The Ontario Real Estate Association (OREA), which represents 70,000 real estate agents and brokers in Ontario, has become involved in a public spat with the real estate industry regulator over the use of a controversial provision in purchase agreements known as an escalation clause.
The dispute began after the regulator, the Real Estate Council of Ontario (RECO), sent a controversial newsletter about the use of escalation clauses to agents across the province. The communication said it was designed to provide “clarity” about the clauses.
An escalation clause is designed to defeat competing purchase offers by automatically increasing the buyer’s purchase price by a pre-set amount over the highest offer. The clause typically sets a cap or upper limit on how much the purchase price will increase so that the buyer will not exceed his or her budget.
Here’s how it works: Two buyers are bidding on a house. One buyer offers $600,000 and a second one offers $550,000 with a $2,000 escalation clause. The second buyer is then told she won the bidding at $602,000. She is not specifically told that the other bid was $600,000 but the escalation clause clearly enables a violation of the privacy rule.
The RECO newsletter notes that the use of an escalation clause could violate a provision in the industry Code of Ethics, which prohibits agents from disclosing the price and contents of competing offers. Despite this, RECO provides detailed advice on how agents should handle offers with escalation clauses without specifically telling the competing buyer the price of the top offer.
Last year, RECO told one real estate agent that this type of clause “not only can contravene (the governing legislation) but also expose the seller and perhaps (an agent) to possible litigation.” But now, RECO is advising agents on how to use the clause and technically comply with the rules.
In an open letter to RECO last month, Ettore Cardarelli, president of OREA, urged the regulator to immediately set the record straight that escalation clauses are not allowed in Ontario because they violate the industry code of ethics.
It asks, “How can registrants use escalation clauses if they are not permitted to disclose the content of another offer?”
Blogs, LinkedIn and Facebook discussions on the Internet lit up with similar criticisms of the RECO position.
On his website torontorealtyblog.com, Toronto broker David Fleming wrote, “This may be the dumbest bulletin ever released by RECO.”
Katie Steinfeld, president and broker of record at On The Block Realty in Toronto, wrote on her LinkedIn page, “This clause is dangerous for many reasons…. Let’s ban escalation clauses altogether.”
In his real estate blog movesmartly.com, well-known Toronto real estate broker John Pasalis wrote that RECO’s position “has just made the bidding process even less transparent and worse.”
In a worst-case scenario, Pasalis says, when the seller’s agent is less than honest, “escalation clauses act like a blank cheque that the seller and their agent can fill in as they please.” This can be “at the expense of all home buyers.”
Pasalis says, and I agree with him, that RECO’s direction to agents, which does not outlaw the use of these clauses but tries to regulate them, “continues to demonstrate that it is an organization run by Realtors designed to protect and promote the rights and interests of real estate agents – not consumers.”
RECO’s mission is to protect the public interest through a fair, safe and informed marketplace, but eight out of 10 RECO board members are real estate agents or brokers.
Pasalis calls on the Ontario government to end the real estate industry’s right to regulate itself because it comes at the expense of the rights of consumers.
When asked about this issue, RECO registrar Joe Richer responded, “RECO does not endorse escalation clauses, because they can create complex situations for buyers, sellers and their representatives. In fact, we recommend that consumers consult with a lawyer if they’re a buyer thinking about submitting an offer with an escalation clause, or a seller who is entertaining an offer with an escalation clause.
“The bottom line is, escalation clauses are not prohibited under the law, we know that they are occasionally used, and we do receive regular inquiries from registrants seeking information about them. For these reasons, as the registrar, I believed it was important that we issue a communication to registrants about how they work, and the challenges that come with them.
“Our consumer protection mandate demands that we ensure registrants know how to comply with the legislation. Our article contains a clear example on how to handle an escalation clause while remaining in compliance with the Code of Ethics.”
Unfortunately, unless RECO acts to prohibit the use of escalation clauses, no one submitting a purchase offer can be confident that the price in the offer will remain confidential and not be used against them. I fail to see how this protects the public interest.