REAL ESTATE LITIGATION
PAPER 5.1
“Shadow Flipping”: The Legalities of Assigning Real
Estate Contracts in British Columbia
These materials were prepared by Alexandra Cocks and Jordanna Cytrynbaum, with case law research
assistance by Glynnis Morgan, all of McCarthy Tétrault LLP, Vancouver BC, for the Continuing Legal Education
Society of British Columbia, May 2016.
© Alexandra Cocks and Jordanna Cytrynbaum
5.1.1
“SHADOW FLIPPING”: THE LEGALITIES OF ASSIGNING REAL
ESTATE CONTRACTS IN BRITISH COLUMBIA
I.
What is Shadow Flipping?............................................................................................................. 1
II.
Is It Legal? ....................................................................................................................................... 2
A. Common Law and Statutory Assignments ........................................................................... 2
III.
Potential Liability of Real Estate Agents.................................................................................... 3
A. Contractual and Fiduciary Duties.......................................................................................... 3
B. Statutory Duties....................................................................................................................... 5
1. Remedies for Breaches of the Rules.................................................................................. 6
IV.
Sample Scenarios ............................................................................................................................ 7
V.
Practice Points................................................................................................................................. 8
A. Acting for the Vendor ............................................................................................................. 8
B. Acting for the Assignor or Assignee ...................................................................................... 9
VI.
New Rules........................................................................................................................................ 9
In February 2016, numerous news articles shone a spotlight on the controversial practice of
“shadow flipping.” The recent revelation of this wide-spread practice has caused many to be
outraged, original sellers to feel cheated, and others to blame the “shadow flippers” for inflating the
already hot housing market.
Many news articles conclude that shadow flipping is “perfectly legal”—but is it really?
The shadow flipping controversy has also exposed alleged misconduct on the part of real estate agents,
including misleading advertising and predatory sales strategies designed to take advantage of consumers.
The exposition of the shadow flipping practice has drawn the attention of the provincial
government and the Real Estate Council of BC (“RECBC”), who have both announced an
intention to revise the rules governing real estate agents, specifically in respect of contract
assignment and penalties for predatory sales practices.
In this paper, we examine the legality of shadow flipping and potential claims against real estate
agents involved in the sale/assignment of property. We also provide a summary of the proposed
changes announced by the government and the RECBC.
I.
What is Shadow Flipping?
Shadow flipping involves speculators (often with the assistance of their realtors) selling their
contractual rights as purchasers one or more times before the deal closes, profiting from each
5.1.2
transfer using assignment clauses in purchase and sale contracts. All of this is done usually without
the knowledge or consent of the original home seller.
In a stable market, assignments were historically used as safeguards for purchasers who could not
come up with the funds required to close; they could assign the contract to a third party and avoid
liability for failing to close. In the present market, assignments are being used by assignees and
realtors to profit from the steep increase in property market value. The original home seller receives
less than what the home is ultimately sold for; the realtors and the “shadow sellers” in the middle
profit. Realtors earn an assignment fee and commission and the shadow sellers pocket the difference
between what they paid and the resale value.
Shadow flipping can be profitable, in part, because shadow sellers are not required to pay Property
Transfer Tax because, technically, the property has not transferred until closing.
Critics say this speculation of shadow buyers is inflating housing prices and is unfair to the original
sellers and the ultimate purchasers.
Example:
The Smiths enter into a purchase and sale contract with Buyer 1 to sell their family home for $1
million. Buyer 1’s real estate agent (the “Realtor”) then arranges for Buyer 1 to assign the contract
to Buyer 2 for $1.3 million. The Realtor then facilitates the assignment of the contract by Buyer 2 to
Buyer 3, the ultimate purchaser, for $1.5 million.
•
The Smiths get $1 million less commission
•
Realtor earns a commission
•
Buyer 1 earns $300,000
•
Realtor earns an assignment fee
•
Buyer 2 earns $200,000
•
Realtor earns an assignment fee
•
Buyer 3 pays $1.5 million and the Property
Transfer Tax
II.
