Introduction

A persistent concern in Quebec has been whether interest or late payment clauses could be considered abusive under civil law in the context of the rules of interpretation applicable to contracts of adhesion1 (as franchise agreements are normally considered) or by being re-characterized as penalty clauses that may be reduced by the court if considered abusive in any contract2.

The Court of Appeal of Quebec has had, in a few recent decisions, the opportunity to provide some guidance with respect to the enforceability of a late payment interest clause when coupled with a collection fee penalty clause. We will examine the recent decision of Diamantopoulos ("Diam") v. Construction Dompat Inc.3 ("Dompat"), in which the Court also relied upon another of its earlier decisions4 regarding similarly worded provisions.

Although rendered in a construction context, these decisions are of significant interest in relation to the interpretation of franchise agreements that contain both late payment / interest provisions and collection fee provisions, or a combined clause to the same effect.

Facts

Diam, a homeowner, appealed a judgment of the Superior Court of Quebec ordering him to pay Dompat, a contractor who worked on the home, the balance owing to it along with 24% interest on said balance. The contract between the parties specified an interest rate of 24% per annum on overdue amounts, as well as a distinct collection fee penalty representing 20% of the aggregate amounts owing.

The Superior Court allowed Dompat's claim including interest at 24% per annum, though on a reduced invoice amount as some charges were found to be baseless. Diam appealed the decision on the basis that certain other invoiced amounts were baseless and that the interest and collection fee clauses were abusive.

Decision

On appeal Diam argued that the interest and collection fee clauses, especially when coupled with Dompat's claim relating to Article 1620 of the Civil Code of Quebec which provides that "interest accrued on principal does not itself bear interest except where that is permitted by agreement or by law or where additional interest is expressly demanded in a suit", constituted abusive penal clauses.

The Court turned to whether Diam could avail himself of the reduction provided in Article 1623 of the Civil Code of Quebec which states that:

"a creditor who avails himself of a penal clause is entitled to the amount of the stipulated penalty without having to prove the injury he has suffered. However, the amount of the stipulated penalty may be reduced if the creditor has benefited from partial performance of the obligation or if the clause is abusive."

The Court of Appeal incorporated its reasoning from its earlier decision in 9149-5408 Quebec Inc. v. Groupe Ortam Inc.5 (the "Ortam Decision") which, it should be noted, had not been rendered at the time the Superior Court of Quebec rendered its judgment in the Diam and Dompat dispute.

In the Ortam Decision, the Court of Appeal considered a contract with very similar clauses, containing an annual interest rate of 24% and a collection fee at 25% (as opposed to 20%).  The Court of Appeal concluded that the annual interest rate of 24% was intended not only to compensate for the late payment but contained a punitive element, given the amount by which such rate exceeded the legal interest rate of 5% together with the statutory additional indemnity of roughly 1% to 2% that may be requested in legal proceedings.  Similarly, the Court of Appeal also concluded that a collection fee of 25% also contained a punitive element. Taken together, these clauses were considered abusive within the meaning of Article 1623 of the Civil Code of Quebec and were accordingly subject to reduction by the Court. Given the facts of the case, the legal rate of interest otherwise applicable in court proceedings, as well as the market conditions for interest rates, the Court of Appeal reduced the aggregate effect of both clauses to an effective annual rate of 15%.

In the Diam and Dompat dispute, the Court of Appeal rejected Dompat's arguments that a monthly 2% interest charge (amounting to 24% annually) was typical in the construction industry, noting that the other three examples adduced as evidence by Dompat were not necessarily representative of an accepted practice and that the variation disclosed in such examples ranged from a monthly 1.5% to 2% interest charge (or 18% to 24% annually) which amounted to a material difference of 6% annually. Without specifically addressing whether the 24% annual interest clause was abusive in the particular circumstances of this case, the Court of Appeal of Quebec acknowledged that it was not necessarily excluding the possibility that a 24% annual interest charge could be considered abusive in and of itself.

However, the Court of Appeal pointed out that these clauses appeared particularly exorbitant in a context in which the respondent Dompat had manifestly and significantly exaggerated its monetary claims without being able to preponderantly prove several elements of such claims, which led to a legitimate debate in respect of which the appellant Diam should not be the only party to support its costs through the collection fee clause.

Rather, the Court of Appeal concluded that it was the combined effect of both clauses that was abusive. It therefore followed its reasoning from the Ortam Decision and exercised its discretion under Article 1623 of the Civil Code of Quebec to reduce the aggregate amount of the penalty (i.e. interest together with collection fees) to an effective annual rate of 15%.

Comment

There are several interesting issues arising from these decisions of the Court of Appeal of Quebec that merit consideration in a franchising context.

As background to this discussion, it should be noted that collection fee clauses entitling a contracting party to a fixed percentage of amounts owing in case legal proceedings were necessary to recover overdue amounts from the other party have been recognized as valid penalty clauses by Quebec courts (subject to being reduced if stipulated as an excessive percentage).

As concerns interest clauses, the Court of Appeal stated in this decision that an annual 24% interest rate is not intrinsically and necessarily abusive, such as in the case, for example, of a loan subject to a third-ranking hypothec (a hypothec being the Quebec civil law equivalent of a security interest in common law). On the other hand, as stated earlier, the Court did not exclude the possibility that an annual 24% interest rate could be considered abusive in certain circumstances.

More importantly, in our view, this analysis of the abusive nature of the interest clause was unusual insofar as it occurred in the analysis of a contract that was expressly acknowledged by the Court not to constitute a contract of adhesion, in respect of which Courts may reduce any obligation considered abusive. Absent the particular rules of interpretation applicable to a contract of adhesion, the only basis for engaging in the foregoing analysis is to consider the interest clause to constitute a penalty clause, which would be a novel development in Quebec law.

Despite the foregoing analysis by the Court of Appeal, it is unquestionable that the issue facing the Court in both cited cases is the abusive character of the combination of a 25% collection fee (20% in the Ortam Decision) with an annual 24% interest rate. Would the Court conclude that an interest clause constitutes a penalty absent a collection fee clause (or any other form of penalty) that is also applicable in the same circumstances? That seems to be the critical issue in a franchising context, as franchise agreements are often considered to be contracts of adhesion.

Finally, it is noteworthy that the Court of Appeal reduced the payment obligations under these clauses to an aggregate annual rate of 15% that it characterized as reasonable in the circumstances. This may lead franchisors and other contracting parties to conclude that charging interest and collection fees (or other amounts paid in the same circumstances) whose combined effect exceeds an effective annual rate of 15% would attract judicial intervention and reduction. Unfortunately, the Court did not provide detailed reasoning underlying the reasonableness of this rate.

While the Court of Appeal's comment that a 24% interest rate is not intrinsically and necessarily abusive is helpful, the inference from the example cited by the Court is that the abusive character of the rate will be judged on the basis of an analysis of the degree of risk associated with the underlying obligation.

Ultimately, these decisions provide some much needed guidance as to the judicial interpretation of the notion of abusive clauses in respect of interest provisions and other amounts that may be charged in late payment circumstances. However, they are also indicative that the courts in Quebec will exercise a fair amount of discretion in evaluating the circumstances when analysing whether a clause is abusive and subject to judicial intervention.

Footnotes

1 Art. 1437 of the Civil Code of Quebec

2 Art. 1623 of the Civil Code of Quebec. It should also be noted that, contrary to common law, civil law recognizes the validity of penalty clauses on which the creditor can rely in lieu of proving its actual damages.

3 2013 QCCA 929

4 9149-5408 Quebec Inc. v. Groupe Ortam Inc., 2012 QCCA 2275

5 2012 QCCA 2275

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