Recent Changes to Prepayment Rights Under the Interest Act (Canada)
The Government of Canada recently enacted new regulations under the Interest Act (Canada) (Act) which have the effect of expanding the class of "prescribed entities" for the purposes of section 10(2)(b) of the Act. These new regulations, which will significantly clarify the practice of commercial mortgage lending throughout Canada, apply to mortgages and hypothecs granted on or after January 1, 2012.
Pursuant to section 10(1) of the Act, closed mortgage loans (other than those given by corporations or joint-stock companies) with terms greater than five years may be prepaid by the borrower at any time after five years from the date of the loan for an amount equal to the principal of the loan and accrued interest, together with an additional three months of interest (as penalty for early prepayment). This provision was originally enacted in 1880 and was intended to ensure that individuals were not locked into long-term mortgages with high interest rates, with no ability to prepay without incurring significant penalties. The Act has always excluded corporations and joint-stock companies from these protections (see section 10(2) of the Act).
Although only corporations and joint-stock companies were identified as entities being excluded from the protections of section 10(1) of the Act, other forms of business organization, notably business trusts, partnerships and unlimited liability corporations were not expressly dealt with in the legislation. Although not expressly exempted from the application of section 10(1), in modern commercial transactions these other forms of business organization are commonly used and, it has been frequently argued, for the purposes of the protections set out in the Act are analogous to corporations and not individuals. In fact, the provisions of the Act have introduced difficulties for these types of business entities accessing long-term mortgage financing.
In Ontario, jurisprudence evolved to partially address this perceived legislative deficiency. In two important cases1 the Ontario Court of Appeal established a "look through" principle such that the relevant analysis for purposes of determining the applicability of limitations on interest prepayment penalties is conducted at the level of the legal title holder of the real property interest being mortgaged. In particular, where the legal title of a property being mortgaged is held by a corporation the fact that beneficial ownership remained with a partnership does not operate to extend the protections of section 10(1) to the corporate mortgagor. The bar in Ontario has also generally adopted this principle with respect to trust property held by a corporate trustee. The Ontario practice has been widely followed in the other common law provinces. In the province of Québec, for various reasons, including the absence of division between legal and beneficial ownership, the analysis put forward in Litowitz and Kucor could not be directly applied.
The new regulations should serve to clarify commercial mortgage practice across Canada. Pursuant to section 10(3) of the Act, the Governor in Council may, from 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. In so doing, such prescribed entities are carved out 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 mortgages or hypothecs granted by such entities on or after such date will no longer attract the prepayment penalty requirements of section 10(1) of the Act. Each of these entities exists for business or commercial purposes and therefore this reform is seen by the government as bringing the mortgage requirements for all business or commercial entities into line.
For further information about these new regulations and reforms to the Act, including how they may impact your company or business, please contact the authors or other members of McCarthy Tétrault’s Financial Services Group.
1 See Litowitz v. Standard Life Assurance Co. (1996, Ont. C.A.) and Kucor Construction & Developments & Associates v. Canada Life Assurance Co. (1998, Ont. C.A.).