CREATIVELY DRAFTED MORTGAGE AGREEMENTS - ILLEGAL INTEREST RATES

March 03, 2017

Krayzel Corp. v. Equitable Trust Company, 2016 SCC 18

    These days it is very rare that the Supreme Court of Canada (the “SCC”) hears a case involving a mortgage matter.  So, when it does, it’s probably worth it to pay attention.
The issue in this case was whether or not the interest provisions of a mortgage agreement violated Section 8 of the Interest Act.  That section states that a mortgage cannot charge a higher rate of interest on arrears than on principal money not in arrears. While that sounds fairly straight forward, the way this particular mortgage agreement was drafted caused considerable differences of opinion through the various courts which heard the case, including the SCC.

The basic facts were as follows:

  • The initial mortgage loan prescribed an interest rate of prime plus 2.875%.
  • The borrower could not pay out the mortgage on maturity.
  • The lender agreed to extend the mortgage by 7 months with a per annum interest rate of prime plus 3.125% for the first six months and 25% on the seventh month.
  • The borrower was unable to pay out the mortgage when the first extension agreement expired.
  • The borrower and lender entered into a second agreement that was made effective as at one month before the first agreement expired.
  • The second agreement provided:
    • a per annum interest rate of 25%;
    • that he borrower was required to make monthly interest payments at the “pay rate” which was the greater of 7.5% or prime plus 5.25%; and
    • that the difference between the 25% rate and the “pay rate” would accrue to the loan and if the borrower did not default, the accrued amount would be forgiven
  • When the borrower defaulted again, the borrower demanded payment at the 25% rate.

In a 6-3 split decision the SCC found that the terms of the first extension agreement did not violate the Interest Act, but the terms of the second agreement did.

In reaching that conclusion, the majority stated that the Interest Act applies to both incentives to performance (i.e. discounts) and penalties for non-performance and if the overall  effect is to cause the payment of a higher interest rate on arrears than on principal money not in arrears, section 8 of the Act is violated. Furthermore, the creativity of the language used and the form of the mortgage agreement is irrelevant. The determining factor is the effect of those terms.

Therefore, although lenders can be creative when negotiating and drafting mortgage agreements, they must always consider how the interest provisions will actually operate should there be a default.
 

 
Jeffrey A.L. Kriwetz
E-mail: jkriwetz@garfinkle.com
Direct Line: 416.869.7618
 

*Please note: The views expressed in this article are those of the writer and have been provided for information purposes only. Nothing in this article should be relied on as specific legal advice in any particular case. For such advice, please contact the writer directly.

               
 
 

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