Supreme Court of Canada decides that substance trumps form in the application of the Section 8 Interest Act prohibition on higher default interest to an incentive rate mortgage
In Krayzel Corp. v. Equitable Trust Co., 2016 SCC 18 (“Krayzel”), the Supreme Court of Canada held that an interest rate increase that was structured as a lower rate in the absence of default infringed Section 8 of the Interest Act (Canada). In its analysis, the majority decision looked at whether mortgage loan that offered a lower rate of interest where there was no default is in substance the same as imposing a higher interest rate after a default. It ultimately found that framing the higher rate of interest as part of an incentive to avoid a default could not save a loan from the Interest Act prohibition.
“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 or hypothec on immovables that has the effect of increasing the charge on the arrears beyond the rate of interest payable on principal money not in arrears.”
In Krayzel, the mortgage terms reserved a lower rate where the loan was not in default by way of a discount. Effectively, interest was set at 25% with a lower “pay rate” applicable to the required monthly payments under the loan. Although the difference between pay rate and the 25% rate accrued to the principal of the loan, the agreement provided that upon payment in full at maturity, these accrued amounts were forgiven. In the majority decision, the decision looked past the form of the interest rate structure and found that in effect, the “pay rate” applied when the loan was not in default and a higher rate applied when the loan was in default.
The Court was careful to point out that “a rate increase triggered by the passage of time alone does not infringe s. 8 [of the Interest Act]” in its analysis of the interest rate structure put in place by the first loan amendment in Krayzel. This should provide comfort to lenders who structure loans with an interest rate that increases at a set date prior to maturity, but lenders must be very careful to ensure that that the rate increase is no way conditional on default, as it was in the second loan amendment at issue in Krayzel. Lenders should work with the lawyers to ensure that their interest rate structure is on side with the Interest Act and that all of the relevant factors have been considered.
Interest Act interest rate lenders loans mortgage Supreme Court of Canada