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The Pitfalls of Using Escalation Clauses
Stephen L. Fussell, Chief CPO
In an effort to gain a competitive advantage, some prospective buyers may ask their agents to include escalation clauses in their offers. An escalation clause is one in which a prospective buyer expresses their willingness to pay a specific amount more than the highest competing buyer. The escalation clause may or may not indicate a maximum amount that the prospective buyer is willing to pay.
The Commission discourages the use of escalation clauses. Commission Rule A .0115 reads as follows: “A broker shall not disclose the price or other material terms contained in a party’s offer to purchase, sell, lease, rent, or to option real property to a competing party without the express authority of the offering party.” How does this rule impact escalation clauses? Assume, for example, that Buyer #1 offers to pay $1,000 more than any other offeror. In order to establish the price that Buyer #1 will pay, the brokers involved would have to share the terms of the highest offer with Buyer #1. Sharing these terms is prohibited except in the unlikely event that the other buyer consents to it.
Pitfalls of escalation clauses:
- If a buyer submits an offer containing an escalation clause without knowing the price and terms of the other offers and without specifying a maximum price, the buyer may end up paying much more for the property than desired.
- If a buyer includes a maximum price in an escalation clause, the seller will immediately know the buyer’s top price thereby compromising the buyer’s bargaining position.
- An offer containing an escalation clause may not become enforceable until a specific price is entered into the contract and the buyer sees the price the seller has specified.
- The seller may fabricate a fictitious offer in order to drive up the sales price for a buyer who uses an escalation clause.
- Real estate brokers are prohibited from drafting escalation clauses, because doing so would constitute the unauthorized practice of law. Hiring an attorney is recommended, but will increase the buyer’s costs. The seller should also have an attorney review an offer containing an escalation clause to protect the seller’s interests. Note that the use of an attorney-drafted escalation clause does not relieve the listing firm and its agents from obtaining the express authority of a competing buyer to disclose the terms and conditions of the competing buyer’s offer as required by Rule A .0115. If the competing buyer refuses to give such authorization, then disclosing the terms of the competing offer would violate this rule and subject a licensee to possible disciplinary action even if the clause were drafted by an attorney.
- If multiple buyers were to include escalation clauses in their offers, a bidding war may follow. If no buyer is willing to commit to a specific price, then no contract is ever formed and no property is sold.
- Since the use of an escalation clause implies that a prospective buyer is willing to pay more than other buyers, it may motivate sellers to seek higher prices, a disadvantage to the buyer using the escalation clause.
- While the use of escalation clauses may lead to higher sales prices, a benefit to the sellers, they could also discourage buyers who do not want to use escalation clauses and risk violation of a Commission rule. The use of escalation clauses may also lengthen the negotiation process, a potential disadvantage to sellers and buyers.
- The buyer who is unsuccessful in a negotiation where a competing buyer used an escalation clause may feel that they were treated unfairly. The perception of unfair treatment may discourage the buyer from purchasing property in the future and may lead the buyer to file complaints against the brokers involved in the transaction.
- A broker who discloses the price/terms of an offer without the buyer’s consent or otherwise gives one party an unfair advantage over another risks disciplinary action by the Commission.
A seller’s best response in a multiple offer situation where one or more of the buyers is using an escalation clause will likely be to invite all buyers to make their highest and best offers. That way, each buyer is given an opportunity to buy the property at the price and terms they are willing to pay and the seller will receive the best offer from each buyer rather than an incremental offer from a buyer who wants to offer slightly more than a competing buyer.
Escalation clauses tend to focus on price. Listing agents should exercise care to advise seller-clients to consider more than the sales price in an offer. An offer from a well-qualified buyer who offers a lesser amount may be a wiser choice than a higher offer from a less-qualified buyer. Similarly, an offer from a buyer who has visited the property may be preferred over one who offers a high price sight unseen.
