Lenders Beware of S.8 Interest Act
Section 8 of the Interest Act (Canada) prevents a lender from charging a higher rate of interest on default of a mortgage than was charged before the mortgage went into default. The section includes fines, lump sum bonuses, late payment charges, default fees, and similar charges intended to penalize a borrower who makes late payments or who defaults. The purpose of section 8 is to protect borrowers from aggressive lending practices that will prevent them from repaying their loans.
Section 8 does not apply only to mortgages. Loans which are secured by promissory notes which are then secured by a mortgage or mortgages are similarly affected. Where the debt instruments secure repayment of the original principal amount, such that, they reflect a single loan, section 8 of the Interest Act (Canada) will apply to the loan and all of the debt instruments securing the loan.
This was the case in P.A.R.C.E.L. Inc. et al v. Acquaviva et al, 2015 ONCA 331 (“the Parcel Case”) where the Ontario Court of Appeal ruled that the lender was bound by the interest rate charged before default and could not charge the higher rate of interest after default set out in the promissory note because it was contrary to section 8 of the Interest Act (Canada). The late payment charges and the default fees set out in the mortgage document also offended section 8 and could not be charged.
In the Parcel case the lender loaned $458,488.07 at an interest rate of 0.75% per annum. Repayment of the loan was secured by a promissory note which, in turn, was secured by a mortgage on real property for the same amount. Payment on the promissory note was payment on the mortgage.
The interest rate on the promissory note was 0.75% per annum which was increased to 10% per annum “after demand, default and pre and post judgement”. The interest rate on the mortgage was 0.75% per annum and did not have the escalated interest rate.
The mortgage included a late payment charge of $10 per day for mortgage payments received after the regularly scheduled payment date, and an administrative fee of $300 for each unreturned or N.S.F. payment, or for each missed or late instalment. These charges were not stated in the promissory note.
The borrower stopped making loan payments and the lender sued. Initially, the lender obtained default judgement on the outstanding principal amount together with interest at the rate of 0.75% per annum, plus pre and post judgement interest at the same rate of 0.75% per annum, plus costs, and a writ of possession.
The borrower challenged the default judgement which was then set aside. The lender then amended its statement of claim and claimed the outstanding principal amount, interest at the rate of 10% per annum on the outstanding principal amount, $300 for each late payment, $10 per day default fees, and three months’ interest under the Mortgages Act.
The lender obtained summary judgement based on the amended amounts. The borrower appealed the interest rate charged on the outstanding principal amount of 10%, the late payment charges, and the default fees on the ground that they offended section 8 of the Interest Act.
The Ontario Court of Appeal agreed. The court held that there was a single loan reflected in two debt instruments which did not contain the same terms, that is, the promissory note included an escalated interest rate after default which was not in the mortgage and the mortgage included the late payment charges and administrative charges which were not in the promissory note.
However, the promissory note and the mortgage stipulated the same principal amount and repayment terms, and payment on the promissory note was payment on the mortgage.
The court stated that “there can only be one term of interest on one loan” and that the interest rate on the promissory note and the mortgage cannot differ. The interest rate must be the same before and after default.
The court concluded that the interest escalation provision in the promissory note violated the statutory prohibition of section 8 of the Interest Act and was ineffective. The interest escalation provision in the promissory note applied to arrears that were secured by a mortgage and because it had the effect of increasing the rate of interest charged on the arrears before default under the mortgage, the lender could not charge the higher interest rate of 10% set out in the promissory note.
Similarly, the court found that, in the absence of evidence that the late payment charges and the default fees were legitimately incurred for the recovery of the outstanding loan, they were “fines and penalties” prohibited by section 8 of the Interest Act.
In summary, so that section 8 of the Interest Act is not contravened, a lender who secures a loan by a mortgage or other debt instruments cannot charge an interest rate greater than the interest rate that is charged when the loan is not in default. Also, administrative charges, N.S.F. charges, or similar charges must reflect the actual cost of recovery of a loan to a lender. Debt instruments evidencing a single loan, such as, a promissory note and a mortgage, must reflect the same terms. There must be careful drafting of these debt instruments to avoid future litigation.
What is the application of the Parcel case in commercial reality? Careful drafting by a lawyer can structure a loan secured by mortgage where an increased rate of interest is not triggered by a default or a maturity date. An increased rate of interest before maturity or default will likely be acceptable if a lender is able to show that the increased interest rate is caused by some other event. Another way that some lenders operate is to structure a loan secured by a mortgage by increasing the interest rate a month or two before the mortgage matures. As such, if the borrower defaults on maturity, the higher interest rate is chargeable. However, a lender is always vulnerable to challenges under section 8 of the Interest Act any time that a lender increases the interest rate and adds additional charges to a loan secured by a mortgage.
Disclaimer and Cautionary Note
The foregoing does not constitute legal advice or establish a lawyer-client relationship. Specific legal advice should be obtained rather than solely relying on this article.