Copyright 2011, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Real Estate, May 2011
Borrowers and lenders take note — an inconspicuous but important statutory right of prepayment exists under the federal Interest Act which applies to non-corporate borrowers.
Right to Prepay after Five Years
Section 10 of the Interest Act (Act) was first enacted to protect farmers from being locked into long-term mortgages at high interest rates. The Act provides for a right of prepayment in circumstances where principal or interest under a mortgage are payable more than five years after the "date of the mortgage". If this is the case, the mortgage can be prepaid in full after the expiry of the five-year period, together with an additional payment equal to three months worth of interest. No additional payments or penalties can be charged by the lender. However, this statutory right of prepayment is expressly stated not to apply to mortgages given by corporations. Section 10 of the federal Act is closely paralleled by similar provincial legislation in Ontario and Manitoba. In Ontario, the similar provisions are contained in section 18 of the Mortgages Act.
During the 1980s, the effect of section 10 of the Act became the subject of considerable judicial comment in the context of renewals. If a mortgage is renewed for a period that, including both the original term and the renewal term, exceeds five years after the date of the original mortgage, can it be prepaid after the expiry of the initial five-year period? Are the parties free to amend the "date of the mortgage" so that the applicable date is the date of the renewal agreement, or is this an unlawful "contracting out" of statutory rights? The Supreme Court of Canada considered these issues in Royal Trust Company v. Potash and laid down the following principles:
- the purpose of section 10 is to ensure that borrowers have the right to pay off their mortgages at the end of each five-year period – they cannot be "locked in" for more than five years
- where the original term of the mortgage is five years or less and the term is extended beyond the five-year period (with the "date of the mortgage" remaining unchanged), the borrower (provided it is not a corporation) has the right to pay the mortgage off at the end of five years
- where a borrower elects not to exercise its prepayment rights under section 10, but instead enters into an otherwise valid and enforceable renewal agreement which deems the "date of the mortgage" to be the date of maturity of the existing loan, and the term of the renewal agreement does not exceed five years, the borrower cannot pay off the mortgage until the end of the five-year renewal period – this does not constitute "contracting out" of the statutory prepayment right because the borrower has made a conscious election not to prepay at a time when that right arose
- if a borrower purports in a mortgage or in a renewal agreement to relinquish its right to prepay the mortgage in future at the end of any five-year period, such a provision would constitute "contracting out" of the Act and would not be enforceable.
Bare Trustee and Nominee Corporations
Although non-corporate borrowers such as partnerships and REITs enjoy the benefit of the prepayment rights afforded by section 10 of the Act, these entities cannot hold title to real property in their own name and frequently do so through the use of bare trustee or nominee corporations. Does the use of a corporate entity as the registered owner of real property and therefore as the party to the registered mortgage affect the ability of a beneficial owner/mortgagor which is not a corporation to take advantage of section 10 of the Act? This issue was considered in several Ontario cases in the late 1990s. The Ontario Court of Appeal determined in Litowitz v. Standard Life Assurance Co. that the right to prepay is determined by the corporate status of the mortgagor. Although individuals or other non-corporate entities might be the beneficial owners of real property, if they arrange to conduct their business through a nominee corporation which signs the mortgage as mortgagor, the corporate status of the nominee corporation will preclude the ability to prepay the mortgage pursuant to section 10. This is true even if the lender is aware of the existence of the individual or other non-corporate beneficial owners and even if they are parties to the mortgage as "additional covenantors". If the registered title to real property is registered in the name of a corporation, the right of a non-corporate beneficial owner to prepay any mortgage given by that corporation will not apply pursuant to section 10.
The Quebec Civil Law Position
In the Province of Quebec, the application of the rule in Litowitz is somewhat uncertain, mainly stemming from the fact that civil law does not divide ownership between legal and equitable title as does the common law. Where a corporation acquires title to a property in Quebec on behalf of another, it is doing so as a prête-nom or mandatary (the civil law equivalent of an agent). The prête-nom has no rights of any nature whatsoever and cannot perform any act without the true owner's permission. According to the Civil Code of Québec, a Quebec hypothec (mortgage) may only be granted by the person having the capacity to alienate the hypothecated property, leading some to believe that the true owner must hypothecate (which they often do by way of intervention to the hypothec). However, the better view is that the rule in Litowitz does apply in Quebec and that, with the true owner's authorization, the prête-nom does have the capacity to deliver the hypothec. To avoid uncertainty, the practice has arisen to create and secure debentures (which is another exception to the right of prepayment) and, where there is title insurance, to obtain a section 10 endorsement.
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.