Prepared By Paul J. Caron, Q.C.
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Sinking Fund, Blended Payments of Principal and Interest, Allowance of Interest
Section 6 of the Interest Act states as follows:
"Whenever any principal money or interest secured by mortgage on real property is, by the mortgage, made payable on a sinking fund plan, on any plan under which the payment of principal money and interest are blended or on any plan that involves an allowance of interest on stipulated repayments, no interest whatsoever shall be chargeable, payable or recoverable on any part of the principal money advanced, unless the mortgage contains a statement showing the amount of the principal money and the rate of interest chargeable thereon, calculated yearly or half-yearly, not in advance". R.S., c. I-18, s.6."
Section 6 of the Interest Act of Canada requires that principal and the rate of interest expressed yearly or half yearly be specified within a mortgage whenever:
- Any principal money or interest is made payable on a sinking fund plan;
- There does not appear to be any judicial determination on what is a "sinking fund plan". For example would a pre-payment of interest be a "Sinking fund plan"? In some cases I have seen a lender set up an "Interest reserve fund" where out of the mortgage advance the lender holds back a portion of the principal and each month applies it to principal. Is this a mortgage made payable on a Sinking fund plan?
- Payments of principal money and interest are blended.
Most standard residential mortgages contain this kind of payment.
In Kilgoran Hotels v. Samek (1968) S.C.R., 3, a mortgage required fixed quarterly payments to be applied both to first interest and then principal. Interest was to be compounded quarterly. No equivalent yearly or half yearly rate was disclosed. The Court stated that a payment is not blended where it is mathematically possible to compute the interest payable. A Court held that a "blended" payment was a payment that was "mixed so as to be inseparable and indistinguishable".
In Paragon Properties (Finance) Ltd. v. Matthews (1996) A.W.L.D., 647 - the interest clause in the mortgage provided for payment at the rate of 3.5% per month calculated and compounded monthly not in advance, and provided that the principal together with interest would be paid in monthly installments of $1,750.00 each, to be applied firstly on interest and secondly on principal. There was no statement showing the equivalent rate calculated yearly or half yearly not in advance. The Master held the clause violated section 6, however on appeal Mr. Justice Lomas held:
"The purpose of section 6 of The Interest Act is to protect a mortgagor from having concealed from him or her the true rate of interest which he or she is paying. In the mortgage in question, the rate of interest was clearly set out, the compounding date was the same date as the calculation date, and the payments were clearly set out. The mathematic calculation involved on each payment date could scarcely be simpler."
Monies are payable on any plan that involves an allowance of interest on stipulated re-payments.
In Edmonton Saving and Credit Union Ltd. v. Trison Developments Ltd. (1988), interest was payable monthly at the CIBC floating rate from time to time plus 1.5%. The Defendants alleged the claim was void by virtue of section 6 of the Interest Act of Canada since the mortgage did not specify an annual rate of interest. The Court held that the mortgage did not contain a "plan that involves an allowance of interest on stipulated re-payments". The Court stated that the purpose of section 6 is to protect the mortgagor from having concealed from him the true rate of interest he is paying. Here the rate was in no way concealed. The mortgage need not specify that this rate is to be "per annum" since it is common knowledge that a prime lending rate is a rate per annum.
Ihnat v. Wetston (1978) 89 D.L.R., 595, the parties entered into a mortgage for one year at a floating rate of interest tied to bank prime. No mention was made of the yearly or half-yearly equivalent rate. The year's interest was deduced from the face amount of the mortgage. The Court of Appeal held that a pre-payment provision was not a "Stipulated Re-Payment".
In Greymac Trust Co. v. Gould (1983) 30 R.P.R., 157, the mortgage provided for payment to be made, in advance, of an amount to cover part of the interest charges on the mortgage. The payment was made as a deposit into an interest bearing account with Greymac. Greymac paid interest on the account and from the account in turn paid interest on the mortgage. The Court held this did not violate the section. Note - in Greymac it was agreed between Counsel that the principal or interest was not made payable on a Sinking fund plan.
