price and sign the Confirmation of Acceptance. There are so many damn loopholes in this nonsense, it’s not even funny.
6) Infinity
Two buyers have escalation clauses.
They continue to bid each other up, over and over, until the price reaches infinity.
The banks won’t insure a property for infinity dollars. But that’s another problem. Maybe Point #7?
7) Fairness
I know, I know, you’re laughing because a real estate agent is talking about “fairness.”
If I have a $499,900 listing, and I have offers of $550,000, $565,000, $609,000, $610,000, and $611,000, I would typically go back to the buyers with the top three offers and ask them to improve once, at which point the “best” offer will be accepted.
You would never go back to the buyers with $609,000 and $610,000, and not $611,000, right?
So if your third-highest offer has an escalation clause, and that clause escalates the buyer’s offer to an amount $10,000 higher than the highest offer, who says that becomes the “winning” offer?
In my world, you’d go back to the highest offer and ask them if they want to improve.
Fair is fair. Go back to one, go back to the other.
In the above case, the escalation clause has no cap, so they would simply beat the revised offer by $10,000 again.
What is a “cap?” Oh, it’s important, but more on that in a moment…
8) Ethics
This is what makes an escalation clause illegal, even though RECO says it’s not.
Under REBBA, a listing agent cannot disclose the terms and conditions of an offer to a competing agent.
If John and Doug have offers on my listing, I can’t tell John, “Hey man, Doug offered $1,000,000 with a $50,000 deposit and no conditions.”
I just can’t. I’m not permitted.
Whether or not I’m inviting John to offer $1,020,000, or not, doesn’t matter.
You cannot disclose the terms and conditions of a competing offer.
But with an escalation clause, you have to.
So how can listing agents work with escalation clauses?
They can’t!
All this talk, all these points, and in the end, I’m telling you: a listing agent cannot work with an escalation clause because it forces he or she to breach the Real Estate & Business Broker’s Act.
And yet, I’m told that escalation clauses are prevalent in cottage country and agents have no problem with them.
A colleague of mine brought this up last week.
He was working with a buyer, who is also a former lawyer, who found an escalation clause that he liked somewhere on Reddit, and decided to use it. But he wanted to take the clause further. He didn’t just want to bid $10,000 more than the next highest offer, after having been told the highest offer by the listing agent. No, he wanted the highest offer sent to his lawyer by email so the lawyer could verify the price!
Imagine that?
The buyer was making an offer, and in his offer was a direction that the listing agent do something illegal?
How does this make any sense?
My colleague, by the way, told the buyer that he couldn’t submit this offer for him. And the buyer said, “Okay,” and went somewhere else.
A cynic will suggest that real estate agents are always bending or breaking the rules, and ask what the problem is here. I won’t pretend that all 60,000 GTA real estate agents follow the letter of the law to a ‘t’ every day, but I don’t think it’s prudent to contract to break the law, do you?
My largest issue with the escalation clause is that it forces agents to breach a code of ethics, but that doesn’t mean the other issues noted above aren’t enough, on their own, to kybosh escalation clauses completely.
I noted above that an escalation clause should include a “cap.”
Most escalation clauses do.
Take the clause we used above and simply add one sentence at the end:
Buyer offers to pay $1,275,000 for the property, but if the Seller receives a bona fide offer that is higher, buyer will increase the price to $10,000 above the amount of the other offer, to a maximum of $1,330,000.
First of all, this simply results in the buyer playing his or her hand.
The buyer has basically said, “I will pay $1,330,000.”
So what’s to stop the listing agent from calling the buyer agent and saying, “Can you put $1,330,000 on paper?”
What’s the difference here?
What is the upside and what is the downside?
I suppose if the buyer’s cap was $1,400,000, and the highest offer was $1,310,000, then the buyer would prefer if he “won” at $1,320,000, but hasn’t he just played his hand?
As noted above, the listing agent may elect to give the highest and second-highest a chance to improve as well, so who says that $1,320,000 is going to “win” anyways?
I mentioned at the onset that I’ve seen one escalation clause as a listing agent.
Here is that clause as it was submitted on a $399,900 listing:
During the time that the Buyer’s Agreement of Purchase and Sale – Condominium Resale (the “Buyer’s Offer”) remains open, should the Seller receive an executed written offer from another Buyer (the “Competing Offer”) that is higher than the Buyer’s Offer, the Buyer hereby agrees to escalate the Buyer’s Offer by increments of ONE THOUSAND DOLLARS ($1,000) until such time as the Buyer’s Offer exceeds the Competing Offer. The Buyer’s Offer shall not escalate unless and until the Seller has received a Competing Offer that exceeds the Buyer’s Offer.
Notwithstanding the foregoing, The Buyer’s Offer shall not escalate beyond a total purchase price of FOUR HUNDRED SIXTY THOUSAND DOLLARS ($460,000). The Seller agrees that each escalation pursuant to this Agreement shall be deemed a valid offer to purchase the property.
This makes no sense.
First of all, the offer was for $450,000
This escalation clause includes escalators of $1,000 up to a maximum of $460,000.
Does the buyer know something here? Like, he’s absolutely pegged the potential sale price here within 2%?
This property sold for $510,000 and there were four offers higher than this one, but let’s set all that aside for a moment.
The problem I have here is with respect to “the seller agrees.”
For that to be true, wouldn’t the seller need to act?
I mean, the buyer can’t just say, “The seller agrees,” and have that firm and binding, before the seller has seen the offer, right?
This is the very roof of the issue with an escalation clause!
I come back to the same point, over and over: there must be an offer and an acceptance!
This isn’t an offer. It’s an offer with ways in which subsequent offers can be submitted, signed-back, re-negotiated, etc.
And who says that “this shall be deemed a valid offer to purchase the property?”
Because it’s not a valid offer.
This is an offer for $450,000. The front page, under “PURCHASE PRICE,” says “$450,000.”
For a $460,000 offer to be “deemed a valid offer to purchase the property,” the offer would need to read “PURCHASE PRICE: $460,000.”
So no matter how you look at this clause, it’s never going to negate the fact that subsequent actions need to be taken in order for the terms of the clause to be met!
Yeesh.
How many people do you think stopped reading already?
Those who did, likely think this is all jibberish.
And I can only imagine what the rest of you think.
Likely anything from, “You’re being lazy, just shut up and work with this clause,” to “I can’t believe people are now putting illegal things in their offer,” to “this is soooooo like real estate agents,” right down to, “other industries use these clauses, you’re a clown.”
I’ve heard it all before, but I would love to hear it again if you’re willing…
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