Interest - The Criminal Illegal Rate #151
CATEGORY: Legally Speaking
TAGS: Buyers Default Commission Court of Appeal Interest Rate
By Gerry Neely
In times like these we might feel that high interest rates are a crime, but they don't become a crime under the Criminal Code of Canada until the effective annual rate exceeds 60%. Since a rate of 59% per annum baldly stated in a loan agreement would make even the most needy borrower blanch, a lower rate is quoted and the difference between it and the true rate is accounted for by bonuses, penalties, commission, brokerage, fees, etc., etc., etc. As a result, and to close this loophole, the definition of interest in the Criminal Code includes all charges and expenses payable as a result of a loan to the borrower.
An Ontario Company trying to develop coal property in Kentucky raised $750,000 through a lender of last resort. $250,000 was the first advance and it was to be repaid in three months with interest at 2% over prime. The borrower agreed to pay a facility fee of $37,500 to cover the services and expenses incurred by the lender. This was deducted from the first advance and no part of it was to be refunded even if no further advances were made.
The company defaulted and the lender sued the directors of the company as guarantors. The guarantors argued that the guarantees were unenforceable because the effective rate of interest for the three month loan exceeded the criminal rate. This argument depended upon whether the facility fee was repayment for services and expenses incurred in connection with the loan agreement and related transactions, or interest as defined in the Criminal Code.
The Ontario Court of Appeal decided that the facility fee was interest, no matter how it may have been described or disguised. Its deduction, together with the expressed rate over prime for a three month term, resulted in an effective annual rate of 88%. Since the rate was illegal, repayment of interest could not be enforced against the guarantors.
The guarantors then said that they couldn't be forced to repay the principal because the illegality of the interest rate tainted the agreement to repay the principal loan. This led the Ontario Court of Appeal to refer to two British Columbia cases in which illegal rates of interest were found, but only one borrower was fortunate enough to be relieved of the liability for repayment of the principal.
In the first case, a purchaser who owed an unpaid vendor $84,000 gave him a mortgage for $100,000 plus interest at 2% over prime. Payment of $84,000 plus accrued interest within 30 days discharged the mortgage, otherwise the sum of $100,000 became payable on demand. Demand for payment was made on the 40th day. The judge held that the $16,000 difference was interest, which meant that the effective rate over the periods of either 30 or 40 days was substantially in excess of the criminal rate.
However, since the primary purpose of the mortgage was to secure the unpaid balance of the purchase price, the agreement was not fundamentally illegal. The way in which the mortgage was drawn allowed the Judge to sever the separate paragraph dealing with interest from the paragraph concerning repayment of principal.
The borrower was ordered to repay the principal but not the interest.
The second case makes interesting reading for loan sharks. There, $25,000 was advanced under an agreement by the borrower to repay $31,250 in 90 days. This worked out to 100% per annum, a criminal rate of interest. The illegal interest rate could not be severed from the obligation to pay principal. The judge held that the only purpose of the loan agreement was to make the loan at a criminal rate of interest, and denied the lender the right to recover either principal or interest.
In the Ontario case, the loan agreement terms for payment of interest and principal could be severed. The Court of Appeal ordered the repayment of principal by the guarantors because: the parties were businessmen who negotiated from a basis of equality, the deterrent effect of prohibiting repayment of an illegal rate of interest would not be reduced by ordering repayment of principal, and the guarantors would otherwise be enriched at the expense of the lender.1
|1.||William E. Thomson Associates Inc. v Carpenter 61 E.L.R. (4th) p.1.|
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