What about situations where a bonus is added to the principal amount. Does this violate the requirement of the section that the mortgage contains a statement showing the amount of the principal money where in effect a nominal principal exists? For example:
A mortgage states that the principal of the loan is $1,000.00 and the interest rate is 10% per annum calculated yearly. In fact only $900.00 is actually advanced. $100.00 is a bonus to the lender. At the end of the year, the $900.00 loan has cost the borrower $200.00. Expressed as a percentage of the principal advanced, the total cost is 22.22%. Can it be argued that the mortgage does not contain a statement showing the amount of principal money?
In London Loan and Savings Co. v. Meagher (1930) S.C.R., 378, the Supreme Court of Canada held that the disclosure of the nominal principal and yearly per annum rate, excluding the bonus, was sufficient. The practical result is that parties may agree to capitalize certain costs, keeping the disclosed interest rate at an attractively lower level. The Courts have consistently applied this rule to bonuses (Asconi Building Corp. v. Vocisano (1987) S.C.R., 358).
There does not appear to be any reported decision where a Court has struck down a mortgage interest rate by virtue of section 6.
Section 8 - Penalty Interest
Section 8 states:
"(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 that has the effect of increasing the charge on the arrears beyond the rate of interest payable on principal money not in 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. R.S., c.I-18, s.8."
The Courts appear more ready to avail a debtor of the protection under this section than section 6 in which the wording is archaic and too inflexible for modern conditions. For example5, it appears that an increase in the rate of interest once the mortgage matures is unenforceable. Levy v. Booksban (1931) 40 O.W.N., 187; Beauchamp v. Timberland (1983) 1 O.A.C., 73 (however a change in the interest rate from a fixed rate to a floating rate appears not to offend the section - see Agricultural Credit Corporation of Saskatchewan v. Lozinski (1993) 8 W.W.R., 373) .
However, in Patrician Land Corp. v. Dillingham (1985) 29, B.L.R. 81, the agreement provided that there would be no interest until maturity and default and thereafter interest at 14% per annum. Commentary on the case has suggested that the Court concluded that the loan was not interest free since the parties had factored in an unspecified amount for interest over the original term and it was therefore impossible to say that the default provision increased the interest. Therefore it did not offend section 8.
In Vohra Enterprises Ltd. v. Creative Industrial Corporation (1988) 47 R.P.R., 243, the mortgage provided that the mortgagee agreed to waive interest provided the mortgagor was not in default of payments by a certain date. The Court concluded that this offended section 8 and no interest was payable under the mortgage. Here, the effect of the mortgage was to increase the charge on arrears beyond the rate of interest payable on principal not in arrears, therefore section 8 was offended.
In TD Trust Co. v. Guiness (1995) Vancouver Registry Number H950544, the mortgaged matured March 1, 1995 and interest was stipulated to be 16.5% until February 22, 1995 and 24% thereafter. It was held that a Court should not restrict itself to the form of the interest provision in the mortgage but should look to its substance. In this case the substance was clearly to abstract a higher rate of interest if the mortgage was not re-paid by its maturity date and was an attempt to avoid section 8 and the higher rate of interest was unenforceable. Contrast this to Rain Tree Financial Ltd. v. Bell (1993) 35 R.P.R., 275 where the mortgage provided that the interest rate would increase from 18% to 24% one week before the date of redemption. Held that the increase in interest which came into effect a week before redemption in this case increased the rate payable on both the principal not in arrears and that portion in arrears thereafter and did not violate section 8. Both cases are from the British Columbia Supreme Court. In Alberta, Grandville Savings and Credit Union v. Pekrich (1995) 28 A.L.R., 17, the mortgage provided for interest at 9% increasing to 14% on any principal outstanding one month prior to maturity. Held the mortgage did not offend section 8.
The Criminal Code of Canada
Section 347 Criminal Rate of Interest
Section 347. (1) reads as follows:
"Notwithstanding any Act of Parliament, every one who
(a) enters into an agreement or arrangement to receive interest at a criminal rate, or
(b) receives a payment or partial payment of interest at a criminal rate,
is guilty of
(c) an indictable offence and liable to imprisonment for a term not exceeding five years, or
(d) an offence punishable on summary conviction and is liable to a fine not exceeding six months or to both".