A.
Is It Legal?
Common Law and Statutory Assignments
At common law, contracts can be assigned unless there is an express prohibition against assignment
in the contract. Where it is permitted, the assignor does not require the consent of the other
contracting party. When a contract (a chose in action) is assigned at common law, the assignee must
sue in the name of the assignor (Dell v. Saunders, [1914] 17 D.L.R. 279 at 280-21 (B.C.C.A.)).
To give the contract assignee the ability to enforce the contract in his/her own name, s. 36 of the
Law and Equity Act, R.S.BC. 1996, c. 253 creates a statutory assignment. Section 36(1) provides:
36(1) An absolute assignment, in writing signed by the assignor, not purporting to
be way of charge only, of a debt or other legal chose in action, of which express
notice in writing has been given to the debtor, trustee or other person from whom
the assignor would have been entitled to receive or claim the debt or chose in action,
is and is deemed to have been effectual in law, subject to all equities that would have
been entitled to priority over the right of the assignee if this Act had not been
5.1.3
enacted, to pass and transfer the legal right to the debt or chose in action from the
date of the notice, and all legal and other remedies for the debt or chose in action,
and the power to give a good discharge for the debt or chose in action, without the
concurrence of the assignor.
For a statutory assignment to be valid and enforceable four requirements must be met:
(1)
it must be absolute;
(2)
it must be in writing;
(3)
it must be signed by the assignor; and
(4)
the debtor (the other contracting party, namely, the vendor) must be given express
notice of the assignment in writing.
Rakhra v. Jhutty, 2012 BCSC 882
The purpose of the requirement in s. 36(1) for written notice of the assignment is to protect debtors
who might otherwise pay the account of the assignor, without notice of the assignment (Rakhra v.
Jhutty, citing Link v. Texas Oil & Gas Inc., 2007 BCSC 1205 at para. 56).
The vendor’s consent to an assignment is not required under s. 36(1) of the Law and Equity Act in
order for the assignment to be valid and enforceable.
So, yes, assigning a purchase and sale contract before a deal closes is legal, and will be effective by
the assignee as against the vendor, if the contract does not expressly restrict assignment and if the
requirements of section 36 of the Law and Equity Act are made out, including providing written
notice of the assignment to the vendor.
III. Potential Liability of Real Estate Agents
Recent reports suggest that real estate agents are at the heart of the controversy about shadow
flipping in more ways than one. In some instances, real estate agents are merely facilitating
assignments on behalf of the initial buyers and earning an assignment fee for themselves. In other
cases, real estate agents are alleged to be purchasing homes in their individual capacities or through
corporate vehicles then assigning the contracts to third parties for higher prices thereby pocketing
the difference as the shadow seller.
In either case, real estate agents may be breaching their statutory and/or common law obligations
and exposing themselves to liability, even to non-clients.
News articles have also uncovered misleading and predatory practices of real estate agents involved
in shadow flipping. These practices include the failure of agents to disclose relevant information
about the property or the transaction to the vendor and/or preferring their own interests over their
clients’ and profiting as a result. These activities may also lead to claims against agents.
Below, we summarize the statutory and common law obligations of real estate agents to their
principals and others in the context of shadow flipping.
A.
Contractual and Fiduciary Duties
A real estate agent owes both contractual and fiduciary obligations to her principal. The
relationship between a real estate agent and her client is historically recognized as a fiduciary
5.1.4
relationship in the agent-principal category (S. Maclise Enterprises Inc. v. Grover, 2014 ABQB 591
at paras. 85 and 86).