Brokers who choose to use escalation clauses should proceed with extreme caution. Real estate transactions are complex even without such clauses. Real estate transactions in busy markets with low inventory can be even more frantic. Escalation clauses may introduce confusion, anxiety, frustration and fraud. For these reasons, the Commission discourages their use.
The July 20 Commission meeting will be in Durham!
Have you ever wanted to attend a Real Estate Commission meeting to see what happens? If so, please join us at the Have you ever wanted to attend a Real Estate Commission meeting to see what happens? If so, please join us at the JB Duke Hotel, 230 Science Drive, Durham, NC, in Meeting Room C at 9 a.m. You are welcome to stay for a portion or for all of the Commission’s meeting. Mark your calendars for July 20!
Disciplinary Actions
CESAR AUGUSTO OSORIO (ARDEN) – The Commission accepted the voluntary surrender of the broker license of Cesar Osorio effective May 18, 2022. The Commission dismissed without prejudice allegations that Mr. Osorio violated provisions of the Real Estate License Law and Commission rules. Mr. Osorio neither admitted nor denied misconduct.
Staff Appearances
Sheryl Graham, Consumer Protection Officer, spoke at the REMAX United office meeting on May 17.
Steve Fussell, Chief Consumer Protection Officer, spoke at the Showcase Realty LLC meeting on May 18.
Shanna Hardy, Consumer Protection Officer, spoke at the REMAX Leading Edge office meeting on May 25.
Employment Opportunities Available
Are you interested in joining the staff of the North Carolina Real Estate Commission? From time to time, employment opportunities become available. They are posted on the Commission’s website under the “About Us” tab.
We currently have opportunities available for the following positions:
Director of Education and Licensing
Auditor – Application Deadline June 28, 2022
Consumer Protection Officer – Application Deadline June 27, 2022
Network Administrator – Application deadline July 5, 2022
Click here for more information.
Active versus Inactive License Status
To lawfully engage in brokerage activity and receive any income for brokerage, an individual must have a CURRENT real estate broker license on ACTIVE status at the time they provide brokerage services.
What is a “current” license?
A broker who timely renews their license during May 15-June 30 has a current license for the subsequent year. All licenses expire on June 30 each year unless they are renewed by that date.
What is an “active” license?
Key Points: Active License Status
- A broker maintains an ACTIVE license status when they timely renew their license during the annual license renewal period AND complete the appropriate 8 hours of Continuing Education by June 10 of each year.
- Provisional brokers must also timely complete Postlicensing Education and be affiliated with a BIC to maintain active status.
Key Points: Inactive License Status
- If a broker fails to complete their required continuing education by June 10, their license status will be changed to INACTIVE at midnight on June 30.
- Once a broker’s license status is changed to inactive, they must immediately cease all brokerage activity until their license is back on active status.
Are BICs responsible for ensuring their affiliated brokers have an active, current license?
Yes. Commission Rule 58A .0110 requires designated BICs to assure that each affiliated broker has a current, active license to engage in brokerage activities. In order to appropriately supervise affiliated brokers and adhere to Commission rules, a BIC should use the Broker-in-Charge Login to examine the license record of all affiliated brokers and remind them of their obligation to renew their license and complete continuing education each year.
How does a broker reactivate an inactive license?
Pursuant to 58A .1703, the requirements for reactivating an inactive license depend upon the length of inactivity AND whether or not the broker has a continuing education deficiency. The reactivation requirements are as follows:
- Individual broker license on inactive status with NO continuing education deficiency
- Individual broker license on Inactive status for LESS than 2 years with a continuing education deficiency:
- Complete the current year’s CE requirement in full (i.e., take the General Update + 1 Commission-approved elective), AND
- take either 1 or 2 approved electives to make up for the number of hours you did not complete during the preceding license year; AND THEN
- submit the License Activation and Broker Affiliation form (REC 2.08)
- Individual broker license on Inactive status for MORE than 2 license years with a continuing education deficiency
- Successfully complete two 30-hour Postlicensing courses within 6 months prior to submitting activation form, AND
- complete the current year’s CE requirement in full (i.e., take the General Update + 1 Commission-approved elective); AND THEN
- submit the License Activation and Broker Affiliation form (REC 2.08)
Can a broker practice brokerage after reactivating their license?