"Criminal Rate" is defined as exceeding 60% and "Interest" means the aggregate of all charges and expenses, whether in the form of a fee, fine, penalty, commission or other similar charge or expense or in any other form, paid or payable for the advancing of credit under an agreement or arrangement, by or on behalf of the person to whom the credit is or is to be advanced, irrespective of the person to whom any such charges and expenses are or are to be paid or payable, but does not include any repayment of credit advanced or any insurance charge, official fee, overdraft charge, required deposit balance or, in the case of a mortgage transaction, any amount required to be paid on account of property taxes.
A breach of the Code means the interest agreement cannot be enforced in a civil action - 667950 Ontario Ltd. v. Artell (1992) 24 R.P.R., 113.
Helo Enterprises Ltd. v. Standard Trust Company (1996) 1 S.C.R., 183 confirms that a broker's fees are not interest and not calculated in determining the rate of interest. This case over-rules prior Court of Appeal decisions.
The stipulation that the borrower was to pay a share of the anticipated profit from a real estate deal was a condition of the borrower receiving the loan and fell within the all inclusive definition of "Interest" - 677950 Ontario Ltd. v. Artell Developments Ltd. (1992) 93 D.L.R., 334. However, note the anticipated profit was pre-set and added to the mortgage and its payment was not contingent upon profits being made. The Court did not comment on what the result would be had this been a true risk-taking venture.
Care should be exercised in the case of short term or demand mortgages. To determine whether the loan is illegal, the return must be converted into a per annum rate. This means the period over which the return has been earned is of crucial importance. For example, a loan of $20.00 for one week at a fee of $1.00 produces a per annum interest rate of more than $260% per annum.
In Nelson v. C.T.C. Mortgage Corporation (1985) 2 W.W.R., 560, the borrower repaid a term loan before the expiry of the term pursuant to a pre-payment option. If the interest was calculated over the term of the loan, the rate was less than 60% per annum. If it was calculated over the period for which the loan was actually outstanding, the rate exceeded the limit. The Court held that the appropriate period was the date at which the lender could require re-payment. They were not prepared to hold that the borrower could, by electing to take advantage of early pre-payment, turn what had been a legal arrangement in its inception into a criminal one. It should be noted that the consideration as earned over the period ending when it was received, was above the criminal rate and indeed in dissent, Hutcheon J. A. considered that this made the loan criminal pursuant to section 347 (10 (b) even though it was not a violation of 347 (1) (a). The majority did not discuss the second branch of this section, but seem simply to have ignored it. The decision of the majority was upheld by the Supreme Court of Canada without additional reasons.
A recent Supreme Court of Canada decision on this topic is Dan Corp. Developments Ltd. v. Metropolitan Trust Company of Canada (October 30, 1998) 165 D.L.R., 417 - In the mortgage there was a 30% bonus and an additional 5% if slightly over half of the mortgage was advanced, a placement fee of $75,000.00 and the payment of all legal other fees with the mortgage re-payable within one year. As a result of the borrower becoming insolvent, the loan was not paid out for approximately three years. Based on the mortgage term the interest rate exceeded 75% and based on the actually time outstanding the mortgage rate was approximately 20%. The Court found three principals as follows:
"Section 347 (1) (a) should be narrowly construed. Whether an agreement or arrangement for credit violates section 347 (1) (a) is determined as of the time the transaction is entered into. If the agreement or arrangement permits the payment of interest at a criminal rate but does not require it, there is no violation of this section although section 347 (1) (b) might be engaged.
Section 347 (1) (b) should be broadly construed. Whether an interest payment violates section 347 (1) (b) is determined as of the time the payment is received. For the purposes of this section, the effective annual rate of interest arising from a payment is calculated over the period during which the credit is actually outstanding.
There is no violation of section 347 (1) (b) where a payment of interest at a criminal rate arises from a voluntary act of the debtor, that is, an act wholly within the control of the debtor and not compelled by the lender or by the occurrence of a determining event set out in the agreement."
Note: In this case the Plaintiff relied on subsection (b) and the Defendant escaped the provision for criminal interest.
