Changes to Mortgage Prepayment Rights Under the Interest Act (Canada)

The Government of Canada recently enacted new regulations under the Interest Act (Canada) (Act) which expand the class of "prescribed entities" that are not entitled to the statutory prepayment rights accorded to borrowers by section 10(1) of the Act. These new regulations, which will significantly impact the practice of commercial mortgage lending throughout Canada, apply to mortgages and hypothecs granted on or after January 1, 2012.

Background

Prior to January 1, 2012, section 10(1) of the Act provided, in effect, that a borrower (other than a corporation or joint-stock company) could prepay a closed mortgage loan with a term exceeding five years at any time after the first five years of the term upon payment of a penalty equal to three months’ interest. This provision was originally enacted in 1880 to ensure that individuals were not locked into long-term mortgages with high interest rates, with no ability to prepay without incurring significant penalties.

As noted, corporations and joint-stock companies were specifically excluded from section 10(1) of the Act. Although this exclusion denied them the same statutory prepayment right available to individuals, it had the effect of motivating lenders to make long-term loans available to corporations. If lenders were limited by statute to a maximum prepayment penalty of three months’ interest, they would be less inclined to offer mortgage financing with a term longer than five years. The exclusion of corporations and joint-stock companies did not, however, address other commonly used forms of business organization (such as business trusts, partnerships and unlimited liability corporations), thereby making it more difficult for such business organizations to obtain long-term mortgage financing due to the risk that the lender might be forced to accept prepayment of three months’ interest as its sole compensation in the event of prepayment.

New Regulations

The new regulations clarify the rules applicable to the commercial mortgage industry across Canada by explicitly expanding the types of business organizations that may not prepay with a three month penalty. Under section 10(3) of the Act, the Governor in Council may, from time to time, designate other entities (i.e., other than corporations and joint-stock companies) as "prescribed entities" for the purpose of section 10(2)(b) of the Act, thereby excluding them from the mandatory prepayment penalty regime established in section 10(1).

Since January 1, 2012, (i) partnerships, (ii) trusts settled for business or commercial purposes, and (iii) unlimited liability corporations (as they exist in the provinces of Nova Scotia, Alberta and British Columbia) are now "prescribed" and, therefore, excluded from the statutory prepayment penalty regime.