The fiduciary duties include:
●
the duty to make full and fair disclosure of all material facts the agent knows
regarding which might affect the value of the property or the beneficiary’s decision
(S. Maclise Enterprise Inc. v. Grover, 2014 ABQB 591; Charette v. AH Fitzsimmons
& Co (1990), 12 R.P.R. (2d) 290 at 2304);
●
the duty of loyalty, to keep the best interests of the beneficiary ahead of his or her
own, or any other party (A fiduciary cannot profit from his principal’s property or
business interests (Canadian Aero Service Ltd. v. O’Maelly, [1974] S.C.R. 592).
In respect of disclosure, the test of what a real estate agent must disclose is objective, determined by
“what a reasonable man in the position of the agent would consider, in the circumstances, would be
likely to influence the conduct of his principal” (Ocean City Realty Ltd. v. A& M Holdings Ltd.
(1987), 36 D.L.R. (4th) 94 at 99 (B.C.C.A.)).
A real estate agent will not be found to have breached her fiduciary duty just because the selling
price obtained for a property is not the best possible price (Phelan v. Realty World-Empire Realty
Ltd. (1994), 38 R.P.R. (2d) 128 (B.C.S.C.)). However, the “price paid must be adequate and the
transaction must be a righteous one and the price obtained must be as advantageous to the principal
as any other price that the agent could, by the exercise of diligence on his principal’s behalf, have
obtained from a third person” (D’Atri v. Chilcott (1975), 7 O.R. (2d) 249 at 258 (H Ct. J)).
Whether or not an agent owes a fiduciary duty to others depends on the circumstances of each case.
A fiduciary duty can arise if the test in Frame v. Smith can be made out:
(1)
the fiduciary has scope for the exercise of some discretion or power,
(2)
can unilaterally exercise that power or discretion so as to effect the beneficiary’s
interests, and
(3)
the beneficiary is peculiarly vulnerable to the fiduciary holding the discretion or
power.
For example, in certain factual scenarios, a fiduciary duty can arise on the part of the selling agent
vis-à-vis the vendor. See, for example, Westrheim v. Gao, 2007 BCSC 274. There, an agent who was
originally the selling agent, but then made an offer to purchase the property in her own capacity,
was found to be liable where she made an offer to purchase, which misled the vendors about the
true nature of her intent to purchase, which was to flip the property immediately after she sold it
(Westrheim v. Gao, 2007 BCSC 274).
A fiduciary duty can arise even in a dual agency agreement if the same three conditions are met
(Maclise Enterprises paras. 115-16).
The measure of damages for breaches of fiduciary duty can be losses suffered or the profits resulting
from that breach (Regal (Hastings) Ltd. v. Gulliver, [1942] 1 All E.R. 378 (H.L.)). Accordingly, any
profits made by the realtor, including commissions, and profits made on a subsequent sale can be
disgorged if a breach is found.
In the shadow flipping context, real estate agents can expose themselves to liability by:
●
making representations to parties other than their principals, which mislead the
party as to the intentions of the initial purchaser;
5.1.5
●
making representations to parties other than their principals without adequately
disclosing his or her interest in the transaction, for example, if the agent or her
company is the purchaser of the property;
●
approaching home-owners with offers to purchase knowing the offer to be below
market value and representing to the vendor that the offered amount is the best they
will get, with the intention of quickly flipping it for a higher price;
●
acting in his or her own self-interest to the detriment of his or her client.
In addition to liability for breach of fiduciary or contractual duties, real estate agents can find
themselves liable for misrepresentation based on the same factual scenario. See, for example,
Westrheim v. Gao, 2007 BCSC 274.
Real estate agents are also bound by statutory duties to their clients and to others. These duties may
inform the content of common law duties owed to clients and others. In addition, as discussed
below, real estate agents may face administrative penalties or fines for offences if they violate their
statutory duties.
B.
Statutory Duties
Real estate agents are self-governed by the Real Estate Council of British Columbia (the
“RECBC”). Pursuant to s. 86 of the Real Estate Services Act, S.B.C. 2004, c. 42, the RECBC can
make rules respecting a number of aspects of the real estate business, including disclosure to clients
and it can enforce standards of conduct, investigate complaints from the public and impose
disciplinary sanctions under the Real Estate Services Act.
