Escalation Clauses in Agreements of Purchase and Sale

By Slonee Malhotra

In today’s hot real estate market, it is not uncommon for prospective purchasers and their realtors to be continually disappointed when their offer is not accepted by sellers. Too often, purchasers and their realtors are left wondering how close their offer compares to the successful offer and whether increasing their offer by a few thousand would have made a difference. For this reason, many have been turning to the escalation clause.

An escalation clause allows a purchaser’s offer to automatically increase in defined increments until the offer either reaches a maximum cap or is otherwise accepted. By way of example: Phillip puts in an offer to purchase a home from Max for $825,000, with an escalation clause that stipulates an incremental increase of $5000 as to defeat competing offers, up to a cap of $875,000. If Olivia puts in a bid for $870,000 without an escalation clause, the escalation clause in Phillip’s offer would escalate his offer to $875,000 instead of his original $825,000 bid. The use of the escalation clause allows Phillip’s offer to become the most financially attractive offer put forward to Max, even though Olivia submitted an initial bid that was higher than Phillip’s original offer.

We encourage you to be wary in using the escalation clause. As laid out below, utilizing an escalation clause or accepting an offer with an escalation clause is something that should not be taken lightly. Very careful consideration of the clause and how the clause is to be dealt with by realtors, purchasers, and sellers alike is required to ensure compliance with the Code of Ethics and the Real Estate and Business Brokers Act. SorbaraLaw is here to ensure you make the most informed decision possible.

Duty to Act in Good Faith

As there is no obligation for the seller to disclose the next best offer to the purchaser, it is possible that an unscrupulous seller could enforce Phillip’s escalation clause to make his offer $875,000, when in reality Olivia’s offer was only ever $830,000. An unscrupulous seller could also compel a friendly offer from a third party (say Claudia, who bids for $870,000) before the irrevocable period expires, where the third party’s offer is designed to trigger the maximum increase in Phillip’s offer. O. Reg. 580/50 requires registrants under the Real Estate and Business Brokers Act to act fairly, honestly, and with integrity. While this safeguard exists, it would be difficult to prove that the seller fraudulently exercised their use of the clause, and it is likely the court would hold the purchaser to their escalation clause as written.

Privacy Concerns

Realtors should take care to comply with the rules around competing bids as laid out in O. Reg. 580/05,: “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.” Some realtors say that the use of an escalation clause indirectly violates s.26, by inferring that substance of the other offers. For example, if Phillip’s bid wins out at $875,000 after his initial bid was $825,000, he would know that the next best competing bid came in at $870,000. RECO has advised that this situation in and of itself is not a violation of s.26, but that a careful process should be followed to ensure compliance with the Code of Ethics.

Our Recommendations

When acting for the seller, realtors must:

• ensure that their clients are willing to entertain offers with such clauses;
• ·verify with the purchaser the substance of the clause (Does it have a cap? Does it cease increasing upon becoming the highest offer? How is it worded?) ;
• disclose the number of competing offers on the home and disclose no more than that. Any disclosure of the substance of other offers is prohibited; and
• In the event that the offer is selected, the offer should be revised to clearly note the purchase price. The seller’s realtor should likewise keep a copy of the second-best offer for the home in case there is a legal challenge on the validity of the selling price.

  When acting for the purchaser, realtors must:

• ensure their client is fully aware that the purchaser’s offer cannot be revoked prior to the irrevocable date, and that the purchaser could be locked in a bidding war until the purchase price cap has been reached;
• communicate clearly with the seller’s realtor that there is an escalation clause included in the offer, to ensure it is not overlooked; and
• confirm that the purchaser understands that the purchaser has no right to receive the next best offer in order to confirm the escalation clause was properly utilized.

This article was written by Nathan Henderson, student-at-law, and edited by Slonee Malhotra.