Brian Madigan’s Annotated Version of RECO’s Escalator Clause Commentary
Quite frankly, I was surprised to read the latest publication from the Real Estate Council of Ontario (RECO). It dealt with “escalator clauses” in Offers, Agreements and other documents. It seems to take a rather cavalier approach to the subject and it is not something that I would ordinarily expect to see from the Regulator.
I have broken this article down into three separate parts:
1) My Review,
2) My Annotated Version of the RECO publication,
3) RECO’s original Version.
My Review
The escalator clause says: “I bid $2,000.00 more than the highest bidder”. Sometimes, there is a cap, for example: “I bid $2,000.00 more than the highest bidder, not to exceed the total sum of $900,000.00”.
Here is something that you need to know about those clauses.
Not every jurisdiction likes it, or thinks it’s legal.
Why don’t other jurisdictions simply approve and let it go:
1) Some think that this type of clause is VOID as against public policy,
2) Some believe that it is an abuse of the administration of justice, Courts are Court Houses not Auction Houses,
3) Some feel that the Courts are reserved for interpretation of contracts, and not reviewing the bids and figuring out the winner,
4) Some believe that this type of bid is uncertain, and therefore lacks the “price”, therefore leaving out one of the essential contract elements, meaning, of course, there is no contract,
5) Some consider it inappropriate to delve into the confidential documents of third parties for privacy reasons, and thereby the “price offered” is not ascertainable through ordinary legal means.
All in all, this clause has had a storied and varied past in those common law legal jurisdictions throughout the world which have been presented with the proper cases to consider their usage and effectiveness
In Ontario, there are no cases before the Ontario Court of Appeal dealing with the legality of the escalator clause, so we just don’t know. It’s a little bit of a gamble to use it. If you decide to use it, you run a substantial risk that the Court will simply conclude that there was no contract, the bid was void and against public policy and therefore there was no contract.
My Annotated Version of the RECO publication
My comments are highlighted in yellow throughout.
What you need to know before using an escalation clause
FOR THE RECORD
May 31, 2017
As the housing market continues to sizzle, buyers often feel tempted to offer more for a property, or remove conditions that are intended to protect them. One tool buyers are considering is an ‘escalation clause’.
Interesting view of the market. It has been going down all month. The peak was in March or April, depending upon the type of property and the location of the property. On 31 May 2017, there was nothing “sizzling”.
Escalation clauses, also known as ‘escalator clauses’, are designed to edge out competing offers by automatically raising the offer price by a pre-set amount when a higher bid comes into play. There are numerous variations of this type of clause. Some identify a maximum price, others may not. It can become particularly cumbersome if more than one offer contains a form of this clause. Escalation clauses are certainly on RECO’s radar, and we’ve been receiving a number of questions from registrants about how to deal with them.
The explanation is a correct one, and only RECO would know whether it’s receiving questions.
An escalation clause may seem like an effective way to get a leg up on the competition. Although there are no specific regulations related to escalation clauses, there are general rules and regulations which still apply.
Perhaps this might be an appropriate spot to jump in and say “they are not legal in some common law jurisdictions. Also, perhaps it is indeed true that escalation clauses are not specifically addressed. That’s because, a good deal of the time they’re not legal!
RECO will review and investigate complaints related to escalation clauses and, if warranted, will take appropriate action.
This statement seems fair enough.
How it works
Let’s say for example you have two buyers: Stan and Fred. Stan’s initial bid is $550,000, while Fred’s offer is $600,000.
However, Stan’s offer also includes an escalation clause, which will increase Stan’s offer by increments of $2,000 over any competing offer that comes in. Stan’s bid rises to $602,000. Stan’s representative also included a cap, which means when a competing bid reaches a certain number – in this case $700,000, the escalation clause won’t increase the offer price any higher. So if a third buyer named Richard put in an offer of $750,000, Stan’s offer would stand at $700,000. It’s then up to the seller to decide which offer to pick.
The example is understandable.