Part 5 of the Real Estate Council Rules and Bylaws regulates contractual matters, disclosure, and
“commissions and other remuneration.”
Of particular note is Rule 5-7, which governs disclosure by agents who will directly or indirectly
acquire real estate or whose associate is acquiring the real estate and the agent is providing real
estate services to the associate. Specifically, the rule requires that agents provide a “Disclosure of
Interest in Trade” statement before “any agreement for the acquisition or disposition of real estate
is entered into where the seller, landlord, buyer, or tenant is licensed under the Act.”
Associate is defined under the Rules as:
… in relation to a licensee means a person who is any of the following:
(a) in the case of an individual licensee,
(i) a spouse or family partner of the licensee,
(ii) a trust or estate in which the licensee, or a spouse or family
partner of the licensee, has a substantial beneficial interest or for
which the licensee, spouse or family partner serves as trustee or in
a similar capacity, or
(iii) a corporation, partnership, association, syndicate or
unincorporated organization in respect of which the licensee, or a
spouse or family partner of the licensee, holds not less than 5% of
its capital or is entitled to receive not less than 5% of its profits;
(b) in the case of a brokerage that is a corporation or partnership,
(i) a director, officer or partner of the brokerage,
(ii) a shareholder of the brokerage who holds more than 10% of the
voting shares of the brokerage,
(iii) a trust or estate
5.1.6
(A)
in which the brokerage, or a director, officer or partner of the brokerage,
has a substantial beneficial interest, or
(B) for which the brokerage, or a director, officer or partner of the
brokerage, serves as trustee or in a similar capacity, or
(iv) a corporation, partnership, association, syndicate or
unincorporated organization in respect of which the brokerage, or
a director, officer or partner of the brokerage, holds not less than
5% of its capital or is entitled to receive not less than 5% of its
profits.
Included in the provisions to be completed by a real estate agent are two boxes with the following
provisions beside them:
●
the real estate is to be held for personal, rental or other use, or
●
the real estate is to be resold.
Immediately under these two boxes are the following provisions:
If the real estate is to be resold, make the following disclosure, as applicable:
I am negotiating or have negotiated/My associate is negotiating or has negotiated the resale of
the real estate on the following terms:
In other words, prior to entering into an agreement to purchase property, a real estate agent must
disclose to the vendor his/her intended purpose in buying that property.
The form also requires the realtor to disclose remuneration “other than remuneration paid directly
by a client” that will be earned or received by the realtor as a result of the agent providing real estate
services to or on behalf of the client, recommending certain other professionals, such as lawyers, to
the client or recommending the client to such individuals (Rule 5-11).
In the shadow flipping context, realtors must be cognizant of their statutory duties to disclose their
interests in the property if they are directly or indirectly acquiring the real estate and to set out their
intentions to resell the property if they anticipate flipping it. They must also do so if their
“associate” (as defined under the Rules) is purchasing the property and they are proving real estate
services to that associate. As discussed below, real estate agents can face administrative penalties or
fines for breaches of their statutory duties.
1.
Remedies for Breaches of the Rules
A real estate agent can be liable for administrative penalties or fines for offences for committing
various breaches of the Rules or the provisions of RESA.
In addition, victims of real estate agent breaches can make a claim for compensation to the RECBC
pursuant to s. 61 of RESA. Section 61 provides:
61(1) In order to make a claim for compensation from the special compensation
fund, a person must apply in writing to the real estate council within the time limit
established by subsection (2), including
(a) particulars of the conduct on which the claim of compensable loss is
based,
(b) if the person is relying on a court decision, a copy of the decision, and
(c) any other information required by the real estate council.
