Section 8 of the Interest Act (Canada) (Section 8)
prevents lenders from charging a higher rate of interest after
default on a mortgage of real property than that charged prior to
In other words, if a mortgage with a rate of interest of five
per cent during its term is increased to 10 per cent should the
borrower fail to pay the amount due at maturity or should the
borrower go into default, such increase contravenes Section 8. This
section is not limited to interest, but also includes fines,
penalties and lump-sum bonuses where the effect is increasing the
charge on arrears beyond the rate of interest payable on the
principal before a default.
In its recent majority decision in Krayzel Corp. v. Equitable Trust Co.(Krayzel), the Supreme Court of Canada (SCC) found that
rate increases triggered by default under a mortgage infringe
Section 8, whether or not the default interest rate is structured
as a discount instead of a penalty.
In Krayzel, when the borrower was unable to pay out its
mortgage loan on the scheduled maturity date, the borrower and
lender entered into multiple mortgage amending agreements,
extending the loan's term and increasing the interest rate. The
second mortgage amending agreement provided for an annual interest
rate of 25 per cent, but also contemplated discounted monthly
interest payments at a significantly lower "pay rate" so
long as there was no default under the loan.
In determining whether the arrangement described above offended
Section 8, the SCC considered whether there is a distinction
Terms imposing, by way of penalty, a
higher rate upon default; and
Terms reserving, by way of discount,
a lower rate in event of no default
The majority of the SCC held that Section 8 applies equally to
mortgage terms providing for "discounts", or incentives
for performance, and penalties for non-performance, whenever the
effect of these terms is to increase the charge on arrears beyond
the rate of interest payable on principal money not in arrears. As
such, the annual interest rate of 25 per cent set out in the second
mortgage amending agreement was held to be void, and the interest
rate in force was deemed to be the lower "pay rate." In
their dissent, three of the nine judges of the SCC disagreed.
The SCC's divided decision in Krayzel suggests that
until there is statutory reform, there will continue to be some
commercial uncertainty surrounding the interpretation of Section 8.
In the meantime, commercial lenders must take notice of the
SCC's application of Section 8 to discounts and incentives as
well as penalties, when structuring real estate loans. Dependent on
the structure of the mortgage loan, it appears that offering a
discount to a borrower for making timely payment as opposed to
penalizing them for not paying on time offends Section 8.
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