On January 10, 2018 the Ontario Superior Court of Justice released its decision in Solar Power Network Inc. v ClearFlow Energy Finance Corp, 2018 ONSC 7286; leave to appeal granted on February 15, 2018 (the “Solar Decision”). This decision, absent reversal upon appeal, could significantly alter long-standing Canadian commercial law and practice. The effects of this decision could extend to virtually all non-consumer loan and credit agreements and other contracts or documents pursuant to which interest is payable.
In light of this decision and in order to ensure compliance with s. 4 of the Interest Act, RSC 1985, c I-15 (the “Act”), creditors and lawyers need to carefully consider how they incorporate and calculate interest, and fees that may be classified at law as interest, into agreements as an annual rate, for interest amounts calculated based on any period less than a year of 365 or 366 days as the case may be (daily, weekly, monthly, etc.).
S. 4 of the Act states:
Except as to mortgages on real property or hypothecs on immovables, whenever any interest is, by the terms of any written or printed contract, whether under seal or not, made payable at a rate or percentage per day, week, month, or at any rate or percentage for any period less than a year, no interest exceeding the rate or percentage of five per cent per annum shall be chargeable, payable or recoverable on any part of the principal money unless the contract contains an express statement of the yearly rate or percentage of interest to which the other rate or percentage is equivalent.
Put simply, where interest is payable under an agreement governed by Canadian law and is not a loan secured by real property, and the agreement does not disclose the interest payable by the borrower as an annual rate then the interest rate is restricted to no more than 5% per annum.
Solar Power Network Inc. and its affiliates (together “Solar Power”) are in the business of installing solar panels on commercial, institutional and industrial rooftops. They initially obtained short-term financing from ClearFlow Energy Finance Corp. (“ClearFlow”) to finance their projects during the development and construction phases but over time this relationship evolved and since mid-2015 ClearFlow has been Solar Power’s primary lender and has advanced them a number of loans
The loan documents for these transactions provided for a base interest rate of 12% per annum, compounded and calculated monthly and the base interest was to increase to 24% per annum upon the happening of an event of default by the borrower.
The loan documents also provided for an administration fee of (typically) either 1.81% or 3.55% of the loan balance depending on the terms of the specific loan documents (the “Administration Fee”) and a discount fee of 0.003% of the outstanding principal of the loans calculated on a daily basis for every day that the loan was outstanding (the “Discount Fee”).
The Administration Fee and Discount Fee in the loan documents were not stated on an annualized basis. Therefore, in order to ensure compliance with s. 4 of the Act in the event that such fees were categorized as interest, ClearFlow’s loan documents provided a formula for calculating the annual rate of interest charged on the Administration Fee and Discount Fee (e.g. 0.003% x 365 = the annual rate for the Discount Fee).
In 2015 Solar Power began to experience financial difficulties and defaulted on a number of loans they had with ClearFlow.
The relevant legal issues that arose in the Solar Decision were the following:
- Are the Discount Fee and Administration Fee provided for under the loan documents properly characterized as interest under the Act?; and
- If yes, is all of the interest under the loan documents capped at 5% in accordance with s. 4 of the Act?
Solar Power submitted that that the Discount Fee and Administration Fee were interest under the Act and were not stated on an annualized basis in any of the loan documents in place with ClearFlow. Therefore, Solar Power argued that these fees violated s. 4 of the Act and all interest (including the annualized base interest rates of 12% or 24%) must be capped at 5% per annum.
Conversely, ClearFlow argued the Discount Fee and Administration Fees were not interest and even if they were characterized as interest, that the loan documents in question included a formula for calculating the annual rate on these fees and as such did not contravene s. 4 of the Act. Specifically, ClearFlow’s loan agreement set out the following:
If the amount of any interest, fee or other amount is determined or expressed on the basis of a period of less than one year of 365 or 366 days, as the case may be, the equivalent yearly rate is equal to the rate so determined or expressed, divided by the number of days in the said period, and multiplied by the actual number of days in that calendar year.
