Increased Rates of Interest on a Mortgage Default (Reliant Capital v. Silverdale Development)

In my blog entry of June 27, 2005 I discussed the British Columbia Supreme Court decision in Reliant Capital Ltd. v. Silverdale Development Corp. The lender in that case appealed and the British Columbia Court of Appeal has now released its decision.

The issue in this case was whether or not the interest provision in the mortgage was enforceable. Section 8 of the Interest Act (Canada) provides that a mortgage cannot provide for a higher rate of interest after default then it does prior to default. In its simplest terms, this means that a mortgage cannot, for example, provide for a rate of interest of 6% during its term to increase to 12% should the Borrower go into default during the term or not pay the amount due at the end of the term.

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 (Canada) with no legitimate commercial purposes to save it. Reliant Capital appealed. The appeal was successful in that the court of appeal found that the provision did not offend Section 8 of the Interest Act (Canada). The court of appeal noted that the increased interest rate became effective by the passage of time, not by payments falling into default. It also noted that the higher interest rate applies equally to arrears and to monies owing that are not in arrears. The structure of the loan here was found not to be in contravention of the strict wording of Section 8.

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.

Bill Rowlands

Increased Rates of Interest on a Mortgage Default

Section 8 of the Interest Act (Canada) states that a mortgage cannot provide for a higher rate of interest after default than it does prior to default. There have been numerous court decisions throughout the years considering various mortgage provisions that attempt to comply with that requirement in creative ways.

The latest such decision comes from the British Columbia Supreme Court in Reliant Capital Ltd. v. Silverdale Development Corp. (2005) R.P.R. (4^th) 303. In this case a creative structure used to try and capture a higher rate of interest on non-payment of the loan when it became due did not succeed.

The mortgage loan from Reliant Capital provided for an interest rate of 14% per annum for the first 12 months and 20% thereafter. The term of the mortgage was 13 months and 22 days. The structure therefore provided for the interest rate to increase after a certain period of time within the mortgage term, and not after default or maturity (which would have been a clear violation of Section 8 in this circumstance).

Notwithstanding this structure, the court found that the true purpose or substance was to create a penalty in the form of a higher rate of interest following non-payment of the loan at maturity. The court 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 (Canada) with no legitimate commercial purposes to save it. The structure did not succeed.

Bill Rowlands

Realizing on Residential Mortgages

The Ontario Court of Appeal has, in Canada Trustco Mortgage Co. v. Park (2005) 72 O.R. (3d) 480, resolved a conflict between the Mortgages Act and the Tenant Protection Act. The Court had to determine when a mortgagee in possession could terminate a tenancy for the benefit of a third party purchaser. 

Canada Trustco Mortgage Co. had realized on a mortgage held against a residential property and, pursuant to a power of sale remedy, had agreed to sell the property to a third party with a closing date of October 3, 2001.  However, the property had been previously rented by the borrower to a third party tenant for a fixed term ending March 31, 2002.

Section 53(1) and related sections of the Mortgages Act provide that a mortgagee in possession may obtain possession of a single family home on 60 days notice.  However, the provisions of the Tenant Protection Act provide security to residential tenants including protecting such tenants until the end of a fixed term.

The Court of Appeal, upholding the previous decisions of both the Divisional Court and the Ontario Rental Housing Tribunal, held that the terms of the Tenant Protection Act prevail.  Accordingly, a mortgagee realizing on security that is occupied by residential tenants cannot terminate a tenancy for the purposes of a sale prior to the end of a fixed term.  If a property has more value being sold to a residential user rather than rental income property, this could affect the realization value of lenders.

Bill Rowlands