In Canada, there are a number of regulations which
encourage transparency by lenders when it comes to disclosing the
cost of borrowing. Such regulations are intended to balance any
real or perceived inequities between savvy financial institutions
and borrowers. This article explores Section 4 of the Interest
Act (Canada)2 ("Section 4") and describes
how lenders can protect themselves from inadvertently taking a
"haircut" on pricing.
An unhappy borrower can use Section 4 to attack (and ultimately
lower) interest rates set forth in a written agreement.3
Section 4 provides that if interest in a written agreement (a loan
agreement, for example) is calculated in any manner other than on a
per year basis (i.e. "X% per month" or "Y% per 360
days"), then the equivalent annual rate must also be expressly
stated. If this rule is not complied with, a borrower can apply to
a court to have interest capped at a maximum of 5% per
While this pitfall is easy to avoid for fixed-rate agreements,
for loan agreements that use floating or variable adjustment rates,
Section 4 can create drafting challenges. This is particularly true
where the reference rate, such as LIBOR or the U.S. Base Rate, is
calculated on a 360-day year, rather than the 365/366-day year as
required by the Interest Act. Accordingly, a clause
providing that "the per annum interest applicable
under this Agreement shall be a rate equal to the LIBOR Rate plus
6%" or that "interest shall be 20% per annum, compounded
monthly" will offend Section 4 unless further explanatory
language is added. The following is an example of explanatory
language which can be added to a loan agreement to avoid
inadvertently tripping a borrower's right to attack the
interest rate provision set out therein, pursuant to Section 4:
For the purposes of the Interest Act (Canada), whenever
any interest or fee under this Agreement [or any other Loan
Document] is calculated using a rate based on a number of days less
than 365 or 366, as the case may be, the rate determined pursuant
to such calculation, when expressed as an annual rate, is
equivalent to (x) the applicable rate, (y) multiplied by the actual
number of days in the calendar year in which the period for which
such interest or fee is payable (or compounded) ends, and (z)
divided by the number of days based on which such rate is
Lenders should be wary of not expressing interest as an annual
effective rate, as non-compliance with Section 4 can radically
prejudice a lender's rights. Adding the above noted explanatory
language to a loan agreement is "cheap insurance" for
lenders and also provides borrowers with the comfort of knowing
exactly what their cost of borrowing is – a win-win for
1 Timothy Jones is an articling student at Aird &
2 R.S.C., 1985, c. l-15.
3 Section 4 does not apply to mortgages on real property
(or, in Quebec, hypothecs on immovables.)
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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