Prospective buyers and their realtors are frequently disappointed in today’s competitive real estate market when their offer is not accepted by sellers. Too frequently, buyers and their agents are left wondering how close their offer was to the winning bid and whether a few thousand dollars more would have made a difference. As a result, many people have turned to the escalation clause.
An escalation clause permits a buyer’s offer to automatically rise in predetermined increments until it reaches a maximum cap or is otherwise accepted. For instance, Ali makes a bid to buy a house from Suzan for $775,000, with an escalation clause requiring a $5000 incremental increase to beat rival offers, up to a limit of $825,000. If Marcus submits a bid of $820,000 without an escalation provision, Ali’s offer will be escalated to $825,000 instead of his original $775,000 bid. The escalation clause permits Ali’s offer to become the most financially appealing offer presented to Suzan, even though Marcus filed an initial bid that was greater than Ali’s original offer.
Here at Cactus Law, we advise you to use caution while utilizing the escalation clause. As stated below, using an escalation clause, or accepting an offer with an escalation clause should not be handled lightly. To guarantee compliance with the Code of Ethics and the Real Estate and Business Brokers Act, realtors, purchasers, and sellers must carefully analyze the provision and how it is to be handled with.
The Duty to Act in Good Faith
Because the seller is not required to reveal the next best offer to the buyer, an unethical seller might exploit Ali’s escalation clause to make his offer $825,000 while Marcus’ offer was always $780,000. An unethical seller may even induce a favourable offer from a third party (say, Ken, who offers $820,000) before the irreversible period finishes, where the third party’s offer is intended to trigger the maximum rise in Ali’s offer. O. Reg. 580/50 mandates Real Estate and Business Brokers Act registrants to act fairly, honestly, and with integrity. While this precaution exists, proving that the seller illegally used the provision would be difficult, and the court would most likely hold the purchaser to their escalation clause as stated.
Realtors must follow the rules regarding competing bids outlined in O. Reg. 580/05, which states that “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.” For example, if Ali’s bid is successful at $825,000 after his original bid of $775,000, he will be aware that the next best competitive price was $820,000. RECO has recommended that while this scenario does not constitute a breach of Section 26, a rigorous process should be followed to guarantee conformity with the Code of Ethics.
Cactus Law’s Recommendations
Realtors who represent the seller must:
- ensure that their clients are willing to consider offers including such conditions.
- verify the substance of the provision with the purchaser (Does it have a cap? Does it stop growing after it reaches the highest offer? How is it phrased?).
- reveal the number of competing bids on the house and no more. Any disclosure of the content of other offers is strictly forbidden; and
- if the offer is accepted, the offer should be updated to explicitly state the purchase price. The seller’s realtor should also maintain a copy of the second-best offer for the house in case the selling price is challenged in court.
Realtors who represent the buyer must:
- ensuring that their client is fully aware that the purchaser’s offer cannot be retracted before the irreversible date, and that the purchaser may be stuck in a bidding battle until the purchase price cap is achieved.
- to guarantee that an escalation clause is not ignored, communicate clearly with the seller’s realtor that one is included in the offer.
- to ensure that the escalation clause was correctly used, check that the buyer knows that he or she has no entitlement to the next best offer.
Overall, escalation clauses are sort of claw back agreement commonly used in contracts entered between a seller and a buyer of land and/or structures. Essentially, they provide for the seller to earn an extra payment or otherwise partake in the increase in property value if a specific future event happens. It goes without saying that creating an effective and enforceable agreement is not always simple; it often necessitates bespoke drafting and may include several parties (and their attorneys) if lenders are involved in the transaction.
If you have any questions about your real estate needs, contact Cactus Law today to speak with a lawyer specializing in real estate law.
The information presented above is solely for general educational and informational purposes. It is not intended to be, and should not be taken as, legal advice. The information given above may not be applicable in all cases and may not even reflect the most recent authority after the date of its publication. As a result, please refer to all updated legislation, statutes, and amendments. Nothing in this article should be relied on or acted upon without the benefit of legal advice based on the specific facts and circumstances described, and nothing in this article should be interpreted otherwise.
About the Author:
Kanwar Gujral is entering his third year at Osgoode Hall Law School in Toronto, Ontario. He has a dedicated interest in real estate, business, and corporate law.