The Second Opinion: Interest is not Interest ... When it is a Penalty

In Diamantopoulos v. Construction Dompat Inc., 2013 QCCA 929, a construction contract specified a late payment interest rate of 24% per annum and a legal/collection fees charge of  20% on the amount due. The Québec Court of Appeal characterized these clauses jointly as “penal”, excessive and abusive, and reduced the charges to a single, global interest rate of 15%. The court exercised its discretion under article 1623 C.C.Q. which permits judicial reduction if the amount in a penalty or liquidated damages clause is abusive. It is noteworthy that the contract in issue was expressly held not to be a consumer contract or adhesion contract which would have given the court other revision powers.

The Court of Appeal stated that an interest rate of 24% is not necessarily and intrinsically abusive.  In another recent decision cited by way of example, the Québec Court of Appeal upheld an interest rate of 24% on a third ranking hypothecary loan. In that case, given the risks associated with the loan, the court declined to exercise its discretion under article 2332 C.C.Q to revise the terms of a loan that are lesionary or exploitative.

The court in Dompat clearly stated that it is the combined effect of both clauses that is abusive. Its analysis involved a comparison with the legal interest rate and additional indemnity available under Québec law at a combined rate of 6%, and with market rates which have been low in recent years. The court also mentioned that the contract terms seemed particularly exorbitant given that the claimant inflated its claim under the construction contract.

The Court relied on its recent decision in 9149-5408 Québec Inc. v. Groupe Ortam Inc., 2012 QCCA 2275, which applied the same analysis to the combined effect of a similar legal fees clause and a clause which imposed interest at 24% per annum for payment after 30 days. Nonetheless, the Ortam decision characterized the 24% interest rate alone as “punitive”, rather than compensatory, given the interest rate applicable by law.

The Diamantopoulos and Ortam decisions clearly indicate that Québec courts will carefully scrutinize and possibly reduce the combined effect of a contractual interest rate and rates related to legal or collection fees in all types of contracts. The favoured reduced rate appears to be 15%. Unfortunately, the decisions do not indicate how the Court of Appeal justified a global interest rate of 15%.

Many more questions arise. To what extent does the presence of a legal fees clause, which is a form of penalty or liquidated damages clause, permit extending the characterization and scrutiny to other clauses? In this regard, the decisions do not appear to distinguish late payment clauses from 30- or 60- day net clauses for the purposes of their characterization as a penalty clause which presupposes a contractual breach rather than an optional deferred payment. Are all interest clauses now to be characterized as penalty or liquidated damages clauses and subject to potential reduction? Or, is this line of cases restricted to contracts specifying both interest and collection fee clauses or interest and another form of penalty clause?  To what extent should the court consider market interest rates and how profound must the analysis be? Finally, would it be possible to apply a notion of severance to the clauses so as to reduce only the rate specified legal fees clause?

The McCarthy Tétrault Opinions Group consists of members of the firm’s litigation department whose practices focus on written advocacy and the provision of strategic advice and opinions in the context of complex business disputes and transactions.  The members of the Opinions Group are Anthony Alexander, Martin Boodman, Brandon Kain, Hovsep Afarian and Kirsten Thompson

abusive collection / legal fees interest interest rate liquidated damages penalty clause



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