(2) The time limit for making a claim is 2 years after the earliest of the following:
5.1.7
(a)
(b)
(c)
the date on which the person making the claim became aware that the
compensable loss occurred;
if the licence of the responsible brokerage was cancelled or suspended
by an order under section 45(2)(a) [orders in urgent circumstances] or
51(2)(b) [superintendent's orders in urgent circumstances] at any time
after the conduct that caused the compensable loss, the date of that
cancellation or suspension;
the date the real estate council or superintendent publishes a notice, in
accordance with the regulations, that compensable loss may have
occurred.
Under the predecessor to RESA, the Real Estate Act, individuals who entered into a contract with a
real estate agent (e.g., selling their home to an agent) could consider that contract voidable in the
event of a breach of the agent’s duties under the Act. Section 48 provided:
The contract is not rendered void or voidable as against a person other than the
agent by or through whom the contract was negotiated or entered into because of a
failure on the part of the agent to comply with any provision of this Part.
This was a statutory right.
Cases held that failure to disclose pursuant to the Real Estate Act makes contract voidable at
instance of the vendor as against the agent (Rakhra v. Jhutty, 2012 BCSC 882 paras. 79, 83). Courts
explained the rationale for this rule was to protect members of the public from unscrupulous real
estate agents (Van’s Nurseries Inc. v. Leung, [1992] B.C.J. No. 1431 at para. 25).
There is no comparable provision under the current Real Estate Services Act, S.B.C. 2004, c. 42.
Query whether an equitable argument could be made to avoid the contract vis-à-vis the realtor on
the grounds that full disclosure had not been made. Whether this claim could be made would
depend on the factual circumstances, for example, whether the full asking price was paid, or
whether there were any representations made by the real estate agent.
In the circumstance where a non-disclosing agent assigns the contract to a bona fide purchaser for
value through an arms’ length transaction, then an equitable claim that the contract is voidable is
unlikely (Rakhra v. Jhutty para. 85).
IV. Sample Scenarios
(1)
Husband and wife list condo for sale for $529,000. Realtor approaches them and presents
offer of $520,000 on behalf of a client. The offer is accepted but the deal falls through. Realtor
then decides to make an offer to purchase on the same terms as her client. Realtor completes
the Disclosure of Interest in Trade checking both boxes, indicating the real estate is to be
resold and to be held for personal, rental or other use. Sellers are suspicious of the offer,
concerned that the realtor knows something they do not. Sellers are very interested in
knowing why the realtor wants to purchase it. Realtor tells sellers that she intends to buy the
condo for investment purposes and that she intended to rent it. She tells them they need not
worry about her “flipping” it. Transaction closes. Six days after closing the property is listed
for sale $100,000 over the closing price. Hardwood floors are installed and the condo is
painted and staged. Ultimately, it resells for more than she bought it for and she profits
$61,500, after deducting carrying and reno costs.
●
Breach of fiduciary duty? Misrepresentation? Breach of statutory duty?
5.1.8
(2)
Sellers list home for sale with listing agent. Selling agent submits an offer on behalf of
prospective purchaser, a friend. Selling agent writes letter presenting first offer which attempts
to influence seller into accepting offer some $30,000 lower than list price. Offer accepted.
Before sale completes, prospective purchaser decides to buy another home, so assigns the
contract to the selling agent. Selling agent then assigns it to a company controlled by him.
Selling agent unilaterally wrote to the seller on behalf of the initial purchaser advising that his
company would become the purchaser without advising of his interest in the company.
The sale closes. Within a few weeks, the selling agent’s company then sells the home to a third
party at a profit. The seller, on learning of the second sale, commences an action against the
selling agent and his company for breach of fiduciary duty.
●
(3)
Seller enters into a purchase contract with Buyer A for the sale of seller’s home. Prior to
completion, Josh, a realtor, approaches the buyer enquiring whether the buyer would like to
assign their interest in the contract to Josh.
●
(4)
Does Josh have to disclose his intention to purchase the contract from the buyer?
