‘Shadow Flipping’ and New Regulations for the BC Real Estate Industry

In the world of real estate, ‘shadow flipping’ is the practice of a purchaser entering into a contract with a vendor to buy real estate and then selling and assigning that contract to another purchaser for a higher price before the contractual closing date. The profit is kept by the purchaser and shared by the people who arranged the deal; this sometimes includes realtors who may induce the original vendor to sell their property to the purchaser (who may be working with the realtor) for a lower price knowing that the property is worth more and that the purchaser can turn around and sell the property to another purchaser for more than the original vendor received. Although this particular use of assignment is objectionable, assignment is in general a legitimate and legal business practice. A real estate contract is generally assignable by common law unless it is expressly forbidden by the contract. Section 36 of the Law and Equity Act provides that there is no requirement that the vendor consent to the assignment provided that the purchaser gives the vendor written notice of the assignment.

Changes to the Regulation of the Real Estate Industry in BC

Due in part to the problems of ‘shadow flipping’ and concerns over consumer protection and public confidence in the regulation and practices of licensed realtors in BC, the Real Estate Council of BC (RECBC) created the Independent Advisory Group (IAG) to review how the RECBC manages realtor misconduct. On February 9, 2016 the IAG was formed to bring together private and public sector experts to review the conduct requirements established for realtors and examine if those requirements are sufficient and are being effectively administered. A report from the IAG was released on June 28, 2016 which recommends “important changes to the regulatory regime to improve public protection, including greater transparency for consumers, higher penalties, improved reporting of [realtor] misconduct, governance changes, and improved public accessibility to the regulator”. Based on this report, Premier Christy Clark announced on June 29, 2016 that the real estate industry will no longer be allowed to regulate itself. Since 2005 the RECBC has been a self-regulating body mostly controlled by realtors overseeing discipline, licensing, and regulation of the BC real estate industry.  When the province’s new changes come into effect, there will be a dedicated Superintendent of Real Estate who will take over these duties.

New Regulations under the Real Estate Services Act

In addition to the changes announced June 2016, Premier Clark also announced earlier on March 18, 2016 that BC would introduce new rules to require real estate vendors to consent to any assignment of real estate contracts and require that any profits from the assignment of real estate contracts go to the vendor. The rules are to prevent the situation described above in which a purchaser buys a property from a vendor and then reassigns the contract at a higher price before the sale closes without the vendor’s knowledge. The new regulations under the Real Estate Services Act came into force May 16, 2016 and state the following in section 8.2(3):

Unless otherwise instructed in writing by the party to whom or on whose behalf the licensee is providing trading services, a licensee must include the following terms in a contract the licensee prepares for consideration by that party before the contract is presented to another party:

(a) this contract must not be assigned without the written consent of the seller;

(b) the seller is entitled to any profit resulting from an assignment of the contract by the buyer or any subsequent assignee.

In response to this legislation, the British Columbia Real Estate Association added the following paragraph to its standard Contract of Purchase and Sale:

20A. RESTRICTION ON ASSIGNMENT OF CONTRACT:

The Buyer and the Seller agree that this Contract: (a) must not be assigned without the written consent of the Seller; and (b) the Seller is entitled to any profit resulting from an assignment of the Contract by the Buyer or any subsequent assignee.

Penalty for Non-compliance

What happens if a realtor does not include the language required by the regulations? Section 35(1)(a) of the Real Estate Services Act states that a “licensee commits professional misconduct if the licensee . . . contravenes this Act, the regulations or the rules”. Section 43(1) says that if a discipline committee determines that a realtor has committed professional misconduct, the discipline committee must do one or more of the following:

(a) reprimand the licensee;

(b) suspend the licensee's licence for the period of time the committee considers appropriate or until specified conditions are fulfilled;

(c) cancel the licensee's licence;

(d) impose restrictions or conditions on the licensee's licence or vary any restrictions or conditions applicable to the licence;

(e) require the licensee to cease or to carry out any specified activity related to the licensee's real estate business;

(f) require the licensee to enrol in and complete a course of studies or training specified in the order;

(g) prohibit the licensee from applying for a licence for a specified period of time or until specified conditions are fulfilled;

(h) require the licensee to pay amounts in accordance with section 44 (1) and (2) [recovery of enforcement expenses];

(i) require the licensee to pay a discipline penalty in an amount of

(i) not more than $20 000, in the case of a brokerage or former brokerage, or

(ii) not more than $10 000, in any other case.

Therefore, if a realtor contravenes the regulations and does not include the required terms in the contract, then the realtor could face serious consequences that could hinder or prevent them from working in the real estate industry.

What Effect will the Regulations Have? Are there any Problems?

The main purpose of section 8.2 of the regulations is to protect vendors who are selling real estate from persons using the legitimate practice of assignment to illegitimately deprive those vendors of additional profits that should rightfully be theirs. However, on the face of it, there are a few problems with the regulations.

One problem is that the regulations only apply to a “licensee”, in other words, a realtor. This means that the regulations do not apply to non-licensed agents. Although many people use licensed realtors to sell real estate, if a person uses a non-licensed agent, the regulations will not apply and that person will not benefit from the protection afforded by the regulations.

Another problem with the regulations is that they do not provide sufficient remedies for the vendor if ‘shadow flipping’ occurs. If a realtor does not include the provision required by the regulations and the purchaser profits by assigning the sale to another purchaser (engages in ‘shadow flipping’), then the vendor has no remedy against the original or second purchaser. The vendor can only report the realtor for committing professional misconduct and take legal act against them for negligence for failing to include the provision. It is questionable if either of these avenues would return the lost profits to the vendor.

Whether these flaws will prevent the regulations from having the intended cooling effect on the practice of ‘shadow flipping’ is yet to be seen as the real estate market in BC continues to heat up and record sales are recorded.