A recent Ontario Court of Appeal ruling on interest disclosure is likely a relief to lenders as it confirms that a small violation of s. 4 of the Interest Act will not impact all interest payable under a loan agreement, Toronto corporate lawyer Marlin Horst tells AdvocateDaily.com.
The case centred around a number of loans made by one party to another — although the respondent party defaulted, it disputed the amount of interest owing.
Specifically, the respondent claimed that term in the loan agreement, requiring payment of a .003 per cent discount fee of the outstanding loans on the repayment date and every day thereafter while it remains outstanding, failed to comply with s. 4 of the Interest Act.
The Act requires that any written agreement for the payment of interest at a rate or percentage per day, week, month or any period less than one year must contain “an express statement of the yearly rate or percentage of interest to which the other rate or percentage is equivalent.”
“Section 4 provides that where an agreement fails to comply with this requirement, ‘no interest exceeding the rate or percentage of five per cent per annum shall be chargeable,’” notes the court.
According to court documents, the trial judge accepted the respondent’s arguments, and held that because the discount fee failed to comply, the appellant was entitled only to interest at the rate of five per cent per year in total — despite the fact that the loan agreements also provided for interest to accrue at 12 per cent per year before maturity, and 24 per cent thereafter in addition to the .003 per cent discount fee.
On appeal, the appellant argued that the “discount fee” is not interest, the loan agreements contain an annualizing formula that satisfies s. 4 or, alternatively, the appropriate remedy would be to limit the application of s. 4 to the discount fee rather than reduce the interest payable on the entire agreement to five per cent.
“The issue is if there’s a violation of s. 4, is all the interest payable under the loan agreement capped at five per cent in total or is it just the interest that violates the section? The appeal court said it’s just the interest that violates s. 4,” says Horst, a partner with Shibley Righton LLP.
“So that meant the 12 per cent, which increased to 24 per cent when there was an event of default, interest was not touched by the fact that s. 4 had been breached because there was disclosure in respect of that interest rate that complied with that section of the Act.”
Indeed, the appeal court agreed that while the discount fee is interest, the trial judge did err by finding that the fee contravenes the Interest Act, and by holding that all interest payable under the loan agreements should be limited to five per cent.
“The real takeaway from this is when you’ve got a number of different ways of calculating the interest for different items, if you violate s.4 for one but you comply for others, it doesn’t bring the whole interest rate down to five per cent — it’s just that particular rate that violates s. 4, which is a huge relief for lenders,” says Horst.
In this case, for example, the discount rate of .003 per cent, calculated at a yearly rate of 1.095 per cent, is well below the five per cent interest rate cap that applies when there is a violation of the Interest Act.
“So the end result is, yes, there was a violation of the s. 4, but the result of that is nothing because the interest rate was already below the five per cent cap,” says Horst.
The trial decision, says Horst, came as a bit of a shock to many people in the industry as suddenly, a violation of a small portion of the income they were earning as interest — the discount rate — would affect everything else.
“When that trial decision came out, people were panicking because they were suddenly looking at all their fees and other rates of interest to see whether they were in any way in violation because it could bring all the interest down to just five per cent,” he explains.
Following the Court of Appeal ruling, however, Horst says, “The fact that they get one small fee offside doesn’t have huge ramifications for lenders.”