Beware The Escalation Clause!

Business

8 minute read

May 17, 2021

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…

Written By David Fleming

David Fleming is the author of Toronto Realty Blog, founded in 2007. He combined his passion for writing and real estate to create a space for honest information and two-way communication in a complex and dynamic market. David is a licensed Broker and the Broker of Record for Bosley – Toronto Realty Group

Find Out More About David Read More Posts

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19 Comments

  1. William Johnston

    at 9:46 am

    Great blog David!

  2. Riley Keller

    at 10:25 am

    Excellent blog!

    I’m a realtor in a different region of Southwestern Ontario, and my office literally discussed this topic at our Zoom meeting this morning as these clauses have recently been popping up in our market. Our collective sentiments are the same as yours.

    Thank you for all of the free content. As a newer agent, your blog is nothing short of a masterclass and has already helped me take listings and succeed with buyer clients.

  3. JL

    at 10:33 am

    Agree with all the points, but just like last week I see this as yet another example of people trying to find creative solutions to perceived market problems, in this case blind bidding. Few people want to overpay by $100K+ just to be sure to get the property, so they try to come up with a clause that will change blind bidding into some form of automated open bidding. Yes, its clumsy and not really workable, but the motivation is understandable.

    1. Keith

      at 7:22 pm

      I look forward to the real estate industry addressing the huge demand in the market for an end to huge price outcomes from the blind bidding process. I wonder how long I’ll have to wait.

      1. Appraiser

        at 9:30 am

        You will have to wait until it’s a buyers market and Toronto is no longer a desirable place to live. So it could be a long time.

        “The Greater Toronto Area (GTA) is projected to be the fastest growing region of the province, with its population increasing by 2.6 million, or 36.7 per cent, from 7.0 million in 2019 to over 9.5 million by 2046. The GTA’s share of provincial population is projected to rise from 47.9 per cent in 2019 to 49.8 per cent in 2046.”

        https://www.fin.gov.on.ca/en/economy/demographics/projections/#:~:text=The%20Greater%20Toronto%20Area%20(%20GTA,over%209.5%20million%20by%202046.

  4. Edwin

    at 11:35 am

    These clauses would get laughed out of a court so quickly.

    1. Sirgruper

      at 12:06 am

      Why if it was well drafted. If two parties execute the agreement and consideration passes why would a court say there is no agreement. Why is this much different from a first right of refusal in a lease? I too hate the concept but I don’t think it can be dismissed out of hand.

  5. Pingback: Best Real Estate Agent In GTA – Beware The Escalation Clause! – Toronto Realty Blog
  6. Don't Trust In The Process

    at 12:21 pm

    This is probably one of the genuinely funniest things I’ve read about the RE industry in a while. What an utter mess of a concept, and it’s mind-blogging why RECO doesn’t forbid this in the interest of consumer protection.

  7. Bryan

    at 12:26 pm

    I think that with a bit more prevalence, these clauses could really be a boon to sellers and detrimental to buyers. There is a reason that buyers submit offers that are less than their hard cap on a property in the first round of offers… so that they don’t “win” a property by paying far more than it is worth when they didn’t need to. The buyer agent can feel out the seller agent and get a sense of that sweet spot that their buyer needs to improve to, without disclosing how high they would really go.

    It is bad enough for buyers to show their hand when they are the only escalating offer(as David points out), but what if there is more than one? While escalating to infinite likely won’t be allowed to happen, escalating to something well above what a place is worth definitely could. The whole point of an escalation clause is that the buyer is saying “I am willing to pay 10k more than what the other offers determine to be fair market value”, but if multiple people do that, it will also escalate what “fair market value” is, as inherently defined in the clause. Let’s say that out of 8 offers on a property, 2 or 3 offers have escalation clauses up to a certain cap. Unlike in the case David described though, let’s say the agents that submitted these offers actually had a reasonable sense of what the property would sell for, and with that knowledge in mind, capped the escalation clause at somewhere around 5-10% over market value in order to “win” the house. Taking the same property David talked about that sold for $510K, that would mean these three offers escalated to their caps at around $530-5550K (Say, arbitrarily, $540K, $544K, and $548K). What happens now? Those 3 offers are all well above what anyone else offered so I suppose David would go back to all 3 and ask them to improve on what was likely already their “best and final”? If one person bites, all of a sudden this $510K property became a $555K property.

