As If Bidding Wars Weren’t Bad Enough – Now We Have Escalation Clauses

Bidding WarsThe super-hot Toronto area market has been rife with bidding wars over the past 1-2 years, as buyers have greatly out-numbered sellers in competing for the dwindling supply of homes for sale. These competitive auctions can be a nightmare for buyers, as the bids are “blind”, meaning that competing bidders only know how many other offers are in play, not what the prices are. It’s not uncommon in these situations for the winning bid to be significantly higher than the next highest bid, though the winner won’t know this and may even be told that ‘the offers were very close’. There’s no way for a buyer to know how high he has to go to win.

Enter the ‘Escalation Clause’. The basic idea is that a buyer can make an offer with a relatively low price, and also include an ‘escalation clause’ that automatically increases his offer to, say, $2,000 more than the highest bid. No matter what other offers come in, his offer will always win, unless he includes in his offer an upper limit on how high he can go. It gets really interesting if there are two or more competing offers with escalation clauses. In this case the winner will be the buyer with the highest upper limit. Imagine the fun.

Does this sound unethical or maybe even illegal? I thought so too, but apparently it’s perfectly OK. The real estate industry’s regulating body, RECO, has actually issued a bulletin advising real estate agents how best to handle bidding wars where escalation clauses are involved.

RECO has a Code of Ethics that directs real estate agents to behave in an ethical manner. However, agents also have clear fiduciary duties under agency law that requires us to follow our clients’ directions as long as they are legal. These fiduciary responsibilities trump the code of ethics. This means that, if a client directs us to do something that is legal but highly questionable from an ethical standpoint, we have no choice but to follow that direction. That’s a very uncomfortable position for an agent to be put in, to say the least.

The only way that this can change is through regulation, so that questionable practices are made illegal. There are enough issues surrounding bidding wars, dual representation, and now escalation clauses, that it would seem clear that it’s time Queen’s Park took some action.