Interesting Interest – How Interested Are You in Your Interest?
Interest rates, accelerated interest, discount rates, administrative fees and the like are common in today’s marketplace. While interest is a fundamental part of loans, most commercial transactions include some form of financing either to offset the cost of business or to penalize late payments. However, when can these various forms of charges contravene applicable law?
This edition of The Battlefront considers a recent Ontario Superior Court decision that significantly reduced the financing-related fees due to noncompliant language in the customer agreement.
In the case of Solar Power Network Inc. v. ClearFlow Energy Finance Corp., the debtor borrowed funds from the creditor on loan terms that included: (1) a base annual interest rate, typically 12% per annum calculated and compounded monthly; (2) an administration fee between 1.81% and 3.55% on the creation and renewal of each loan, calculated according to a 90-day and 180-day formula; and (3) a discount fee of 0.003% calculated on a daily basis. Over the course of a few years, the creditor made thousands of advances of funds to the debtor on these loan terms. When the debtor began to default on these loans, the creditor and debtor entered into various forbearance agreements.
The debtor alleged that all these three categories of charges were effectively interest charges that did not comply with Section 4 of the Interest Act (Canada). This section reads as follows:
“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.” (emphasis added)
Essentially the statute requires that to collect interest, the written contract must include an effective annual rate of interest, otherwise the interest is set at 5% per annum regardless of the agreement between the parties. The debtor sought a declaration from the court that these three fees were all forms of interest and, as such, the agreement must state an aggregate annualized interest rate. As no such aggregate interest rate was set out in the agreement, the Interest Act would cap total interest at 5% per annum. The creditor disagreed with the characterization of the various fees as interest and also disputed the 5% cap.
The court conducted its analysis of the various types of fees. First, the court did not agree that the administration charge was a disguised interest charge as that fee was reflective of the work the creditor had to carry out on an ongoing basis to establish, administer and renew the various the loan advances.
However, the court determined the discount fee was a form of interest charge as it was not proportionate to any continuing effort by the creditor or tied to any specific event. The discount fee was a regular recurring charge not linked to any event or new effort by the creditor. This was a form of “interest” governed by the Interest Act.
As the discount fee was not expressed in the loan agreement as an annual interest amount as required by the Interest Act, the court determined the entirety of all interest charges had to be capped at 5% per annum.
Even though there was a clearly stated base annual interest rate of 12% per annum, the lack of compliance regarding the smaller discount fee tainted the entire agreement. With proper disclosure, the creditor would have received interest at approximately 13% per annum. However, the noncompliance resulted in the aggregate interest being reduced to 5% per annum in accordance with the Interest Act.
The knowledge and understanding of the debtor regarding the various charges was not relevant to the court’s analysis or the application of the law. The burden of compliance with the Interest Act is entirely on the creditor and is not reduced or diminished by the debtor’s knowledge or agreement. The creditor alone has the burden of proper disclosure regarding interest charges.
(A few side notes: First, the name of the fee is irrelevant. In simple terms, interest is: (1) compensation for the use or retention of money; and (2) relates to a principal amount or obligation to pay money; and (3) accrues over time. Any “fee” or amount charged to a customer may be interest regardless of the description used in the agreement. Second, while this court decision relates to a loan arrangement, the language of the Interest Act applies to any written agreement; hence any fees in commercial agreement may well be at risk of being captured by the Interest Act.)
Thoughts to Take Away
Technical compliance is important! Business owners and operators should review their agreements carefully to determine whether charges and fees may be viewed as interest under the Interest Act. If so, an effective annual interest rate must be clearly disclosed that includes all forms of interest charges. In addition, providing a simple numeric example should also be considered for clarity. This burden is solely on the company seeking to impose interest charges and similar fees. As knowledge does not reduce this obligation, a customer can accept the agreement, but still challenge the fees at a later date.
Noncompliance could result in a severe reduction in the fees that a business can charge its customers. Separating charges into various categories may be common in an industry, but the court is prepared to take a strict approach to protect customers, regardless of whether the customers were aware or even perhaps understood the various charges. A small lack of compliance can result in a large loss by the business!
Interest is an integral part of our financial market, but businesses must pay attention to their interest practices. Don’t let the interesting interest of the Interest Act affect your business’ interest in interest!
As a postscript, this court decision may be appealed. If so, more “interesting” developments may follow!
This article contains general information only. The Battlefront is a brief canvasing of the topic presented and should not be relied upon as professional advice in making any personal or business decisions. Always consult with a licensed legal professional before making any decisions regarding your own personal or business needs. The author takes no responsibility to update any of the information presented in this article. All rights reserved. © Loopstra Nixon LLP 2018