Multiple clauses
That’s a simple example, but if two buyers who have both included escalation clauses in their offers, there could be additional issues.
This is the standard, straightforward reason that other common law jurisdictions do not wish to give any merit to this type of clause. What if all 10 bidders used it?
Imagine that both Stan and Fred included escalation clauses in their offer, with $2,000 increments. If Stan has a cap of $700,000 and Fred’s cap is higher, then there’s no problem—Stan’s offer would stand at $700,000 while Fred’s would escalate to $702,000.
The two caps would create a conflict, as would additional participants.
But what if they both have the same cap, or both have no cap at all? In this case the seller’s representative may ask both Stan and Fred to remove the escalation clause and submit a final, best offer.
This is very difficult to administer by the Listing Agent without disclosing the substance of Fred’s Offer to Stan, and the substance of Stan’s Offer to Fred.
Here is a provision from the Code of Ethics:
Competing offers
26. (1) If a brokerage that has a seller as a client receives a competing written offer, the brokerage shall disclose the number of competing written offers to every person who is making one of the competing offers, but shall not disclose the substance of the competing offers.
(2) Subsection (1) applies, with necessary modifications, to a brokerage that has a seller as a customer, if the brokerage and the seller have an agreement that provides for the brokerage to receive written offers to buy.
The underlining is mine. The Listing Agent cannot disclose the substance of the Offer.
That provision applies to the Listing Agent and anyone who is regulated under the Real Estate and Business Brokers Act, 2002.
This would leave out Sellers, Sellers’ lawyers and Buyers. They would all be free to exchange this information.
From a privacy perspective, Buyers would have to agree that their information could be freely disclosed. But, I suppose that could be set up and accomplished. An “open bid” arrangement would have to be set in place. In Ontario, at this moment, we have a “closed bid” system.
Protecting your buyer
The rules and regulations that govern your conduct apply when you recommend an escalation clause or submit one as part of an offer.
You have a duty to look out for your clients’ best interests, and to provide conscientious and competent service, while demonstrating reasonable knowledge, skill and judgment. Before submitting an offer with an escalation clause, the buyer must fully understand the implications and provide informed consent. There are a number of questions you should ask before you proceed.
As a basic fact, before going ahead the Buyer should understand that:
1) It is not available in many common law jurisdictions,
2) There are no Court of Appeal cases on point in Ontario,
3) The Listing Agent must breach s. 26 of the Code of Ethics in order to get everyone the information they require in order to make this process work.
All of the above would constitute “implications” and need to be properly understood before we have the Buyer’s “informed consent”.
For example, are you confident that the home will receive multiple offers? Does the buyer have flexibility in their budget to allow for a higher purchase price? Be sure your client understands that when this clause is in effect, they could be locked into a bidding war until their maximum bid has been reached.
Generally, it seems foolhardy. You are right at your maximum almost instantly. Even if this doesn’t work out, you are likely to get a “signback” at your maximum.
Here are some other key tips when dealing with escalation clauses:
- You must take all practical steps to verify your client’s approved borrowing limit. Ideally they would be able to provide a commitment or pre-approval letter from a financial institution. Make sure your client understands that the lender may require an appraisal after the offer is finalized. There is no guarantee that financing for the purchase price will be approved.
- This applies if every bid no matter what, nothing new here!
- A cap or provision for stopping the escalation is required to protect the buyer’s interest.
- Absolutely necessary, or you just offered infinity dollars. This is why some places have it VOID as against public policy. Two bidders and you don’t have access to the other bid. This will be your “signback” amount, if nothing else happens.
- A seller may choose not to accept an offer that includes an escalation clause.
- Fair enough, in many jurisdictions, they are simply VOID at the outset. Let’s not accept it now, rather than wait until closing and find that the Buyer has decided to walk away. Such an arrangement amounts to nothing more than an option to purchase given freely to the Buyer until closing without an “option price”.
- The seller may not always choose the highest offer.
- This may happen in any case. This is not new.
