Edward D. (Ned) Brown
Readers of the writer's recent paper entitled "LENDERS AND THEIR LAWYERS: BEWARE OF SECTION 4 OF THE CANADA INTEREST ACT" will be aware of the recent (January 10, 2018) Ontario Superior Court of Justice's decision in the Solar Power Network Inc. v. ClearFlow Energy Finance Corp. case (the "Solar Case"). That Court held that Section 4 of the Interest Act invalidated certain interest-like claims of a creditor, notwithstanding that the interest payment, calculation and determination provisions of the documentation between the parties contained provisions which were very broadly utilized in Canadian credit transactions. Fortunately, the Trial Court's decisions were - in part - overturned by the Appeal Court.
To recap the Trial Court's confirmation of the facts in the Solar Case, Solar Power Network Inc. and related entities were renewable energy companies specializing in installing solar panels in commercial, institutional and industrial rooftops. The respondent ClearFlow Energy Finance Corp. was a project finance company that provided financing to the solar energy and clean technology sector. And that was precisely the relationship between ClearFlow (as "Lender") and Solar Power Network (as "Borrower"). The Lender provided a number of separate loans (or financings) to the Borrower to enable it to obtain and install solar power equipment. The loans were initially intended - by both parties - to be of a short term nature, with the Borrower arranging for longer term more "conventional" financing in due course. The loans were documented in various ways, including loan agreements and promissory notes, but, as observed by the Court, regardless of the form of the documentation, each loan provided for three different "components" of remuneration payable by the Borrower in connection with the making of the loans, namely:
- An interest rate which was usually set at 12% per annum, compounded and calculated monthly, and 24% per annum following default (the "Base Interest").
- An administration fee charged at the outset of the loan transaction calculated as a percentage of the principal amount of the loan advanced. If a loan was not repaid on time, then the initial administrative fee was tacked on to the principal balance of the loan and carried forward as an extended loan, with a new administrative fee being charged on the total amount of the extended loan. These fees are referred to herein as the "Administration Fees"; and
- A discount of 0.003% of the outstanding principal balance of a loan, calculated on a daily basis for each day that the loan was outstanding. If the discount fee had not been paid when the initial term of the loan had expired, the outstanding balance of the discount fee applicable to the loan during its initial term would be added on to the loan and carried forward to form part of the principal amount of the extended loan, to which a further discount fee would be applicable. These discount fees are referred to herein as the "Discount Fees".
The Trial Court concluded that:
- The Discount Fees were interest within the meaning of Section 4, but the Administration Fees were not interest.
- Although the Administrative Fees provisions were not subject to Section 4 and the Base Interest did not contravene Section 4, the fact that the provisions dealing with the Discount Fees breached Section 4's requirements "tainted" the Base Interest (as well as the Discount Fees) with the result that Section 4 applied so as to require reduction of the Base Interest to 5% per annum (the "default rate" where there is non-compliance with Section 4).
- The relatively simple to state and simple to understand formula typically used by lenders to specify a rate of interest based on a one year period when the contractually stipulated rate is for a unit of time less than one year was not sufficient compliance with the disclosure requirements of Section 4.
- Proper disclosure under Section 4 requires that the lender provides rate information which takes into account the compounding of interest.
The Ontario Court of Appeal agreed with the lower Court's view that the Administration Fees were not interest and that the Discount Fees were interest. But it took exception to the lower Court's conclusion that the typical annualizing formula found in many Canadian business transaction documents was not sufficient disclosure. This should be comforting to creditors and their counsel given that, had all of the trial Court's conclusions been upheld, it would have potentially invalidated a large number of interest calculation and payment provisions frequently found in credit transaction documents. It was no coincidence that The Canadian Bankers' Association became an intervener at the Court of Appeal hearing.
Of particular interest were the following Appeal Court's holdings:
- The Trial Court's conclusion that the Administration Fees were not interest and that the Discount Fees were interest was correct. Just because the parties call a fee something other than "interest", it will in law be interest if, in the circumstances and considering the "purpose" of the fee, it carries the hallmarks of interest. Specifically, the Discount Fees were "compensation for the use or retention of money, related to the principal amount owing and they accrued over time".
- The commonly used "annualized formula" to produce a rate or percentage "equivalent" to the less than annualized stated rate was sufficient for the disclosure purposes of Section 4. Thus an initially stated rate of, say, 2% per month is properly disclosed under Section 4 by additionally describing the rate as 24% per annum. Or, frequently, a rate stated at 2% for a 360 day year is equivalent to 2% times 365/360.
- Although using these formulas does not take into account the effect of the compounding of interest (typically, monthly in arrears), this is about all that the creditor can do in those situations where compounding may occur, but it is impossible, at the outset, to know exactly when - and how frequently - the compounding will occur. In the Solar Case scenario, and as stated by the Appeal Court, "…whether the Discount Fee would ever compound was entirely contingent on Solar Power requesting and ClearFlow granting an extension of the loan at the end of its term. It was therefore impossible for the Loan Agreement to state an equivalent rate or percentage that took into account compounding of the discount fee".
- The fact that there was no annualizing formula stated for the Discount Fees did not "taint" the provisions for payment of the Base Rate, so as to reduce it to 5% per annum. The Base Rate had an annualizing formula which complied with Section 4. In this case however, the matter was academic because the annualized rate for the Discount Fees was less than 5% per annum.
The Appeal Court noted that the parties in the Solar Case were experienced and business-sophisticated parties who both engaged counsel.In applying the conclusions of the Court to future transactions, lawyers should keep this salient fact in mind.In any event, and on the whole, it is refreshing to see a Court make the following statements:
- "…consideration of all relevant principles of statutory interpretation indicates that a different interpretation, more in line with modern commercial reality and the expectations of the parties, is appropriate";
- "Courts have repeatedly departed from the "plain meaning" (of statutory language) when interpreting legislation to avoid absurd results"; and
- "(in the dealings between the parties in the Solar Case) there was plainly no attempt to subvert the law".