In Port Capital Development (EV) Inc. (Re), the British Columbia Supreme Court recently declined to provide further comfort to a debtor-in-possession (DIP) lender in CCAA proceedings by granting a declaration that the interest rate and fees charged under the loan did not violate the Criminal Code by charging an annualized interest rate above 60%. DIP lenders in highly distressed situations, especially those involving short-term loans, have to carefully ensure the interest and other charges payable by debtors under their loans do not exceed this statutory threshold to avoid the potential consequences of doing so including, in extreme cases, all interest payable thereunder being invalidated.
Criminal Interest Rates: When “Interest” isn’t Just Interest
It is an offence under section 347(1) of the Criminal Code for a lender to enter into an agreement providing for, or to receive a payment of, interest in excess of 60% per annum. In applying this section, interest includes not only the rate of interest specified in the agreement, but virtually all other elements of the cost of borrowing, regardless of how the parties have characterized them.
Costs that have been included in the interest calculation include, among others, commitment fees, arrangement fees, loan advance fees, facility fees, extension fees, finance charges, bonuses, legal fees and other lender’s costs, capitalized interest and compensation for interest lost on money advanced on short notice.
In addition to being a criminal offence, courts will generally decline to enforce an agreement charging interest above the criminal rate as contrary to public policy. Courts have discretion to apply a host of remedies in this situation. On one end of the spectrum, the court may hold that the contract as a whole is void ab initio, which is only used in the most egregious and abusive cases. The court may invalidate payment of any interest but still require payment of the principal. On the other end of the spectrum, the court may apply notional severance (the so-called “blue-pencil” test) and strike out provisions of the contract that result in interest being charged below the criminal rate (such as charges and costs that put an otherwise compliant interest rate over the criminal rate).
Bill C-274, a private member’s bill that received first reading on May 11, 2021, would reduce the criminal rate of interest to 30% plus the Bank of Canada's overnight rate on the day the agreement is entered into or renewed (among other changes to the criminal interest provisions). However, the Bill has not advanced since first reading.
Port Capital: The “Onerous” Loan
Port Capital is the owner of a proposed real estate development in downtown Vancouver. In May 2020, Port Capital commenced Companies’ Creditors Arrangement Act (“CCAA”) proceedings after its construction lender and first mortgagee (CMLS) stopped funding and demanded payment of its loan. A sale and investment solicitation process was carried out, and three liquidation offers were submitted along with a “refinancing” proposal from another company that had common ownership with Port Capital (“129”) that included a loan from Domain Mortgage Corp. (“Domain”) and other sources of financing that would pay out the existing DIP loan and CLMS first secured loan and provide additional funding for Port Capital to stay afloat and continue to seek a replacement construction lender.
In June 2021, the Honourable Madam Justice Fitzpatrick of the British Columbia Supreme Court dismissed an application by 129 to approve and implement its proposal and instead approved the best liquidation proposal. This decision was overturned by the British Columbia Court of Appeal in September 2021 and the re-financing proposal put forward by 129 was completed in October 2021. All amounts advanced by Domain were secured by a super-priority DIP charge.
Port Capital brought a subsequent application to increase the amount of its loan from Domain, which was approved by Justice Fitzpatrick, despite the “onerous” terms of the financing, as it was the only option available to avoid liquidation.
Court Refuses to Declare That DIP Loan Does Not Cross Criminal Threshold
Port Capital also sought the following declaratory relief on the application:
The terms of the February Commitment Letter do not violate s. 347 of the Criminal Code, R.S.C. 1985, c. C‑46.
The Domain loan had an annual interest rate of 24% and various other fees and charges. Domain filed a spreadsheet demonstrating that the “total annualized interest” under the additional loan from Domain would be 52.45% (perhaps too close to 60% for comfort).
Justice Fitzpatrick declined to grant the declaratory relief sought on two bases:
- First, since the additional financing was conditional and had not yet been advanced yet, the declaratory relief sought was “in respect of what is potentially a moot matter or scenario that is speculative.”
- Second, it was improper for the Court to “backstop the legal opinions of corporate actors who intend to act in a certain way in the business world” by approving the legal advice that Domain had obtained and calculations that they had undertaken.
Takeaways: Calculate Twice, Lend Once
The decision highlights that lenders in highly distressed situations where the interest and costs under a DIP loan may approach the 60% criminal threshold should exercise extra diligence in ensuring that the total interest does not exceed this threshold at any time, especially given the harsh relief that can be meted out by courts if the threshold is exceeded. This risk is particularly acute in short-term loans, where facility fees and other charges can rapidly increase the total interest rate given the shorter time horizon.
It appears that DIP lenders will not be able to rely on the court supervising CCAA or other insolvency proceedings to provide greater comfort by granting a declaration that the threshold is not in fact exceeded. Counsel can assist in determining whether various charges and other provisions of a DIP loan may constitute “interest” and need to be taken into account in a DIP lender making these crucial calculations.