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New Interest Act Regulations Clarify Mortgage Pre-Payment Rights

The federal government has recently passed new Regulations under the Interest Act to clarify the law relating to commercial mortgage lending pre-payment rights. The change is an important one, because it expands upon the categories of those business and commercial entities which are excluded from legislated ramifications related to the exercise of mortgage pre-payment options.

As background, the Interest Act is relatively succinct federal legislation establishing general principles relating to the charging of interest on loans, including loans secured by mortgages. Section 10 of that legislation states that, in circumstances where the principal or interest under a mortgage is payable more than five years after the date of the mortgage, the borrower has a right of pre-payment; specifically, the borrower can pay off the principal, accrued interest, plus a pre-payment penalty equivalent to three months’ interest. After that, no further payments or penalties can be charged by the mortgagee. [Note: This is very similar to s. 18 of the Ontario Mortgages Act.]

However, this provision does not apply to all mortgages, nor to all borrowers. Instead, s. 10(2) specifically exempts: 1) mortgages given by a joint stock company or “any other corporation”; and 2) a “prescribed mortgage” given by a “prescribed entity.” These “prescribed” classes are defined by regulation.

Over time, certain issues have arisen from the operation of these provisions. First of all, there was some legal uncertainty surrounding their application to mortgage renewal situations where the original term plus the renewed term exceeded five years after the original mortgage date. (It was subsequently clarified by the Supreme Court of Canada in Royal Trust Co. v. Potash that, with a proper renewal letter, the mortgage can be closed for a further five-year period, without the pre-payment right arising in the borrower’s favour.)

Secondly, in the modern commercial context the Interest Act’s s. 10(2) exclusion of joint stock corporations and “any other corporations” had resulted in an impractical differentiation between types of business entities. Practically speaking, the pre-payment option in s. 10(1) generally applied to non-corporate organizations such as business trusts, partnerships and unlimited liability corporations. However, some had argued that these entities are similar to the “joint stock company” and “other corporation” categories specifically exempted by s. 10(2). (Indeed, in a case before the Ontario Court of Appeal called Litowitz v. Standard Life Assurance Co., the issue was whether the narrow distinction could be circumvented. There, borrowers in a partnership – i.e. a non-corporate structure normally eligible to pre-pay under s. 10(1) – had chosen to use a nominee corporation to hold title to real property, since they were unable to do so in their own names. The court held that this precluded the partnership’s ability to avail itself of s. 10(1), since the right to do so was dictated by corporate status of the mortgagor – in this case, the nominee corporation that had signed as such).

Partly to settle these kinds of issues, the federal government has recently passed a Regulation under the Interest Act, effective January 1, 2012 (titled the Prescribed Entities and Classes of Mortgages and Hypothecs Regulations), which expands the list of “prescribed entities” in s. 10(2), thereby broadening the category of organizations that do not fall under the s. 10(1) pre-payment regime. Specifically, “prescribed entities” now includes partnerships, as well as trusts settled for business or commercial purposes. (And for Alberta, Nova Scotia and British Columbia, it also includes unlimited liability corporations.) Therefore, mortgages given by these newly-included “prescribed entities” no longer fall within s. 10(1) of the Act and its pre-payment provisions. In light of these recent changes, a borrower or lender should consult with their legal advisors before utilizing any of these additional entities as a borrower with a mortgage extending beyond a five-year term.