Although a broker may have completed the required steps to reactivate an inactive license, they may not engage in brokerage activity without first submitting the License Activation and Broker Affiliation form (REC 2.08) to notify the Commission of the broker’s desire for ACTIVE status and of the office with which they will be affiliated and doing business.
REMEMBER: A broker may use the Licensee Login to analyze their license record and determine if they have completed their continuing education. A BIC may also review the license record of affiliated brokers by logging into their Broker-in-Charge Login. Do you have additional questions about ACTIVE versus INACTIVE license status? Contact the Education and Licensing Division at LS@ncrec.gov or 919.875.3700, x772.
It’s Time to Renew your License (May 15-June 30)
Be sure to renew your license between May 15 and June 30, even if you haven’t completed CE. If you do not renew by June 30, your license will expire.
Following are the most frequently-asked questions regarding license renewal. The answers to all of these questions, as well as step-by-step renewal instructions, are also provided in the Commission’s Renewal Video, which is posted in the Video Library.
When do I renew?
The annual period for renewal of your real estate license begins at midnight on May 15 and continues until 11:59 pm on June 30.
How do I renew?
- Go the Commission’s homepage, www.ncrec.gov.
- Click on Renew My Broker License. The renewal link will appear on the website on May 15.
- Enter your license number and PIN (password). Your PIN will be the last four digits of your Social Security number unless you have changed it.
- Verify your contact information, and update information if needed.
- Provide the “Employee Misclassification” disclosure and certification.
- If you are a Broker-in-Charge, you will be required to disclose information regarding your trust account(s) and any criminal convictions or disciplinary actions that have occurred within the previous year, if applicable.
- Pay the $45 renewal fee by Visa, MasterCard, Discover, American Express, or PayPal.
How much is the renewal fee?
The renewal fee is $45.00. You may pay by Visa, MasterCard, Discover, American Express, or PayPal.
Will I get a receipt?
Yes. A printable confirmation of renewal will appear on your screen when the process is complete.
Will the Commission mail me a new pocket card?
No. A link to download your new digital pocket card will appear on your screen when the process is complete. You may print a copy of the pocket card if you prefer to have a paper copy.
I haven’t completed CE, yet. Can I still renew?
Yes. Be sure to renew your license by June 30, even if you do not complete your continuing education by June 10. If you don’t renew, your license will expire.
Can I pay my renewal fee by check?
No. Per Commission Rule 58A .0503, you must renew online.
Can I call the Commission office and pay by phone?
No. Per Commission Rule 58A .0503, you must renew online.
Can I go to the Commission office and pay in person?
If you come to the Commission office, you may renew and pay online, using a computer in our lobby. No cash or checks will be accepted, even in person.
What will happen if I don’t renew by June 30?
If you do not renew your license online by 11:59 pm on June 30, your license will expire. To reinstate an expired license, you must pay a $90 fee between July 1 and December 31. Failure to reinstate the former license by December 31 will result in your having to submit a new application, including application fee and criminal background report. You will also be required to take additional education and/or pass the state license examination. https://www.ncrec.gov/Licensing/Reinstatement
NOTE: If you are a BIC or BIC Eligible and your license expires or changes to inactive status on July 1, you will automatically lose BIC Eligible status and, in turn, BIC designation (if applicable). If that happens, and you wish to regain BIC Eligible status, you must (1) return the license to active status; (2) meet the experience requirements for BIC designation; (3) take the 12-hour Broker-in-Charge Course before re-designation; and (4) complete and submit the Request for BIC Eligible Status and/or Designation form (REC 2.25). Do NOT take the 12- hour BIC Course before your license is on active status! Refer to Rule 58A. 0110 for detailed instructions regarding regaining BIC Eligible status and BIC designation.
