Whether you are an individual borrower, a commercial debtor or a lender, below is a summary of some of the most important interest rate provisions to be aware of.
Section 10 of the Interest Act (Canada) allows a borrower who is a natural person to prepay a mortgage loan or hypothec having a term of 5 years or more at any time after the first 5 years, in exchange for 3 months’ interest payments (in addition to the principal and interest owing). This right of prepayment protects individuals from being locked into a long-term mortgage at a high interest rate with either no ability to prepay or with prepayment subject to a large penalty. However, the same rule restricts individuals from negotiating their own prepayment terms which may preclude them from securing more favorable long-term financing.
The provision does not apply to commercial borrowers such as corporations, partnerships, certain trusts or unlimited liability companies, allowing such parties to freely negotiate the prepayment terms of their financing arrangements based on factors such as the perceived risk to the lender, ability of the business to succeed, etc. It also allows lenders to offer different pricing models to commercial borrower clients. On the flip side, small businesses without the expertise or bargaining power to negotiate favorable prepayment terms do not have the benefit of the protections afforded to individuals.
2. Criminal Rate of Interest
Parties to a financing need to be aware of the criminal rate of interest which, pursuant to section 347 of the Criminal Code (Canada), is 60% per annum. Although it is rare for a loan agreement to explicitly state a rate this high, courts have taken a liberal approach to interpretation such that certain fees and expenses to be paid under an agreement may be included in the court’s calculation. It is an offence to receive interest payments at a criminal rate or to even enter into an agreement to receive interest at a criminal rate.
Loan agreements commonly include a provision whereby parties agree to reduce the rate of interest (if found by a court to be a criminal rate) to a rate allowable under law. Such a finding remains at the discretion of the court, but if accepted, may save contracting parties from having to enter into a new agreement, and would allow the lender to recover the maximum amount permitted under law.
The Interest Act requires that any loan agreement setting out a rate of interest payable at a rate or percentage for any period less than a year to also expressly state the yearly rate or percentage (except in the case of a real estate mortgage). Failure to provide this statement could mean that a lender is only entitled to a rate of 5% per annum (the statutory cap). This was the result in a recent case (currently subject to appeal) pursuant to which a conversion formula in the loan agreement was found to be insufficient. Interestingly, although only a fraction of what the court considered “interest” was non-compliant, the court limited the entire amount of interest to 5%. Lenders should carefully consider the wording of interest rate provisions to ensure that they are not later challenged on grounds of non-disclosure.
4. Default Rates
Except for loans secured by a mortgage over real property (or its Quebec equivalent), a lender is permitted to charge a higher rate of interest after the occurrence of a default. Default rates should be reviewed carefully to ensure that a minor default doesn’t result in a large penalty.
5. No Interest Rate
If the parties fail to provide an interest rate in an agreement, a lender may be prohibited from charging any interest over the 5% cap. Case law suggests that a lender cannot unilaterally amend the terms of a loan agreement to add in an interest rate, even if such a rate was previously stipulated in a loan application.
The foregoing provides a very brief summary of some of the most important interest rate provisions to be aware of. However, tailored advice related to your particular financing arrangements may be warranted.
Darcy is a partner in McMillan LLP’s Ottawa office where she advises lenders and borrowers on all aspects of financing transactions including initial structuring, loan documentation and execution, whether it be syndicated, asset-based, DIP, real estate, PPP, mezzanine or otherwise. She also regularly advises international and domestic deposit-taking institutions and insurers with respect to financial institution regulation in Canada, and is named as a 2018 rising star in the IFLR1000 Financial and Corporate Guide. On most days outside of the office, Darcy can be found hiking in Gatineau Park close to her home in Chelsea.