In Bankers Mortgage Corporation v. Plaza 500 Hotels Ltd., the British Columbia Court of Appeal recently considered whether an "Exit Fee" payable on mortgage default to a mortgage broker (not to the lender) was a "penalty" on arrears payable on default and, therefore, prohibited under section 8 of the Interest Act. Section 8 prohibits the imposition of fines or penalties "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 court found that it was not sufficient for a default charge to be "related" to arrears secured by mortgage for it to be captured by the Interest Act. The charge must be "on" arrears secured by mortgage. The charge must also qualify as a "fine, penalty or [additional] rate of interest" on the arrears to be prohibited. Where, as here, the default charge is unsecured, a genuine pre-estimate of damages, does not inhibit the ability to payout the arrears and obtain a discharge of the mortgage, this decision suggests that the default charge will not be a prohibited penalty under the Interest Act and can be enforced. While it is important to note that in this case the default charge was payable to a broker, and not to the lender, the reasoning does not appear to turn on that fact. It should also be noted that the mortgage in this case was a commercial loan. Additional considerations apply for consumer mortgage loans due to restrictions on default charges in consumer protection legislation, such as those imposed in British Columbia under section 75 of the Business Practices and Consumer Protection Act.
The reasoning in the case was essentially as follows:
(a) section 8 is a restriction on the general right to freedom of contract recognized in section 2 of the Interest Act and must be interpreted in that context. Section 2 states that "[e]xcept as otherwise provided by this Act or any other Act of Parliament, any person may stipulate for, allow and exact, on any contract or agreement whatever, any rate of interest or discount that is agreed on.
(b) while the interpretation of section 8 must be guided by its purpose of protecting owners of property, it should be narrowly construed and informed by the fact that it is a restriction on the general right to contract freely, expressly affirmed in the Interest Act.
(c) the purpose of section 8 is to protect owners of real estate from charges that have the effect, regardless of their form, of obstructing, making it more costly, or even making it impossible for owners to redeem or protect their equity.
(d) the fact that an unsecured charge is triggered by default alone is not enough to bring it within the purview of section 8, even though it increases the borrower's overall obligations arising out of the transaction. Likewise, the fact that an unsecured obligation may affect the owner's equity, because it is capable of being enforced by way of judgment that can be registered against title, is insufficent to bring a charge within the prohibition.
Where an "exit" or default fee is a reasonable pre-estimate of damages and otherwise enforceable at common law, is unsecured, and, therefore, does not offend these purposes of the Interest Act protections, it is, based upon the this case, enforceable.
This case is helpful in clarifying the rights and obligations of financial institutions and other parties involved in facilitating mortgage transactions. It affirms that at least reasonable unsecured fees, with a valid commercial purpose, should be enforceable even if payable on default.