Questions about the renewal process?
Email us at LS@ncrec.gov or call us at 919.875.3700.
“Multiple Trust Account Violations” – A Regulatory Affairs Division Case Study
The Commission’s auditors visit brokers-in-charge throughout the state to perform spot audits of trust accounts. This case is an example of why brokers-in-charge are now required by Rule A.0110 to take the Basic Trust Account Course within 120 days of assuming responsibility for a trust account (but no more than every three years). In the spot audit of a real estate firm that performed both sales and long term property management, the auditor found multiple areas of concern. Unfortunately, the broker-in-charge had been making mistakes in their trust account recordkeeping for so long that it was impossible to determine exactly how much of the money in the trust account belonged to which owner. Being able to identify exactly whose money is in the bank is a primary reason for the trust accounting rules – A.0116, A.0117, and A.0118.
The Ledger Problem:
The first problem the broker-in-charge had was that the software used for the property management accounting created ledgers where rent was treated like an accounts receivable, meaning that at the beginning of the month the rent populated as being due from the tenant. This is perfectly fine for tenant ledgers and tracking outstanding balances. However, Rule A .0117(c)(4) also requires that property or owner ledgers be maintained, and this firm did not have either. Property or owner ledgers should show the exact amount of money on hand, at any given time, for a particular property or owner. The problem with ledgers that populate an amount due is that, if the tenant does not pay their rent for that month or multiple months, there is a balance on the ledger that is an outstanding amount owed by the tenant when the ledger should indicate the amount of money on hand for the owner.
Sometimes when ledgers do not exist or are unclear, auditors use owner statements as a substitute, which is what we attempted to do on this audit. In this case, many owner statements had negative balances. Negative balance owner statements indicate that the expenses exceeded the income for that particular owner. When more money is spent on a property than the owner has in the trust account, it usually means that another owner/client has just paid those expenses. This is one form of deficit spending.
The Journal Problem:
Deposits and withdrawals on the ledgers and owner statements should be traceable to a journal. A journal is a check register where all deposits and withdrawals in a trust account are recorded. In this case, a journal was maintained but individual entries were not recorded. Instead, one amount was entered for all deposits on one day and another lump sum entry was made for all the withdrawals. There was no way to trace deposits or withdrawals on the journal to the ledgers or to confirm that all the journal entries were being posted.
The Reconciliation Problem:
In addition, there was no way to reconcile to the journal, which meant that the required three-way reconciliations were not being performed. The bank statements were not being reconciled against the journal because there was no way to confirm that the journal was accurate. The journal was not reconciled against the trial balance because no trial balance was maintained.
A trial balance is the sum of all of the ledgers at a set cutoff date, usually the same date as the bank statement. If a property management firm represents fifty owners, then every month the balance of each of those fifty owner ledgers should be totaled. This total should match, exactly, the reconciled bank balance and journal balance. In this case, since there were no owner or property ledgers, a trial balance could not be produced.
The Shortage Problem:
A true trial balance could not be created from the owner statements because of all the negative balances. Using the owner statements, even with the negative balances, it showed that the property management trust account had a significant shortage.
As seen in this case, failure to maintain trust account records properly at any stage in the process can have a domino effect. The auditor found other more minor infractions in addition to the major problems. The firm was given an opportunity to correct the deficiencies but they were unsuccessful in bringing the trust account into compliance and, therefore, received a disciplinary sanction. Trust account problems and shortages do not necessarily stem from theft or evil intent. A shortage can result if the broker-in-charge is not taking the necessary steps to maintain records. If any of the above sounds familiar (or unfamiliar) and you maintain a trust account, then take the trust account course and start to work on fixing your trust account records. It is only a matter of time before an auditor from the Commission will be knocking on your door.