Section 8 of the Federal Interest Act prevents lenders from charging a higher rate of interest after default on a mortgage of real property than the rate charged prior to default.

Section 8 of the Interest Act reads as follows:

8(1) 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.

Supreme Court of Canada Decision On Section 8 of the Interest Act

In 2016, the Supreme Court of Canada addressed this issue in Krayzel Corp. v. Equitable Trust Co. In that case, the court ruled that under s. 8 of the Interest Act increases in interest rates tied to an event of default are prohibited. The court also ruled, however, that increases in interest rates due to a passage of time are not prohibited.

In a recent Ontario case, a court decided a case on this issue, after a couple challenged a higher interest rate imposed following renewal.

Couple Challenges Interest Rate Upon Renewal

In the recent Ontario case, a mortgage corporation had advanced funds to a husband and wife on the security of an investment property they owned in Brampton. The husband and wife were joint owners of the property. The loan was made in September 2016.

The requisite mortgage documents stipulated a mortgage term of one year but also a due date of September 2, 2017.

The subject mortgage was in the amount of $800,000. Interest at the rate of 7.5% per annum was payable on the 2nd of the month with the last payment and balance due date being September 2, 2017. No payments of principal were required until the end of the term with prepayments being permitted without penalty.

The schedule to the mortgage registration form included an automatic renewal clause that read as follows:

Provided that should the mortgage loan not be repaid in full on the maturity date, then and at the sole option of the Chargee/Mortgagee, the Chargor(s)/Mortgagor(s) … shall be deemed to have accepted and the mortgage shall be automatically extended for a further period of six (6) months, at a rate of interest, commencing on the first day of the extended term, equal to the rate of interest of the immediately previous term plus 3.0%, per annum, calculated and payable interest only monthly, together with a renewal fee equivalent to 5.0% of the then outstanding balance, said renewal fee to be due and payable on the first day of the extended term failing which same shall, at the sole option of the Chargee/Mortgagee, automatically be added to the then outstanding balance of the mortgage loan, as principal.

The mortgage was advanced somewhere between August 29, 2016 and September 7, 2016;  payments were made thereunder as required in the usual course.

On August 22, 2017, the lender’s agent sent the couple a letter, stating that “your mortgage loan matures on September 2, 2017 and will be automatically renewed for Six (6) months as per mortgage terms”. The letter went on to refer to a renewal fee of $40,000 and requested six post-dated cheques reflecting the increased monthly interest payments based on 10.50% per year interest.

The letter was sent to the property’s address though it was never received by the couple.

The mortgage was not repaid on September 2, 2017 when it was due, and the couple took no steps to deal with the mortgage at that time.

The parties attempted to negotiate a consensual renewal but no arrangement was reached. Some payments on account were made, but none under circumstances that amounted to an acceptance of the alleged automatic renewal. The discussions continued until May 2018 when it was agreed to disagree regarding some of the mortgagee’s claims by repaying the mortgage and placing the disputed amounts into a lawyer’s trust account to await a court order.

On May 17, 2018, the couple paid $800,000 to the mortgagor and a further $100,000 was paid into escrow. The parties sought direction from the court regarding the disposition of the $100,000 held in trust.

At issue before the court was whether terms in the mortgage that deemed an “automatic renewal” at substantially higher cost in the sole discretion of the mortgagee were enforceable.

The couple submitted that the automatic renewal provisions – providing for a 5% fee for a six-month renewal plus a 3% increase in the interest rate – operated as a penalty upon non-payment of principal that violated s. 8 of the Interest Act and could not be enforced.

The lender argued that the automatic renewal clause was not a penalty but represented a bona fide agreement allowing a simple means of renewing the mortgage at predictable cost. The mortgage corporation further submitted that because of the automatic renewal clause, there was no principal amount “in arrears” at any time. The trigger for the obligation to pay the fee and higher interest was not the non-payment of principal in arrears but the exercise of the automatic renewal right by the mortgagee. Therefore, it submitted that s. 8 of the Interest Act simply did not apply.

Court Finds Automatic Renewal Clause Unenforceable

The court examined the terms of the agreement and stated:

“There can be no question that the decision of the mortgagee to exercise the right of automatic renewal and thereby to claim the additional 3% interest plus 5% fee amounts to exacting an increased charge beyond the rate of interest payable on principal money in arrears.  The fees do not become due as a result of the mere passage of time but as a result of non-payment of the principal due at term by the mortgagee. The fact that the mortgagee can unilaterally deem a different outcome and thereby exact additional fees does not alter that fundamental fact.  The clause creates a penalty – and a significant one at that – payable if and only if the principal amount of the mortgage is not repaid at term.”

The court ultimately concluded that the automatic renewal clause was of no force or effect,  finding that the mortgage provided that non-payment of principal resulted in the ability of the mortgagee to choose to exact a penalty in the form of fees and higher interest. The court stated: “A clause granting the mortgagee the unilateral right to exact such a penalty on that event is precisely what Parliament intended to invalidate.”   

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Buying or selling a piece of property is likely the biggest financial transaction you will make in your life. Skyrocketing real estate prices can make what is an already stressful process even more stressful. In today’s market, buyers and sellers may be tempted to forego consulting with a lawyer to save some money. However, a real estate transaction should never be undertaken without the advice of a knowledgeable real estate lawyer who regularly handles such matters.

Whether you are buying your first home, purchasing a cottage or investment property, or selling your home to downsize to a condo, the real estate lawyers at Campbells LLP can guide you through every step of your residential real estate transaction. We will explain your options, review all relevant paperwork and contracts, negotiate on your behalf, and defend your interests in any potential disputes that may arise.

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