Defaulting on a mortgage is an extremely stressful event for any property owner. Many consequences can arise in the event of a default. Fortunately for the defaulting party, an interest rate hike on the money owing is not one of them.
Keep reading to learn about the prohibition against mortgagees from charging punitive fees after a mortgagor has defaulted.
Terminology
Before reading on, here’s an explanation of the terms used frequently in this blog:
- Arrears – the state of having a debt that is overdue.
- Mortgagor – the party that has obtained a mortgage.
- Mortgagee – the party that has granted the mortgage.
- Default – non-compliance with the terms of the mortgage agreement; normally, this occurs when the mortgagor fails to pay out the balance of the mortgage at maturity (i.e., when the mortgagor is in arrears).
Section 8 of the Interest Act
The Interest Act is a piece of federal legislation that governs the levying of interest on loans. According to s. 2 of the Interest Act, “any person may stipulate for, allow and exact, on any contract or agreement whatever, any rate of interest or discount that is agreed on.”[1] Note that corporations have the status of legal personhood, so s. 2 applies equally to all individuals and corporations, including banks.
Section 8 sets out the prohibition against punitive fees, and provides that:
No fine, etc., allowed on payments in arrears
8 (1) No fine, penalty or rate of interest shall be stipulated for, taken, reserved or exacted on any arrears of principal or interest secured by mortgage on real property or hypothec on immovables that has the effect of increasing the charge on the arrears beyond the rate of interest payable on principal money not in arrears.
Interest on arrears
(2) Nothing in this section has the effect of prohibiting a contract for the payment of interest on arrears of interest or principal at any rate not greater than the rate payable on principal money not in arrears.
In simpler terms, s. 8(1) prevents the mortgagee from raising the interest rate on money that is in arrears. Subsection 8(2) explains that interest can be charged on money in arrears, but it must be at most the same rate that was charged on the principal amount of the mortgage.
Let’s look at a case to illustrate how s. 8 operates.
Krayzel Corporation v Equitable Trust Co., 2016 SCC 18
Facts
A corporation called Lougheed Block Inc. (“Lougheed”) owned an office building in Calgary with multiple mortgages on it, including the one held by the appellant, Krayzel Corporation. In 2006, Lougheed obtained a mortgage from Equitable Trust Co., which is now known as Equitable Bank (“Equitable”). The terms of the mortgage were as follows:
- Maturity date: June 30, 2008;
- Amount of loan: $27 million;
- Interest rate: prime plus 2.875 per annum.[2]
- At the time of the mortgage transaction, the prime rate was 6% and at maturity, it was 4.75%, so the rate fluctuated between 8.875% and 7.625% over the course of the mortgage.[3]
The maturity date arrived, and Lougheed defaulted on the mortgage. Equitable did something very commonly employed by mortgagees: it extended the mortgage for a short period of time under what they called a Renewal Agreement.[4] The Renewal Agreement was effective as of August 1, 2008, for a period of 7 months and carried an interest rate of prime plus 3.125 for the first 6 months, and then 25% for the 7th month.
