On May 6, 2016, the Supreme Court of Canada ("SCC") released its decision in Krayzel Corporation v The Equitable Trust Company. The case was an appeal from the Alberta Court of Appeal.
Lougheed Block Inc. ("Lougheed") was the owner of an office building over which it had granted a mortgage to Equitable Trust Company ("Equitable Trust"). After a series of instances where Lougheed was unable to make the required payments, the terms of the mortgage were amended by way of a second renewal agreement which specified a per annum interest rate of 25 per cent. However, Lougheed would only be required to make monthly interest payments at a "discounted rate" of 7.5 per cent or at the prime rate plus 5.25 per cent, whichever was greater. The difference between the "discounted rate" and the 25 per cent rate would accrue to the loan and be forgiven so long as Lougheed did not default. Lougheed eventually defaulted and Equitable Trust sought repayment at the 25 per cent interest rate.
The issue on appeal was whether the loss of the "discounted rate" upon default was in contravention of section 8 of the Interest Act.
Section 8(1) of the Interest Act states that "[n]o fine, penalty or rate of interest shall be stipulated for, taken, reserved or exacted on any arrears of principal or interest secured by mortgage on real property or hypothec on immovables that has the effect of increasing the charge on the arrears beyond the rate of interest payable on principal money not in arrears."
The majority of the Alberta Court of Appeal had upheld the chambers judge, holding that the interest terms of the second renewal agreement complied with section 8 of the Interest Act, as the section was aimed at penalties for non-performance rather than incentives for performance. However, a strong dissent by Berger J.A. argued that non-penal and penal provisions imposing a higher interest rate upon default were both in contravention of section 8.
The SCC began its analysis with a consideration of statutory interpretation, and in particular the correct interpretation of section 8 of the Interest Act in light of section 2, which states, "[e]xcept as otherwise provided by this Act […] any person may stipulate for, allow and exact, on any contract or agreement whatever, any rate of interest or discount that is agreed on" (emphasis added).
Brown J., writing for the majority of the SCC, determined that, had Parliament intended section 8 be limited in application to penalties, it would not have included the terms "fine" and "rate of interest" in section 8 as a type of item that might be prohibited. Furthermore, the inclusion of the phrase "has the effect" indicated Parliament's intention that items guised as non-penal discounts be included in the purview of section 8. The omission of the term "discount" in section 8, as included in section 2 of the Interest Act, did not mean that section 8 did not apply to discounts.
Accordingly, the majority of the SCC held that section 8 of the Interest Act prohibits both discounts to incentivise performance as well as penalties for non-performance whenever their effect is to increase the charge on the arrears beyond the rate of interest payable on principal money not in arrears. The terms of the second renewal agreement with respect to the loss of the discounted interest rate upon default was, consequently, found to be in contravention of section 8 of the Interest Act.
Côté J., writing for the three judge dissent, found that section 8 of the Interest Act was not engaged by the second renewal agreement because section 8 does not apply to provisions that give the borrower relief from an interest rate under an agreement. This conclusion was based on an interpretation that section 8 only provides a narrow exception to the foundational rule of freedom of contract contained in section 2 of the Interest Act.
The case has important consequences for lenders taking security by way of real property. According to the decision, secured parties who grant a borrower a discount on interest payments may not be able to later claim the full interest rate on any arrears of principal or interest secured by a mortgage.