Court of Appeal upholds mortgage exit fee in face of Interest Act challenge

Section 8 of the Interest Act, R.S.C. 1985, c. I-15, prohibits any "fine, penalty or rate of interest . . . that has the effect of increasing the charge on the arrears beyond the rate of interest payable on principal money not in arrears." Relying on this provision, borrowers often challenge fees and charges that borrowers levy when seeking to enforce a secured debt that has gone into arrears. For the defaulting borrower, it can slow down the lender's effort to seek judgment and, if successful, can amount to relief from portions of the debt being claimed. However, what section 8 actually means and how it applies in any given case is a question that constantly bedevils courts.

Two recent decisions illustrate the practical difficulties in categorizing the nature of charges accruing to a secured debt and whether they contravene the Interest Act. Arguably, one decision, Krayzel Corp. v. Equitable Trust Co., 2016 SCC 18, does away with prior judicial distinctions that made commercial sense (though were difficult to apply) and makes relief under section 8 more likely. The other decision, Bankers Mortgage Corporation v. Plaza 500 Hotels Ltd., 2017 BCCA 66, illustrates a clear mechanism for lenders to avoid the perils of section 8 of the Interest Act.

In Krayzel, the Alberta courts applied a strict or narrow interpretation of s. 8 and categorized the interest rate in issue as "an incentive to pay" rather than a penalty for non-payment. In Krayzel, the borrower and lender renegotiated a secured loan after the borrower ran into difficulties. It was agreed that the loan interest rate would be 25% but that the borrower need only pay a monthly rate of 7.5% with the remaining interest accruing to the debt. If the borrower repaid the loan on time, the unpaid interest would be forgiven. If not, the unpaid interest would form part of the secured debt to be repaid. The Alberta trial and appellate courts held that this was not a "fine, penalty or rate of interest" on the arrears but rather an incentive to the borrower to repay on time. They upheld the interest rate. The Supreme Court of Canada (though with a dissent) disagreed, choosing instead to see this interest arrangement as contravening section 8. It reasoned that the focus of the inquiry was not on how to characterize the impugned charge (incentive v. penalty), but to look at its effect. If the effect is to impose a higher rate of interest on arrears of interest or principal than that payable on principal money not in arrears, the charge will offend the Interest Act because it makes it more difficult for borrowers who are already in default to redeem or protect their equity.

In the Plaza 500 Hotels case, the borrower sought to invoke the reasoning in Krayzel to argue that a mortgage exit fee it was obliged to pay to a mortgage broker offended the Interest Act and could not be enforced. As part of the original loan, the borrower agreed it would pay the mortgage broker an exit fee of $96,000 (0.67% of the principal amount of the loan) if the loan was either not renewed or not repaid on time.  After the mortgage went into default, the lender foreclosed and the mortgage broker sued to recover the exit fee. The broker then registered its judgment on title to the property that had been mortgaged to the lender.

The borrower argued the mortgage exit fee was "related to the mortgage" as it was triggered by default under the mortgage and had the practical effect of making repayment more difficult. The B.C. Court of Appeal disagreed and upheld the mortgage exit fee. The distinguishing feature was that the mortgage exit fee was not part of the secured debt. It was, in the words of the Interest Act, not "stipulated for, taken, reserved or exacted on any arrears of principal or interest secured by mortgage on real property . . . that has the effect of increasing the charge on the arrears beyond the rate of interest payable on principal money not in arrears." In other words, because the mortgage exit fee was not part of the secured debt, it did not fall within the scope of the Interest Act.

This decision is good news for lenders as it illustrates that there are sound commercial methods to set up incentives for borrowers to meet their obligations without worrying about running afoul of the Interest Act. While "incentives," "bonuses" or "discounts" can still be used, they just cannot be tied to the secured debt. As an unsecured debt, this may make recovery more difficult but charges of this nature are nonetheless enforceable against a debtor and its guarantors. The Interest Act will not interfere to prevent recovery.


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