Equity or Participation Mortgages
The issue of the Criminal Rate of Interest is likely to raise its ugly head where the lender takes part of the equity of the project in the form of a participation mortgage. The Helo case was a case involving participation mortgages however, once the brokers fee was eliminated the rate fell below 60% per annum. Another case involving participation mortgages is First Island Financial Services Ltd. v. Kirkstone Management Ltd. (1995) 7 W.W.R., 135. In this case, the mortgage called for 18% per annum and a 20% profit participation. The mortgage provided that in the event the aggregate of payments exceeded the maximum payment permitted by law, the agreement would be modified to negate the excess. The case established or re-affirmed a number of principals:
The standard of proof required was not proof beyond a reasonable doubt but on a preponderance of probability;
b. The following items were either included or excluded in the calculation of interest;
(i) Any sharing by the lender in the mortgage brokers fee was included;
ii) Insurance premiums and appraisal costs were excluded although possibly for facts peculiar to the case;
(iii) Registration fees were excluded;
(iv) Solicitors fees were excluded;
c. The "Severance" clause was effective and "negates the mental element required to prove an infringement of section 347 of The Criminal Code". The lender had acted reasonably in taking steps to ensure that an infraction of this section did not occur. Rather than re-writing the parties agreement this was a recognition of a consensual solution to a problem of contingencies.
Contrast this, however, to B.C.O.R.P. Financial Inc. v. Baseline (1990) 46 B.C.L.R., 89, which held that such a severance clause was ineffective to save the transaction. Essentially the Court found that declaring the parties' intention was irrelevant when the contract on its face called for a Criminal Rate. This case also confirms that such a severance clause should be precise on how the contract must be re-written.
The practice appears to be to remove the participation aspect of the loan from the mortgage and place it in a separate agreement registered as an encumbrance against the title. The argument is that such clause in the mortgage may constitute a clog on the equity of redemption. There does not appear to be any case authority substantiating this practice. BCE Development Corporation v. Cascade Investments Ltd. (1987) 55 A.L.R., 22 confirms that a mortgage cannot be made irredeemable by a collateral agreement entered into at the time of the mortgage and as part of the mortgage transaction. The Court should look to the substance not the form of the transaction. In North American Life Assurance Co. v. Beckhuson (1981) 2 W.W.R., 446, the Court held that a participation clause which allows the mortgagee to share in profits is not a clog in the equity of redemption.
Avoiding interference by the Courts in mortgage terms by disguising the mortgage as a sale with an option to repurchase has generally not been successful. "Once a mortgage always a mortgage". Kreick v. Wansborough (1973) S.C.R., 588; Cresswell v. Raven Bay (1984) 53 B.C.L.R., 183
The Unconscionable Transactions Act; Consumer Credit Transactions Act; and Fair Trading Practices Act
The Unconscionable Transactions Act - this legislation does not confine itself to interest however, interest is included in the definition of "Cost of the Loan" along with other items such as discounts, dues, bonuses, etc. Under section 2, with respect to money lent the Court may re-open the transaction if it finds having regard to the risk and all the circumstances that the cost of the loan is excessive and that the transaction is harsh and unconscionable.
Consumer Credit Transactions Act - this Act applies to mortgages on real property and requires that the "Credit Charges", which include interest or discount, be calculated in the manner prescribed pursuant to the Act. In particular it requires them to be expressed as an annual percentage rate. The Act does not apply to mortgage loans greater than $150,000.00 (section 2 (e)) nor to loans to a corporation or a partnership other than for farming purposes (section 2 (i)). Under section 8 (a) (iii), in the event of failure to comply with the Act the mortgagee is entitled to receive the principal amount of the loan back and under section 8 (c) the Court may allow "Credit Charges" that it considers appropriate in the circumstances. However, section 3.1 (2) of the Regulations exempt the application of section 8 to mortgages on real property.
This Act will be replaced by the new Fair Trading Act, September 1, 1999.
Fair Trading Practices Act - pursuant to section 60 (iii) it appears that the Act only applies to mortgage loans for personal, family, household, or farming purposes and if the mortgage lender enters into the agreement in the course of carrying on a business or the credit agreement is arranged by a loan broker.
This Paper Was Prepared By Paul J. Caron, Q.C.
Originally submitted to the Foreclosure Law Subsection of the South Alberta Canadian Bar Association, May 27, 1999