Amy, realtor, wants to buy her neighbour’s house that is for sale, but she and her neighbour
hate each other. Amy convinces a friend to make an offer, which is then accepted by the
neighbour, with the understanding that the friend will assign the contract to Amy prior to
completion.
●
(5)
Could the realtor be liable? Remedy?
Does Amy have to disclose that she is behind the offer?
Real estate transaction collapses when the seller learns, through a conversation with his
realtor, that contract has been assigned. No written notice was provided of the assignment.
The Assignee paid assignment price of $9,000 to the original buyer and reimbursed it for the
deposit payment. The assignee sues the vendor for specific performance.
●
Does the vendor have to close?
V.
A.
Practice Points
Acting for the Vendor
As set out above, assignment of the contract is legal if the contract does not expressly prohibit it.
Further, the assignment will be effective against the vendor by the assignee if the requirements of
the Law and Equity Act, including written notice of the assignment, are met.
One way for vendors to protect themselves is to include a “No assignment clause” in the contract of
purchase and sale. This will eliminate the ability of anyone to assign or sell the contract to a third party.
Example: “The Buyer will not assign this contract in whole or in part to any third party.”
If a buyer learns of an assignment and refuses to close in the absence of a “no assignment clause” in
the contract, the buyer should be cautioned about his/her obligations to close.
However, if a real estate agent is a purchaser or acting on behalf of an associate who is purchasing
the property and that agent has not disclosed his/her interest to the vendor, there may be recourse
for the vendor to back out of the deal before it closes, depending on the specific facts of the case.
5.1.9
B.
Acting for the Assignor or Assignee
Some practice points to consider when acting for the assignor or assignee include the following:
●
Check the contract to ensure the buyer has the right to assign and the assignee has a
right to receive a valid assignment;
●
Ensure a proper assignment is drafted and validly executed;
●
Confirm that the seller has been given notice in writing of the assignment;
●
If assignor or assignee is a corporate party, confirm that the individual signing on
behalf of the corporate entity has the authority to bind the corporation; and
●
If the assignor or assignee is a real estate agent, ensure he/she has met his/her
disclosure obligations.
VI. New Rules
After the media uproar about shadow-flipping in February 2016, both the provincial
government and the RECBC announced that they would be considering changes to legislation
and the Rules, respectively.
In February 2016, the RECBC and the Superintendent of Real Estate formed an Independent
Advisory Group (the “IAG”) to examine issues of concern relating to real estate agent conduct and
practices that had come to the attention of the RECBC and to the general public. In particular, the
IAG was tasked with looking at the examples of agent misconduct in respect of improper contract
assignments and misuse of limited dual agency.
In March 2016, the provincial government announced that it was working on proposed changes to
the Real Estate Services Act that would make it illegal to assign a contract without the vendor’s
informed consent, and that would require any profits from a flip be given to the vendor. The
premier announced that the enforcement of the new rules will likely be left to the RECBC.
On April 8, 2016, the IAG released an interim report. The interim report suggests that there is likely
a need for higher fines under the Real Estate Services Act for agent misconduct and that there are gaps
in respect of rules governing agent conduct under the RESA and the RECBC Rules and Bylaws.
On April 12, 2016, the IAG issued a follow up comment on its interim report noting that the IAG
was considering:
●
whether misleading advertising and predatory sales strategies are being sufficiently
deterred; and when identified, adequately punished, particularly in cases where
agents are trained to use sales strategies to take advantage of consumers;
●
whether more can be done to deter abuse of the otherwise legal practice of assigning
a contract in a way that fails to disclose the interests of a agent or puts those interests
ahead of a client’s; and
●
whether or not the limited dual agency continues to have a place in the real estate
services industry. Agents are expected to at all times, solely in their client’s bests
interests. This obligation and giving dual advice cannot co-exist given the dual
conflicts between the parties’ interests.
A final report is expected to be issued by the IAG at the end of May 2016.