Canada: Closed Hypothecary Loans With A Term Exceeding Five (5) Years: Legislative Change

Last Updated: December 13 2011
Article by François Martel

To the contentment of lenders and owners of commercial properties, a long-awaited amendment involving section 10 of the Interest Act (Canada) (the "Act") has just been made. Indeed, on October 20, 2011, the Canadian government adopted the Prescribed Entities and Classes of Mortgages and Hypothecs Regulations. These regulations define the entities that will be eligible for the purposes of applying paragraph 10(2)(b) of the Act.

A brief historical reminder is called for Paragraph 10(1) of the Act, passed in 1890, provided that borrowers could repay their loans secured by hypothecs on immovables after five (5) years, even if the hypothec was a closed hypothec for a longer term, subject to paying a penalty equal to three (3) months' interest. At that time, Parliament wished to protect individuals by means of this provision, in particular farmers. Later, to encourage commerce, particularly the railway companies attempting to structure their long-term debts, Parliament amended the Act by adding a second paragraph to section 10 that provided that the abovementioned general rule did not apply to joint stock companies or other corporations.

From then on, the companies had access to loans for more than five (5) years secured by hypothecs on immovables.

Commercial real estate practice having greatly evolved since then, owners of commercial immovables increasingly structure themselves as limited partnerships or commercial trusts, for tax purposes.

Unfortunately, not being governed by the exception in the second paragraph of section 10 of the Act but rather by the more generous general rule of paragraph 10(1), it is difficult for these owners to access loans for more than five (5) years because lenders do not want to allow their borrowers to repay their loans in advance after the fifth year by paying a modest penalty (the general rule of paragraph 10(1) of the Act being of public order).

Therefore, structures such as holding an immovable through a nominee corporation have been conceived and implemented by these property owners in order to benefit from long-term loans. However, numerous lenders remain hesitant, with good reason, to take on this kind of loan, fearing that these structures will not be recognized by the courts.

In the explanation of its new regulation, the government clearly states the reasons for the change: "Some business and commercial entities, not structured as corporations... have had difficulties in accessing long-term mortgage financing because the prepayment terms for their mortgages are prescribed by the Act."

Under this new regulation, partnerships (notably limited partnerships) and trusts established for business or commercial purposes will benefit from the exception in the second paragraph of section 10 of the Act, in the same way as joint stock companies and other corporations, with respect to hypothecs on immovables entered into after January 1, 2012.

That will be the long-awaited end of convoluted property structures aimed at obtaining loans for more than five (5) years secured by hypothecs on immovables. Lenders will, from then on, be able to grant such loans to limited partnerships and trusts established for business or commercial purposes and to freely negotiate the repayment terms of their loans.

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.

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