Court of Appeal: Increase in interest rate one month before maturity legal, Autumn 2006

The British Columbia Court of Appeal recently ruled in favour of a lender to allow a clause in a mortgage increasing the interest rate one month before the mortgage came due. The court held that the clause did not offend section 8 of the Interest Act (Canada), which prohibits lenders from charging borrowers a penalty by way of a higher rate of interest, if the increase occurs as a result of a borrower’s default.

The original lender, Gibraltar Mortgage Ltd. which later assigned the mortgage to Reliant Capital Ltd., entered into a mortgage loan agreement in September 2001 with Silverdale Development Corp., and took a mortgage of $3.5 million. Silverdale is a B.C. developer whose intention was to replace existing financing and to subdivide and service an industrial park on 40 acres of vacant land in the District of Mission, B.C. Silverdale’s ability to repay the loan was directly tied to the successful completion of the project.

The mortgage was for a term of 13 months and 22 days. The interest rate was 14% but would rise to 20% one month before the loan was to mature. Prepayment during the first 6 months was allowed upon payment of 3 months interest, in the 7th to 11th month of the term on payment of one month’s interest, and in the last 30 days of the term without penalty or bonus.

Silverdale’s project experienced unexpected costs and delays and payments went into default about 8 months into the term. Gibraltar assigned the loan to Reliant Capital Ltd., and in early June 2002, Reliant commenced foreclosure proceedings. The amount claimed included interest at 14% up to August 1, 2002 but 20% after August 1. At the time of the sale, the parties agreed that the question of whether the increase in the interest rate was enforceable would be decided later, with some $186,000 paid into court pending resolution of that issue.

At the initial motion and before a chambers judge at the first appeal, Reliant was unsuccessful, the master and judge holding that the increased rate was a penalty with no legitimate commercial purpose. Reliant appealed and won. The British Columbia Court of Appeal held that the provision did not violate the Interest Act and was not a penalty. It found that the Act does not prohibit a lender from charging higher rates of interest on arrears than on amounts owing that were not in arrears, it only prohibits an increase in the rate of interest which is dependant on default. In this case the higher rate of interest kicked in only based on the passage of time, not on default, and applied equally to monies in arrears and on all other amounts owing.

Reliant Capital Ltd. v. Silverdale Development Corp. [2006] B.C.J. No. 1028, B.C.C.A.