Publications

Phillip C. Querin
Partner - Portland, Oregon Office

philquerin@dwt.com
(503) 241-2300

Competing Offers and Escalator Clauses
[January 2004]

In almost every economic period, whether prices are rising or falling, buyers of real estate may occasionally find themselves competing for the same property. This is frequently so when the reasons for the competition are not economic, but emotional, e.g. the competing buyers want to acquire the property because it holds a special significance, such as location, appearance, prestige, etc.

For sellers, such competitive activity may be rewarding, but for buyers, especially those who lose out – and sometimes even the winners - the experience can be unpleasant and frustrating. Oftentimes, the frustration is directed against the real estate agent or agents handling the process. Here are some risk management tips:

Office Policies. Principal brokers should consider developing a written office policy for agents to follow when handling competing offers – how to explain them to clients, how to write them up and how to present them. Such policies serve at least three purposes: (a) They reduce the risk of civil liability arising from disgruntled sellers or buyers who believe the agent breached his or her fiduciary duty; (b) They similarly reduce the risk of licensing liability for the same reasons; (c) Lastly, in the event of licensing action being filed against an agent for mishandling a competing offer situation, the principal broker’s licensing exposure for lack of supervision¹ could be reduced if the company has a specific office policy outlining the proper protocol.²

The Disclosed Limited Agency Conundrum. Although Oregon law expressly allows disclosed limited agency - if consented to in writing - including the representation of competing buyers - implementing this in actual practice imposes an almost impossible task upon the disclosed limited agent.

For example, say the agent represents both buyers vying for the same property and the offers are to be submitted simultaneously. Obviously, this means that after writing up the first offer, the agent will be privy to what price and terms will be necessary for the second offer to be accepted over the first. Although the agent cannot disclose to the second buyer the price or terms of the first offer, how is he or she to advise the second buyer in the preparation of their offer, knowing, in advance that it can mean the difference in acceptance or rejection? It is much easier to ethically advise the second buyer if the agent has no knowledge about the contents of the first offer. In circumstances like these, principal brokers may wish to consider assigning another agent to the second buyer and making sure that there is an effective firewall between the two agents and restricting access to the files.

What if the agent represents only one buyer, but also represents the seller in a multi-offer situation? This form of disclosed limited agency can be equally problematic, especially if the other side submits their offer first. Once a disclosed limited agent representing the seller and a buyer learns the price and terms of the other side’s offer, he or she is in a much better position to advise the seller about accepting or rejecting it. However, without the client’s express consent, it would be a breach of fiduciary duty for the disclosed limited agent to inform the seller in advance of a submitted written offer, of his/her buyer’s price and terms.³ How can a disclosed limited agent suggest to their seller-client that it is in their best interest to reject another agent’s offer, if doing so would require the agent to disclose the contents of an offer that has not yet been submitted? And how can a disclosed limited agent recommend their seller’s acceptance of a competing offer, when doing so is not really in the best interest of the disclosed limited agent’s own buyer-client? In such circumstances, assuming that time and circumstances permit, the simultaneous submission of all competing offers is one solution that helps avoid the appearance of impropriety or claims of a breach of fiduciary duty. A buyer who loses out of a competitive bidding situation believing their offer was “shopped” by the other agent (acting in a dual capacity as the disclosed limited agent for another buyer and for the seller) would be a likely candidate to complain.⁴

An alternative approach, where the listing agent also represents a competing buyer, is to have the listing firm’s principal broker become the listing agent, and then permit each buyers’ agent to submit their offer separately. This approach has the advantage of creating a firewall insulating both buyers (and their agents) to the terms of the other’s offer – and therefore reducing the chance of any claims of impropriety. The playing field becomes level and each offer is then considered solely on its own merits.

Escalator Clauses. Occasionally, in an effort to assure success in multi-offer situations, buyers have been encouraged by their agents to insert an “escalator clause” into the sale agreement or addendum, providing, for example, that the purchase price will be $X higher than the highest competing offer, not to exceed $Y.
Escalator clauses are a more recent phenomenon to the Northwest than other regions of the country, especially the East Coast. For that reason, agents are encouraged to consult with their principal broker if they do not feel comfortable with the effect or meaning of such a clause.

However, escalator clauses can be fraught with danger to those agents who use them without a complete understanding of their meaning or an inability to fully explain them to their clients. Here are some tips in drafting and explaining escalator clauses:

• Always discuss with the buyer the importance of placing a cap on the clause, in order to reduce the risk of obligating the buyer to a price that is unrealistically high. For example, saying that the buyer will pay $1,000 above the highest competing offer, places the buyer at risk that another buyer’s outrageously high offer (plus $1,000) would become binding on the agent’s buyer. Putting a “not to exceed” provision in the escalator clause is necessary to avoid this risk.
  
  
• Make sure that the buyer understands the impact of using an escalator clause. If the buyer later tries to avoid their obligation under the Sale Agreement, or is otherwise dissatisfied with the outcome, licensees are at risk that a complaint will be lodged against them. Oregon case law requires that agents make an adequate explanation of the transaction, commensurate with the level of understanding of the client.⁵
  
  
• Agents representing sellers should make sure they understand the escalator clause being submitted to their clients. If there is any doubt, or the offer is ambiguous or poorly drafted, agents should consult their principal broker with regards to how to proceed. In all cases, agents should discourage their sellers from accepting offers that are ambiguous or capable of more than one interpretation.

Conclusion. Is the use of an escalator clause in a competitive offer situation wise? Like any other contractual provision, they may have a limited use if properly drafted and understood by all parties, including the agents. However, they are fraught with risk if not fully understood. For example, the use of an escalator clause can backfire if it results only in encouraging the seller to “fish” for other buyers, in order to up the bidding. And since there is no firm purchase price identified in the Sale Agreement containing an escalator clause (i.e. the price is $X dollars plus another buyer’s highest competing offer), the risk of buyer or seller confusion about the actual sale price could lead to claims against the agent.
For the same reason that office policies should be developed for presenting multiple offers, escalator clauses should similarly be addressed in written policy at the company level. And principal brokers must be especially vigilant when reviewing documents including such clauses.

FOOTNOTES

1 ORS 696.301(29).
2 This is not to say that principal brokers are “immune” simply by having written office policies. Not only must such policies exist, they must be implemented and followed. In other words, office policies do not eliminate the principal broker’s duty to review the written transactional documents and step in when they see poorly drafted or ambiguous agreements.
3 ORS 696.815(2)(c)(A),(B) & (C) Moreover, seller expectations can be unrealistically raised if the disclosed limited agent discusses with the seller what the buyer “intends” to offer – only to have the buyer change his or her mind. If the seller rejects or fails to accept another offer in reliance upon an agent’s representations of a better offer to be submitted that never materializes, the disclosed limited agent may find themselves on the receiving end of a civil or regulatory claim.
4 Conversely, even buyers who tie up the property with the highest bid can complain that their disclosed limited agent encouraged them to bid more than was actually necessary.
5 Prall v. Gooden, 226 Or 554 (1961).

© Copyright 2004. Phillip C. Querin, Davis Wright Tremaine. No part may be reproduced without the author’s express written consent.