The Interest Act sets out mandatory prepayment rights
for loans secured by mortgages on real property or hypothecs on
immovables that have terms of more than five years. Section 10(1)
of the act provides that any person who is liable or entitled to
pay such a loan may prepay the full amount of the loan after five
years, subject only to a penalty of three months of interest.
Section 10(1) does not apply to a hypothec or mortgage granted by a
corporation or securing a debenture issued by a corporation.
Historically, borrowers have only been free to negotiate prepayment
terms for mortgage loans directly with lenders where this exemption
As Mr. Justice Robins of the Ontario Court of Appeal pointed out
in the frequently cited case of Litowitz v. Standard Life,
the Section 10 right of prepayment was first enacted by Parliament
in 1880. It was intended to remedy the problem of farmers being
locked into long-term mortgages at high interest rates and being
subjected to large penalties when they sought prepayment. The
exemption for corporations was enacted roughly 10 years later to
allow corporations, particularly railway companies, to obtain
long-term financing by way of loans secured by real estate. Section
10 of the Interest Act has not since been amended in any
meaningful way and, with the evolution of finance and commerce, has
become seriously outdated and an obstacle to commercial
Because the provisions of the Interest Act are of
public order and cannot be contracted out of, most lenders have,
understandably, been reluctant to provide loans with a term of more
than five years where the security for that loan is a hypothec or
mortgage granted by an entity other than a corporation. Three
months of interest simply is not adequate compensation to the
lender for the "breakage" costs associated with
prepayment of, for example, a 10-year loan after five years. It has
become common for real estate to be held through vehicles such as
partnerships, trusts or certain other "pass-through"
entities for income tax, capital tax and other legitimate reasons.
The prepayment right provided in the Interest Act has
severely limited access of commercial borrowers who hold real
estate through such vehicles to longer term loans, and indeed has
required the adoption of complicated, expensive, and otherwise
unnecessary, structures in order to provide access to longer term
Even when the hypothec is granted by a corporation, there has
been uncertainty in Québec as to whether there is a right to
prepay after five years where the corporation granting the hypothec
is a prête-nom or nominee of a beneficial owner that is not a
corporation. The Ontario Court of Appeal is generally thought to
have resolved this particular issue for the common law provinces in
the Litowitz case by deciding that individuals who held
registered title to real estate through a nominee corporation were
precluded from claiming Section 10(1) relief because they had
chosen to conduct their affairs through a corporation. However,
because of differences between the laws of Québec and the
common law provinces, there has been considerable doubt as to
whether the reasoning of the Litowitz decision would apply
Thankfully, the federal government has at long last recognized
that there are compelling reasons to make it possible for a wider
variety of business entities to obtain long-term loans secured by
real estate. After broad consultation with real estate stakeholders
as to which business entities should be free to negotiate
prepayment privileges on their own, the federal government has now
published regulations that provide that the statutory prepayment
right will not apply to mortgages of real property or hypothecs on
immovables granted after January 1, 2012 by (i) partnerships, (ii)
trusts settled for business or commercial purposes, (iii) Alberta
unlimited liability corporations, (iv) British Columbia unlimited
liability companies, and (v) Nova Scotia unlimited companies.
This is a welcome legislative reform that should allow most real
estate investors to obtain long-term secured loans without having
to restructure their real estate holdings to accommodate the
anachronistic provisions of the Interest Act.
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guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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