  8. Geoff

    at 1:17 pm

    This seems a lot like the ‘welfare queen’ scenario often discussed, but rarely proved to actually exist for all the reasons you outline above. (Note: I’m not saying they’ve never happened; before if 99.9% of all sales close without one, it shouldn’ t be the top of mind concern).

  9. Appraiser

    at 10:05 am

    “The housing market is hot, but the rental market could quickly catch up as economy reopens…The likely scenario of higher demand for rental housing in the next few months is expected to put pressure on rents if new listings cannot keep pace with the demand. Rents are likely to increase faster for ground-oriented, large-sized dwellings that have become increasingly attractive to millions working from home during the pandemic.

    https://financialpost.com/real-estate/the-housing-market-is-hot-but-the-rental-market-could-quickly-catch-up-as-economy-reopens.”

    1. Chris

      at 10:17 am

      “Hard disagree with TRREB. The reason there are way more rental transactions this year is people have been swapping apts to get cheaper rent elsewhere (Downwards arrow17% 1 bdrm, Downwards arrow13% 2 bdrm). That in turn causes their old apt to go up for rent.

      A re-shuffling is not “pent-up demand.”

      – Scott Ingram

      https://twitter.com/areacode416/status/1385250728030134272

      1. Appraiser

        at 2:37 pm

        This is an example where Mr. Scott Ingram is at his weakest – when he ventures into conjecture without a shred of supporting data. His empty theory about large-scale apartment-swapping is embarrassing. He would do well to remember the plural of anecdote is not data.

        On the positive side, I admire and utilize some of his his data collection for its accuracy and timeliness. This is where Ingram excels. His opinions and analysis – not so much.

        Also, many of his negative TRREB diatribes are disappointing at best. He, like Pasalis, seems to be trying too hard to position themselves somehow as the “anti-realtor” realtor. Shtick is growing old.

        1. Chris

          at 3:12 pm

          Do you have any data to indicate that he’s incorrect in his assessment? Or do you simply object to his opinion and anecdotes because they don’t align with yours?

  10. Condodweller

    at 11:33 pm

    I get the point about not having a contract but how hard is it for the listing agent to signal the buyer that they won if they resubmit pronto with the winning bid amount without any conditions their offer will be accepted? That takes care of not having a contract. The only problem I see is how do you do this without disclosing the amount of the highest bid? If the offer says 10k+ then clearly the buyer can deduce the highest offer price by subtracting the 10k from the price they are given. Perhaps the clause should say they bid 9-10k above the highest bid at the choosing of the seller. This way the buyer will know the offer was within a 1000 without having the exact amount disclosed.

    Clearly, this would only work with a limit amount to stop escalation to infinity. This should help keep people from way overbidding since if only one offer has this clause we wouldn’t see them overbid by 100k. If two or more offer has this then the best offer takes as it should since the limit price for each would be their max offer and the highest one will take it after all the escalation has been done to the limits.

    The biggest issue here of course is the honesty of the seller agent. What keeps him/her from going to the buyer and simply saying their limit amount won? Nothing. So worst case is the buyer pays what they would have paid anyway if they submitted a moon shot offer at their max if the agent is dishonest. But the best case is the seller agent is honest and the buyer only pays 10k over the highest bidder. If we hope that bad apples who would take advantage of a buyer are in the minority then this should benefit buyers as well as the seller in most cases.

  11. Bruce Jones

    at 12:55 pm

    Only in a market as hot as it is right now would you be dealing with any verbiage concerning escalation clauses. Buyers are obviously getting very tired of loosing and they are trying to hedge their bets with these tactics.

  12. Go1Mr

    at 12:16 pm

    Keep sharing such stuff

  13. jayakumar duraisamy

    at 12:11 pm

    i completetly disagree. Why cant there be a template to null out all cons still provide a better process instead of blindly bidding and the buyer loosing out money in the fear of losing the house. And not only that particular buyer lost money, that blind price becomes the base for the next house in the street and the chain continues leading to un justifiable price increase !!!
    When this works well in US, why not here ?

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