Claim to Three Months’ Bonus Interest Found Invalid Post-Maturity

In Lee v. He, the court was asked to resolve the straightforward question of whether, in the face of the borrower’s default post-maturity, the lender on a mortgage was entitled to three months’ bonus interest under section 17 of the Mortgages Act.

The facts were uncomplicated: The lender advanced $700,000 to the borrowers, secured by a mortgage on their primary home and on a second renal property. The mortgage had a 12-month term, at which point it was to be paid in full.

The borrowers were unable to pay off the mortgage at the end of the term. After some initial negotiations to renew, the defaulting borrowers went silent, so the lender launched mortgage enforcement proceedings. The lender claimed for $881,000, representing the total claim for principal, interest, costs, and miscellaneous administrative fees. Included in this amount was approximately $210,000, part of which reflected the lender’s putative claim for three months’ bonus interest under s. 17 of the Mortgages Act. The borrowers resisted, claiming the fee was illegal given that it was now the post-maturity period.

Before the court, the lender’s argument was straightforward: Now that the mortgage was in default, the lender was entitled to either three months’ notice of the borrowers’ intent to repay it, or else three months’ interest by way of bonus under section 17 of the Mortgages Act. Since the borrowers were not in a position to pay (having failed to secure alternate financing in the interim), the lender could opt for the bonus interest.

The court disagreed. It observed that mortgages are loan agreements entitling the borrower to use the lender’s capital for a stipulated period. In return, the lender is provided with a stream of interest income, together with the ultimate repayment of its capital. When a borrower defaults, the lender is theoretically entitled to not only repayment of its capital, but also the present value of the lost income it would have received by way of interest had the breach not occurred.

That said, the intent of section 17 – which is deemed to be part of every mortgage in Ontario – is to protect the defaulting borrowers by allowing them to pay their arrears without penalty, or else allow them early redemption at a price. It also gives the lender a three-month period during which to arrange for the reinvestment of the principal, or else – at the borrowers’ option – the payment of money to compensate the lender for not having received proper notice from the borrowers.

The rationale behind section 17 ceases to make sense when a mortgage goes into default after maturity. Then, the lender has already received (or is entitled in law to receive) the whole of the income stream contracted-for. In such circumstances the three months’ bonus interest would be nothing more than a penalty, which is something it was never intended to be.

The court conceded that section 17 does not distinguish between defaults occurring before maturity, and those occurring after. However, every mortgage agreement also entitles the lender to expect repayment on the maturity date; in effect the borrowers are giving notice of an intent to pay on that date. Also, as a practical matter, where mortgages go into default after maturity, lenders typically institute enforcement proceedings quickly – as was the case here. In doing so, the lender takes the redemption option out of the borrower’s hands; the lender cannot then “tack on” an extra three months’ bonus interest. In other words, having acted to take enforcement steps, the lender cannot convert the borrowers’ option to redeem into an obligation to pay bonus interest.

The court adjusted the amount of the balance outstanding, down from $210,000 to $22,000 which still included legal fees and certain modest statement fees. See Lee v. He, 2018 ONSC 3656 (CanLII).