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Increased Rates of Interest on a Mortgage Default (Reliant Capital v. Silverdale Development)
In my blog entry of
The issue in this case was whether or not the interest
provision in the mortgage was enforceable. Section 8 of the Interest Act
(
The mortgage loan from Reliant Capital in this case provided for an interest rate of 14% per annum for the first twelve months and 20% thereafter. The term of the mortgage was 13 months and 22 days. This structure therefore provided for the interest rate to increase after a certain period (12 months) within the mortgage term and not after default or maturity (which would have been a clear violation of Section 8 in this circumstance).
The chambers judge found that the true purpose or
substance of the structure of the loan was to create a penalty in the form of a
higher rate of interest following non-payment of the loan at maturity. The chambers judge followed a number of other
cases that looked at the substance of the mortgage provision, rather than its
form. Creating an “artificial” later
maturity date and increasing the rate before that date was seen as a device
simply to avoid the application of Section 8 of the Interest Act (
The court also indicated that the legitimate commercial purpose test used by the chambers judge here and by certain courts in other cases is an unnecessary and unhelpful gloss on Section 8. The court of appeal felt that the use of a legitimate commercial purpose test would give rise to commercial uncertainty and lead to arbitrary application. The court of appeal seemed to feel it was better to simply look at the words of the statute objectively.
While in this case the objective approach favoured the lender, cases involving Section 8 often deal with interest free loans, such as loans from employers to employees. In many of these situations, for what has been seen as a legitimate business purpose by the parties, the mortgage has provided that the loan will be interest free but if the debtor fails to pay the amount back when it was due, a market interest rate would then apply. Some courts have struck these down as offensive to Section 8, while others have recognized the legitimate commercial purpose. The court of appeal of in the Reliant Capital case may make it easier for a court to strike down these types of arrangements to the detriment of employer/lender (as the employer/lenders may not be able to rely on the legitimate commercial purpose test to allow the interest to be payable after default). On the other hand, the decision also seems to support a very strict reading of Section 8 allowing creativity in drafting around its restriction. A slight change to an employee loan structure to take it outside the strict wording of the Section could save the provision.
June 20, 2006 in Financing | Permalink
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