This type of formula for calculating annual rates to ensure compliance with s. 4 of the Act is consistent with standard commercial practice across the country.
The Ontario Superior Court of Justice agreed with ClearFlow that the Administration Fee did not constitute interest as it was compensation to the lender for the significant costs associated with administering the loans but held that the Discount Fee should be characterized as interest.
After establishing that the Discount Fee was interest, the court moved on to its s.4 analysis and held that ClearFlow’s conversion formula did not produce a sufficient and equivalent annual rate for the purposes of satisfying s. 4 of the Act. Stated differently, the court determined that ClearFlow’s standard form conversion formula was not a sufficient statement of an equivalent annual rate for the purposes of s. 4 of the Act.
The court stated that confusion arose over ClearFlow’s conversion formula and that it did not produce an “effective annual rate” as required by s. 4: “it was not accurate to say that by simply multiplying 0.003% x 365 that the Discount Rate could be annualized so that the borrower’s obligation could clearly be understood”. While it was not explicitly stated, the court implied that a conversion formula can never be explicit enough to satisfy the requirements of s. 4.
Since this one component of the ClearFlow loans contravened s.4 of the Act, the court applied a blanket interest rate cap of 5% per annum for all of the interest provisions in the loan documents. This meant that the base interest rate (12%), the default interest rate (24%) and the Discount Fee were collectively reduced to 5% per annum. As stated by the court: “…if there is any non-annual interest rate [that does not comply with the s.4 disclosure requirements], then the aggregate interest rate must be limited to 5%”.
This decision has broad reaching implications for all creditors with respect to their standard conversion formula clauses and their usual practices regarding the calculation of interest as an annual interest rate and nominal versus effective interest rates.
Canadian lenders and lawyers alike are working to fully absorb the impact of the Solar Decision and its far reaching implications. It is hoped that this case will be limited to its facts and can be distinguished from loans with all interest, and fees that may constitute interest at law, expressed as a rate per annum calculated on an annual basis, or where that cannot be done, a formula is given to provide the equivalent rate on an annual basis. It may be prudent to give a sample calculation of the formula to help the reader and in any dispute that goes to court, to more readily understand the formula.
Pending the results of the appeal, creditors need to be vigilant about how they address any interest provisions where interest is made payable at any rate or percentage for any period less than a year.
In its decision the Court firmly called into question the ability to satisfy the requirements of s. 4 using a conversion formula and seemed to indicate that disclosure of an “effective annual rate” as opposed to the “nominal interest rate” is required to satisfy s. 4. The reality is that in many instances, unless lenders completely restructure the way that interest is calculated on many of their loans, a conversion formula will be the only feasible option for disclosing equivalent annual rates and that even then the interest calculated will only be on the basis of the nominal annual rate.
In those instances, at a minimum, it is prudent for the lender to obtain a rep and warranty from the debtor:
(i) confirming that they are a sophisticated commercial purpose entity and that they understand and are comfortable using the conversion formulas contained in the documentation, and
(ii) acknowledging and agreeing that the conversion formulas satisfy the disclosure requirements stipulated in s.4 of the Act.
Since the Court in the Solar Decision characterized s. 4 as consumer protection legislation (although no consumers were involved in this case), it is our hope that express confirmation from the debtor that they understand the formula and how to convert the prescribed interest rates to annual rates using the formula will be sufficient to satisfy the legislation. That said, we could not have predicted the outcome of the Solar Decision in the first instance and cannot be certain about what the future holds with its appeal and the long-standing implications it will have on commercial practices in this area.
At this time we recommend vigilance and documentation with as much detail as possible with the hope that reason will eventually prevail. Until such time, lenders should expect that any enforceability opinions they receive may be qualified to the extent that s.4 of the Act and the Solar Decision applies.