Escalation clauses can cause added stress to a buyer during a bidding war, especially if they don’t fully understand how it works. Communicate with your client to make sure they know what to expect, and always remember that your first duty is to the client’s interest.
This is a wonderful summary. The publication is causing stress to the real estate community. No one knows what it means, or why it was intended or what issue it was intended to address. There was no reference to s. 26 of the Code. There was no reference to the fact that other jurisdictions do not permit it. There was no reference to the fact that there is a lack of certainty in Ontario because the Court of Appeal has not deal with it.
RECO’s original Version
This is the RECO original, intact, without commentary.
What you need to know before using an escalation clause
FOR THE RECORD
May 31, 2017
As the housing market continues to sizzle, buyers often feel tempted to offer more for a property, or remove conditions that are intended to protect them. One tool buyers are considering is an ‘escalation clause’.
Escalation clauses, also known as ‘escalator clauses’, are designed to edge out competing offers by automatically raising the offer price by a pre-set amount when a higher bid comes into play. There are numerous variations of this type of clause. Some identify a maximum price, others may not. It can become particularly cumbersome if more than one offer contains a form of this clause. Escalation clauses are certainly on RECO’s radar, and we’ve been receiving a number of questions from registrants about how to deal with them.
An escalation clause may seem like an effective way to get a leg up on the competition. Although there are no specific regulations related to escalation clauses, there are general rules and regulations which still apply.
RECO will review and investigate complaints related to escalation clauses and, if warranted, will take appropriate action.
How it works
Let’s say for example you have two buyers: Stan and Fred. Stan’s initial bid is $550,000, while Fred’s offer is $600,000.
However, Stan’s offer also includes an escalation clause, which will increase Stan’s offer by increments of $2,000 over any competing offer that comes in. Stan’s bid rises to $602,000. Stan’s representative also included a cap, which means when a competing bid reaches a certain number – in this case $700,000, the escalation clause won’t increase the offer price any higher. So if a third buyer named Richard put in an offer of $750,000, Stan’s offer would stand at $700,000. It’s then up to the seller to decide which offer to pick.
Multiple clauses
That’s a simple example, but if two buyers who have both included escalation clauses in their offers, there could be additional issues.
Imagine that both Stan and Fred included escalation clauses in their offer, with $2,000 increments. If Stan has a cap of $700,000 and Fred’s cap is higher, then there’s no problem—Stan’s offer would stand at $700,000 while Fred’s would escalate to $702,000.
But what if they both have the same cap, or both have no cap at all? In this case the seller’s representative may ask both Stan and Fred to remove the escalation clause and submit a final, best offer.
Protecting your buyer
The rules and regulations that govern your conduct apply when you recommend an escalation clause or submit one as part of an offer.
You have a duty to look out for your clients’ best interests, and to provide conscientious and competent service, while demonstrating reasonable knowledge, skill and judgment. Before submitting an offer with an escalation clause, the buyer must fully understand the implications and provide informed consent. There are a number of questions you should ask before you proceed.
For example, are you confident that the home will receive multiple offers? Does the buyer have flexibility in their budget to allow for a higher purchase price? Be sure your client understands that when this clause is in effect, they could be locked into a bidding war until their maximum bid has been reached.
Here are some other key tips when dealing with escalation clauses:
- You must take all practical steps to verify your client’s approved borrowing limit. Ideally they would be able to provide a commitment or pre-approval letter from a financial institution. Make sure your client understands that the lender may require an appraisal after the offer is finalized. There is no guarantee that financing for the purchase price will be approved.
- A cap or provision for stopping the escalation is required to protect the buyer’s interest.
- A seller may choose not to accept an offer that includes an escalation clause.
- The seller may not always choose the highest offer.
Escalation clauses can cause added stress to a buyer during a bidding war, especially if they don’t fully understand how it works. Communicate with your client to make sure they know what to expect, and always remember that your first duty is to the client’s interest.
Brian Madigan LL.B., Broker
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