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Escalation clauses: an invitation to litigation

“I will pay $5,000.00 more than the highest offer received.”

This is what is known as an escalation clause and has been developed to give a person in a bidding war an advantage over the other bidders. It usually will also include a “cap” such that the maximum price to be paid will not exceed a certain amount. The question is whether escalation clauses are permitted in an Ontario bidding war where agents are being used. It has long been my own view that these clauses are not permitted. Yet the Real Estate Council of Ontario has recently issued a bulletin stating that while they do not endorse the use of escalation clauses, they are not illegal. Here is what you need to know;

  1. Real estate agents are not permitted to disclose the substance of any offer in a bidding war.

In the Real Estate and Business Brokers Act 2002 Code of Ethics, it is clear that a real estate salesperson can only disclose the number of bids received in a bidding war, but cannot disclose the substance, or contents of any offer received. It is for this reason that auctions are not permitted in the sale of real estate when you use an agent. If you want to have an auction, hire an auctioneer, as they do with many farm sales. In my own experience, I note that auctions are not successful in a regular resale home situation and that is why they are not used.

  1. How is RECO permitting this?

The RECO bulletin seems to state that if an escalation clause is used, the seller can just insert the “escalated price” into the agreement and accept the deal. So in my example above, if the highest other offer received was $400,000, the seller could just write in $405,000 and the contract would be accepted. My question is “How can you write in $405,000.00, without disclosing that your highest offer received was $400,000.00. To me, this would clearly be a violation by the agent of their Code of Ethics obligation,

  1. Could an agent be sued if they insert an escalated price?

In my opinion, an unsuccessful buyer in a bidding war could bring a lawsuit against a seller or brokerage who comply with an escalation clause, stating that they only put in their bid on the understanding that their bid price would remain confidential. They never agreed to their price being communicated to any other bidder, whether directly or through an escalation clause.

  1. Can a buyer verify the price paid by the other offer?

Here RECO says that you cannot disclose any part of the other offer to the buyer who wins using an escalation clause. Yet they also warn the seller agent that they should consider keeping a copy of that offer in case it is challenged by a buyer later. So what this means is that the only way a buyer winning using an escalation clause can find out whether the other offer was legitimate, they would have to sue. This clearly opens up in my mind the possibility for fraud, with sellers perhaps encouraging friends to put in an offer at a high price to use as a basis for the escalation price.

  1. How do you know this is an escalated price or a counter-offer?

More confusion. When the seller puts in a price, are they actually inserting an escalation price or just submitting a counter-offer for the buyer to accept. And where is this escalation price to be inserted in the contract. This could also lead to more confusion as to whether the contract was legitimately accepted or not in the first place.

In conclusion, until we have a court decision that may explain these issues, it is my advice that brokerages representing sellers in a bidding war, should make clear prior to any bid received that escalation clauses will not be permitted or shown to the sellers, due to concerns about possible litigation. That way every buyer is treated the same in a bidding war.

At our firm, we close real estate deals all over Ontario If you have any questions about bidding wars, do not hesitate to contact me toll free at 1-888-876-5529 or at mark@realestatelawyers.ca

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