In our March 2015 issue of Fully Secured, we summarized the decision of the Alberta Court of Appeal in Lougheed Block1. In that case, the Court considered the question of whether incentives for prompt payment in a mortgage agreement, which would be lost upon default, offend the prohibition on penalties for non-performance contained in section 8 of the federalInterest Act2. Leave to appeal Lougheed Block to the Supreme Court of Canada was recently granted,3 and the appeal is scheduled to be heard on December 4, 2015.
The case involved two agreements for the renewal of a $27 million mortgage registered against a heritage office building in downtown Calgary. When the mortgage matured, the parties entered into the first renewal agreement, which specified an interest rate which would increase to 25% one month before maturity. When the borrower defaulted, the parties entered into a second renewal agreement. The second renewal specified an interest rate of 25%, but the difference between that and a lower “pay rate” would be added to the principal each month and ultimately forgiven if there was no default before maturity. The borrower defaulted under the terms of the second renewal and the lender demanded payment based on the 25% interest rate.
Master Hanebury found that both the first and second renewals breached section 8 of theInterest Act. On appeal by the lender, Justice Romaine of the Court of Queen’s Bench found that the first renewal did not offend section 8 because the increased interest rate was triggered by the passage of time, rather than upon default. She also upheld the second renewal agreement, finding that the parties were free to contract for the 25% interest rate and theInterest Act did not prohibit incentives or discounts for performance.
On appeal by the borrower, the guarantors and the subsequent encumbrancers, the Alberta Court of Appeal concurred that the first mortgage renewal did not offend the Interest Act. The justices unanimously agreed that the higher rate of interest took effect due to the passage of time, not upon default. In relation to the second mortgage renewal, the Court was split: the majority found that it was essentially an agreement for 25% interest, with a discount to be applied to the principal if there was no default. This did not fall within the literal and narrow meaning of section 8, which prohibits “penalties for non-performance”, not incentives for performance. The dissent allowed the appeal in part finding the second renewal had “all the earmarks of a penalty”.
The Lougheed Block decision appears to diverge somewhat from authorities in British Columbia and Ontario which suggest section 8 prohibits both penal and non-penal incentives. However, the decision suggests that, at least for the time being in Alberta, mortgage agreements may contain provisions for increased interest rates triggered by the passage of time or incentives for prompt payment without offending section 8 of the Interest Act, even if the effect is to increase the charge on arrears. It will be interesting to see how broadly the Supreme Court of Canada interprets section 8, and how it resolves the conflicting provincial appellate decisions.