Copyright 2011, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Real Estate, May 2011
Most lenders don't expect to be subject to criminal charges or imprisonment due to loan agreements entered into with commercial borrowers or due to receiving payments from their commercial borrowers. However, section 347 of the Canadian Criminal Code (the Code) makes that a possibility. Section 347 contemplates fines and imprisonment for those who enter into agreements or arrangements to receive interest at a criminal rate or those who receive interest payments at a criminal rate.
Section 347 of the Code is an anti-loan-sharking provision which some commentators have suggested is overly broad. Initially, the parliament of Canada dealt with the problem of those who lent money at what is seen as an overly high rate of interest by regulating interest rates on small consumer loans. The trouble with the early legislation was that it required police to be able to show that there were threats, violence or fraud involved in the arrangement. Parliament responded with provisions that are now no longer limited to consumer loans but apply to all sorts of credit arrangements, whether the parties are individuals, large corporations or financial institutions.
The criminal rate referred to in section 347 means an effective annual rate of interest calculated in accordance with generally accepted actuarial practices and principles that exceeds 60% on the credit advanced under an agreement or arrangement. Though the 60% rate per annum may, on its face, seem high, it is interesting that the parliament of Canada has determined that rates in excess of that amount are criminal in nature, even though there may be good business reasons for a short-term higher rate interest rate where, for example, the risk would not be properly priced unless the lender were to receive such a rate.
The Canadian courts have shown some discomfort in implementing the provisions of section 347 of the Code. In one of the leading cases, the court noted that if the section was intended to be more directed towards street-level loan-sharking, it is up to parliament and not the courts to legislate amendments to limit the breadth of the section. Generally, the Supreme Court has stated that where an agreement or arrangement is entered into where a lender may, but will not necessarily receive interest at a rate in excess of 60% per annum, there is no violation of the Code until such an amount is actually received by the lender. Therefore, if the loan agreement permits but does not require payment of a criminal rate of interest, there is no breach of the first part of section 347 and the analysis shifts to whether a payment of the illegal interest was, in fact, received by the lender. That means that the criminal rate of interest is not triggered until the payment is actually received by the lender if, on its face, the loan agreement or arrangement may result in, but does not require, payment of interest at a criminal rate.
The court has also held that if the payment is made voluntarily, such as when a borrower determines to pay off a loan within a few days of it being advanced, the interest payable would not breach the Code even if it exceeds 60% per annum. Accordingly, a transaction that was legal at the time it was entered into is not rendered illegal by the voluntary act of the borrower.
The provisions of section 347 also set out what constitutes "interest" for the purposes of determining whether a criminal rate of interest is contemplated. It states that "interest" means the aggregate of all charges and expenses, whether in the form of a fee, fine, penalty, commission or other similar charge or expense or in any other form, paid or payable, for the advancing of credit under an agreement or arrangement. It specifically states that it does not include any repayment of credit advanced or any insurance charge, official fee, overdraft charge, required deposit balance or, in the case of a mortgage transaction, any amount required to be paid on account of property taxes.
Case law provides that the following do constitute interest for the purposes of the prohibition: monthly monitoring fees, standby fees, royalty payments, commitment fees, processing fees, late fees associated with advancement of the credit, and loan application fees. Arrangements between a borrower and a lender requiring the borrower to pay a share of anticipated profit as a condition of receiving the loan – but where the loan was not contingent on realization of the profits – have also been held to constitute interest for the purposes of this section of the Code.
Certain fees have been held as not constituting interest. For example, an administrative fee for dealing with overdue accounts does not constitute interest and broker fees were seen not to be interest where the borrower had independently retained the services, and negotiated the fee, of the broker, and the broker was not an agent of the lender. Instead, the fee was held to be a charge or expense incurred by the borrower for professional assistance in finding someone who would lend money. In that case, it was also noted that fees paid to a solicitor to advise on mortgage documents would likely not qualify as interest.
It should be noted, however, that there is extensive case law on the topic as to what fees constitute interest for the purposes of section 347 of the Code and, accordingly, there is some uncertainty for lenders who receive fees which could constitute interest for the purposes of that section.
From a practical perspective, loan agreements should include language stating that, if all the amounts payable under the agreement that constitute interest for the purposes of the Code would exceed 60%, then such amounts shall be reduced to the amount that is permissible under the Code. It should be noted that while this will "save" those agreements it does not necessarily solve the problem where a lender has actually received amounts that exceed a 60% interest rate. Accordingly, it is appropriate to bear in mind that when, for example, a borrower pays out the loan prior to its maturity date, the amount of the actual payments made by the borrower to the lender over the course of the time that the credit was advanced should in no circumstances ever be permitted to exceed 60% per annum, unless the early prepayment is a voluntary act of the borrower.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.