Mortgage Arrears and Interest
Many solicitors involved in the administration of trusts and estates have occasion to assist Trustees in arranging, renewing, or discharging mortgages. When litigation erupts, an unfortunate by-product can be that the principal parties become deadlocked on matters of administration and there is a need to enter into short-term lending arrangements at higher interest rates. A new decision of the Supreme Court of Canada respecting mortgage interest is helpful.
In Krayzel Corp. v. Equitable Trust Co., 2016 SCC 18 (S.C.C.), a question of statutory interpretation arose with respect to the Interest Act, R.S.C., 1985, C.I-15. Section 2 provides:“[e]xcept as otherwise provided by this Act or any other Act of Parliament, any person may stipulate for, allow and exact, on any contract or agreement whatever, any rate of interest or discount that is agreed on.” The ability to contract is limited by Section 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.
(2) Nothing in this section has the effect of prohibiting a contract for the payment of interest on arrears of interest or principal at any rate not greater than the rate payable on principal money not in arrears.
In the case before the Court, a mortgage was allowed to fall into arrears and a 7-month renewal agreement was made at 3.125% for the first 6 months and 25% for the seventh month. This fell into arrears and a second renewal agreement (which was made retroactive to the 7th month of the first agreement) was made for payment on an interest rate of 25%. [These events happened in 2009; the prime interest rate at the time was 2.2%.]
The majority of the Court, in a judgment written by Justice Russell Brown, considered the law on mortgage interest and held that Section 8 of the statute read purposively precludes both “discounts” for mortgages that are paid on time as well as “penalties” for higher rates of interest in respect of arrears in certain circumstances: “the ordinary sense of the words that Parliament chose to include in s. 8, read together with s. 2 and considered in light of the Act’s objects, support the conclusion that s. 8 applies both to discounts (incentives for performance) as well as penalties for non-performance whenever their effect is to increase the charge on the arrears beyond the rate of interest payable on principal money not in arrears. [Emphasis added.] Applied to the case, Justice Brown held:
Article 1 of the Second Renewal Agreement sets the interest rate at 25 percent per annum. Article 3 sets the “pay rate” (being the per annum rate applicable to the monthly interest payments Lougheed was required to make) at the greater of 7.5 percent and the prime interest rate plus 5.25 percent. By operation of articles 4 and 5, the difference between the interest rate of 25 percent and the pay rate accrues to the principal of the loan, but would be forgiven in the event of no default and repayment in full upon maturity. The effect of this scheme is therefore to reserve a higher charge on arrears (25 percent) than that imposed on principal money not in arrears (7.5 percent, or the prime interest rate plus 5.25 percent). The labelling of one charge as an “interest rate” and the other as a “pay rate” is of no consequence, given s. 8’s explicit concern for substance over form. [Emphasis added.]
What’s the take-away? Estate administration and litigation sometimes give rise to high risk lending. Solicitors for trustees should be aware of the limits of proper interest to protect their clients. If improper arrangements are agreed upon and then satisfied, beneficiaries who have not consented may well object leaving the trustee exposed personally. It’s a technical point sure, but the sort of technical point that may exacerbate problems.