The federal government recently introduced a new regulation (the "Regulation") to the Interest Act which clarifies the application of what is commonly referred to as the "5-year rule." The Regulation will come into force as of January 1, 2012.

The 5 Year Rule

Section 10 of the Interest Act allows any person to repay or prepay a mortgage on real property which has a term beyond five years, once the first five years of the term have passed. As a consequence of such prepayment, a nominal penalty of three months interest is imposed. This statutory right of prepayment was first enacted by Parliament in 1880 in order to protect farmers from being locked into long-term mortgages subject to large penalties upon prepayment.1

Shortly after its enactment, section 10 began to cause problems. The country was growing rapidly. Large corporations, and railway companies in particular, were entering into major ventures of development. However, these companies found it difficult to obtain long-term financing necessary for their projects due to the statutory right of prepayment after five years. Parliamentary proceedings from the time found this to be hindering the speedy development of railways and other large ventures.2 In response, Parliament enacted subsection 10(2) in 1890 which provides an exemption for corporations to the 5-year rule. The rationale was that corporations are generally sophisticated entities and should be able to negotiate their own prepayment terms.

Effect of the Regulation

Up until now, courts were left to determine the applicability of (and exemptions to) the 5-year rule in peculiar fact scenarios often involving commercial entities other than corporations. The Regulation now clarifies and expands the types of entities which are exempt from the 5-year rule as follows:

  • partnerships;
  • trusts settled for business or commercial purposes;
  • unlimited liability corporations under the Business Corporations Act (Alberta);
  • unlimited liability companies under the Business Corporations Act (British Columbia); and
  • unlimited companies under the Companies Act (Nova Scotia).

Jurisdictional Uncertainty

The Ontario Mortgages Act contains a provision which essentially mirrors the 5-year rule as it appeared in section 10 of the federal Interest Act prior to the passage of the Regulation. However, the coming into force of the Regulation will now create a discrepancy between federal and provincial legislation, which shall be resolved either through legislative change or by the courts.

The take-away for lenders is that they should still remain mindful of the 5-year rule when providing mortgages secured by real propery to entities other than corporations. Depending on the outcome of future case law or changes to the Mortgages Act, commercial entities in Ontario other than corporations may still be entitled to the statutory right of prepayment after 5 years.

Footnotes

1. Litowitz v. Standard Life Assurance Co. (Trustees of) (1996), 30 O.R. (3d) 579, [1996] O.J. No. 3816, (Ont. C.A.), at paragraph 7. 2 Ibid.

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