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First Source Mortgage Corporation agreed to lend $15.5 million to 660 Sunningdale, secured by a mortgage on its development property. As consideration for the loan, 660 Sunningdale agreed via a commitment letter, to pay a “Lender Fee” of about $426,500, which was about 2.75% of the loan amount. The parties acknowledged in the commitment letter that this fee was a reasonable estimate of First Source’s costs to source, underwrite, and prepare the loan and was deemed earned “upon acceptance and execution of this Commitment.” The Lender Fee was to be paid in two installments:  $100,000 when the loan was accepted and the balance to be paid later.

660 Sunningdale duly remitted the $100,000 upon signing, but later decided not to proceed with the loan. Among other things, it claimed First Source had made unreasonable demands and demonstrated a lack of good faith, and effectively breached the contract. 660 Sunningdale then refused to pay the remaining Lender Fee balance of $326,500.

The parties went to court to determine whether 660 Sunningdale remained liable for that amount, and whether its initial $100,000 payment should also be forfeited to First Source.

The key issue was the characterization of the Lender Fee clause in the commitment letter. 660 Sunningdale claimed it was an unenforceable penalty clause, rather than a mechanism for pre-estimating First Source’s damages. In law, a penalty clause obliges a party to pay a set sum if it breaches a contract, regardless of the damages actually suffered by the innocent party. They are typically unenforceable unless the sum is a reasonable pre-estimate of that party’s losses. 660 Sunningdale also claimed the Lender Fee was not “earned” by First Source, since it was never required to do the customary work to source, underwrite and prepare for the loan, because the monies were never advanced.

Before a lower court judge, the results were mixed: First Source was entitled to keep the first $100,000 paid, since this amount was a valid pre-estimate of its damages. However, 660 Sunningdale was relieved of having to pay the $326,500 balance, since it was found to be an extravagant and unconscionable amount arising under an unenforceable penalty clause.  Even if the $326,500 did remain payable, First Source could be blamed for its unreasonable conduct and demands, which prompted 660 Sunningdale to seek financing elsewhere. In the lower court judge’s view, this misconduct by First Source made 660 Sunningdale eligible for relief from forfeiture of the Lender Fee balance.

On appeal, the court found several errors in this reasoning. First, the requirement to pay the balance of the Lender Fee did not arise from any sort of unenforceable “penalty clause,” since it was not tied to any contractual breach. Rather, the parties’ own written contract had simply earmarked the entire Lender Fee of $426,500 as legal consideration for the loan commitment.  That meant the balance was payable whether or not the contract was breached. What the lower court judge had incorrectly done, the Appeal Court noted, was to effectively absolve 600 Sunningdale from its obligations under the commitment letter, by misapplying the law on penalties.

Next, this was not a case for granting 660 Sunningdale relief from having either the $100,000 or the $326,500 forfeited. That remedy is only available in those limited scenarios where it is fair to relieve a party of the consequences of its own contractual breach. Here, First Source was not demanding the Lender Fee balance because 660 Sunningdale breached the contract; rather it was relying on the terms of the commitment letter, which designated those funds as consideration for the loan. Likewise, it was wrong to factor in whether the Lender Fee was “unearned” by First Source; its payment was never contingent on the loan funds actually being advanced.

The appeal was accordingly allowed. The court ordered that First Source could keep the initial $100,000, and ordered that 660 Sunningdale remained liable to it for the $326,500 balance of the Lender Fee. See 660 Sunningdale GP Inc. v. First Source Mortgage Corporation, 2024 ONCA 252.