Again, the agreement matured and Lougheed couldn’t pay. So, the parties entered into a second Renewal Agreement. The terms of the second agreement were quite complex, so the Supreme Court of Canada (“SCC”) broke them down as follows:
- The 2nd agreement was effective as of February 1, 2009 – meaning it was retroactive to before the 1st agreement matured;
- The yearly interest rate would be 25%;
- Lougheed was to make monthly interest payments at a “pay rate” of either 7.5% or prime plus 5.25%, whichever was greater;
- Interest would accrue to the mortgage at a rate of the difference between the amount payable at 25% and the amount payable by Lougheed at the rate in #3; and
- “[Were] Lougheed to make all payments in full and on time and to pay out the loan when due, it would be excused from paying the amount representing the difference between interest payable at 25 percent and interest actually paid in accordance with the lower rate.”[5]
Unfortunately, they defaulted on the first payment, so Equitable demanded repayment at 25% interest.[6]
Issues
- Was s. 8 of the Interest Act violated by the imposition of an interest rate effective only where the mortgagor defaulted?[7]
- Judgment: YES
- Is s. 8 violated where the mortgagee raises interest rates solely because of “the mere passage of time”?[8]
- Judgment: NO
Reasoning
The Purpose and Scope of Section 8
The Supreme Court of Canada (“SCC”) first looked into the true purpose of s. 8 of the Interest Act. Brown J., writing for the majority, agreed that the holding of the BC Court of Appeal in Reliant Capital Ltd. v Silverdale Development Corp. that this clause exists “to protect the owners of real estate from interest or other charges that would make it impossible for owners to redeem, or to protect their equity.”[9]
Brown J. then turned to the wording of s. 8 and noted that it is directed at “the effect of the [particular] mortgage term” and not merely the explicit term itself. Section 8 is concerned with the consequences flowing from the operation of the term. Brown J. therefore concluded that if the term’s effect “is to impose a higher rate on arrears than on money not in arrears, then s. 8 is offended”.[10] Even if the term is presented by the mortgagee as a discount, if the discount is effectively punitive to the mortgagor, then that term violates s. 8 of the Interest Act.[11]
The First Renewal Agreement
Recall that the first renewal agreement implemented the higher rate of 25% only after 6 months had passed, and was to occur regardless of Lougheed’s level of compliance therewith. Brown J. held that this increase was “triggered by the mere passage of time” rather than purely because Lougheed defaulted. In light of this, there was no violation of s. 8 under the terms of the first renewal agreement.[12]
The Second Renewal Agreement
The second renewal agreement was where the rate increase lost its legitimacy. Recall that under term #5, if Lougheed made good on all its mortgage payments, it would pay the lower rate, or what Equitable labelled as the “pay rate”. However, once Lougheed defaulted, Equitable drastically increased the interest rate and demanded repayment carrying a 25% interest rate. Brown J. held that the second renewal agreement had the effect of placing a higher charge on arrears than what Equitable was charging on the principal money owed.[13] The “pay rate” was actually a discounted rate, and once Lougheed was in arrears, the rate rose to 25%, the real rate. Brown J. thus concluded that to label “one charge as an ‘interest rate’ and the other as a ‘pay rate’ is of no consequence,” because the effect was to punish Lougheed for defaulting.[14]
Conclusion
There are myriad reasons – legal and financial – to make your mortgage payments in full and on time. However, mortgagees cannot fiddle with the interest rates as a way to incentivise or punish you for paying or defaulting.
Whether you’re a lender or a borrower, it’s essential to have legal advice to assist you with drafting, negotiating, interpreting, and enforcing (or contesting!) your mortgage loan terms. Contact a DSF lawyer today for assistance.
This blog was co-authored by articling student Rachel Weitz.
Disclaimer: This blog is for educational purposes only and does not constitute legal advice. If you are in need of assistance, please contact a lawyer. Each case is unique, and a lawyer with the proper training and sound judgment can provide you with advice tailored to your specific situation and needs.
[1] Interest Act, RSC 1985, c I-15, s 2 [Interest Act].
[2] Krayzel Corporation v Equitable Trust Co., 2016 SCC 18 at para 4 [Equitable].
[3] Bank of Canada, “Interest rates posted for selected products by the major chartered banks,” 2005-2010, retrieved on September 20, 2024, <https://www.bankofcanada.ca/rates/banking-and-financial-statistics/posted-interest-rates-offered-by-chartered-banks/>.
[4] Equitable, supra note 2 at para 5.
[5] Ibid at para 6.
[6] Ibid at para 7.
[7] Ibid at para 1.
[8] Ibid at para 2.
[9] Ibid at para 21.
[10] Ibid at para 25.
[11] Ibid at para 31.
[12] Ibid at para 33.
[13] Ibid at para 35.
[14] Ibid.
