Interest Act Prohibitions Extend to Promissory Note

The provisions of s. 8 of the federal Interest Act, R.S.C. 1985, c. I-15, which place strict prohibitions on the interest penalties that can be charged on mortgage arrears after default were the subject of the Ontario Appeal Court’s scrutiny in an important recent decision. The issue was whether the restrictions applied not only to interest penalties arising under a mortgage, but also to those arising under a related promissory note for the same debt.

As part of the parties’ consulting arrangement, the lender had advanced a one-time loan of almost $500,000 to the borrower, secured by both a promissory note (the "Note"), as well as a mortgage on certain properly located in Markham (the "Mortgage"). However – and this is an important point – the Note was itself secured by the Mortgage and arose out of the same loan. Both the forms of security (which would be paid down equally with every payment) called for the principal amount and interest to be paid in 80 equal monthly instalments of $6,000, with interest at 0.75%, until August 15, 2017. But there were some key differences as well: the Mortgage provided for a Late Payment Charge (of $10 per day), a Missed Payment Fee (of $300 per late installment) and an N.S.F. Fee (of $300 per cheque). The Note, on the other hand, contained none of these late payment charges but did contain a clause that bumped the interest rate from 0.75% to 10% per annum "after demand, default and pre and post judgment" (the "Interest Escalation Provision").

When the borrower stopped making monthly payments after only a year, the validity of the Note’s Interest Escalation Provision and of the Mortgage’s various late payment charges became the focus of the subsequent litigation, in light of section 8 of the Interest Act. That section states that in connection with mortgage default "[n]o fine, penalty or rate of interest" can be taken on arrears of principal or interests if it has the effect of increasing the charge on arrears to a higher rate of interest than what is being charged on the money not in arrears. The borrowers claimed that this section operated to invalidate the lender’s ostensible late payment charges (totaling over $30,000), and the 10% per annum it was claiming under the Note’s Interest Escalation Provision (amounting to almost $60,000). An earlier ruling by a motion judge had granted the lender’s claim, which for a one-year period post-default had totalled amost $100,000 more than the amount of the original loan.

On later appeal, the court began by declaring the Note’s Interest Escalation Provision to be invalid. It agreed with the borrower that although it was contained in the Note rather than in the Mortgage itself (which had no equivalent clause), it had the practical post-default effect of increasing the initial 0.75% interest rate to a 10% rate on arrears for a loan that was secured by a mortgage, and was therefore in the Act’s purview. The Note itself was secured by the Mortgage, which in turn related to security on land and both stemmed from a single loan. The Act’s own wording focused on whether arrangements to increase the interest on arrears had a prohibited "effect"; nothing suggested it had to arise from interest charged under a mortgage per se. Rather, section 8 could apply even where the prohibited charges were contained in another debt instrument that secured a loan which was itself secured by a mortgage on real property. As the court put it:

Where, as here, the debt instrument and the mortgage that secures it are for the same principal amount and provide for the same payment terms, and where payment of one is payment of the other ….the two instruments secure repayment of the original or principal liability – here, the single loan – and s. 8 applies to both.

The Appeal Court determined that the appropriate post-default interest rate was the agreed 0.75%, and re-calculated the lender’s entitlement accordingly. It also held that the various late payment charges and default fees totaling more than $30,000 were also in breach of section 8, since they fell within the category of "fines" or "penalties" and noted that the lender had not proven that it incurred any actual losses due to the borrower’s late payment, in any case. See P.A.R.C.E.L. Inc. v. Acquaviva, 2015 (ONCA).