Edward D. (Ned) Brown
Those who are familiar with the writer's various "case comments" and related papers will recall that a number of them have dealt with Section 8 of the Interest Act (Canada) (respectively, "Section 8" and the "Act"). A recent case dealing with Section 8 is Walia v. 2155982 Ontario Inc., 2019 ONSC 1059, judgement issued February 13, 2019 (hereinafter, the "Walia Case"). The Walia Case not only dealt with a facet of Section 8, but also considered what is commonly called the "indoor management rule". Thus the Walia Case is a good source of guidance for commercial practitioners who frequently have to deal with both of these issues.
- Section 8 of the Act. 2155982 Ontario Inc. as mortgagor (the "Mortgagor") mortgaged some Ontario realty to Mr. Walia as mortgagee (the "Mortgagee") with the secured indebtedness carrying interest at a rate of 12% per annum. The parties agreed that (to quote from the judgement) "…upon default or if the mortgage is not paid in full by the due date…interest will accrue at the rate of 21% from the date of default or the due date until the balance is paid in full". Both parties acknowledged that the stipulation for interest "upon default" at the (increased) rate of 21% ran afoul of Section 8. But the Mortgagee argued that the stipulation for the increased interest rate "if the mortgage is not paid in full by the due date" did not run afoul of Section 8. Section 8 refers to a post-interest rate increase which is triggered by a mortgagor's default, and should not invalidate an increase in the interest rate merely upon maturity of the secured debt.
The Court disagreed and posed the question: "Does the term "arrears" in the case of a mortgage in default apply only to missed monthly payments or does it also apply to the entire mortgage amount if not paid when due?".The Court concluded that when a mortgage secured debt has matured, and it is not then - virtually immediately - repaid in full, the outstanding balance - which would usually be the entire outstanding balance - is "in arrears".Thus what the parties had agreed to was contrary to Section 8.
However, readers should keep in mind the fact that The Supreme Court of Canada (in Krazel Corp. v. Equitable Trust Co., 2016 SCC 18) held that "…a rate increase triggered by the passage of time alone does not infringe Section 8…". Presumably it is - and continues to be - permissible for the parties to contract for a rate at, say, 5% per annum for, say, the first two years of a mortgage secured loan's term, and then stipulate for an increase in the interest rate to, say, 8% per annum, for the third and following years of the term.
- Application of the "Indoor Management Rule". The Mortgagor and the Mortgagee had entered into what is commonly called a "commitment letter" pertaining to the financing secured by the mortgage. A "commitment letter" is an offer of financing made by a lender to a borrower which, when accepted or agreed to by the borrower, becomes a form of loan agreement (hereinafter, a or the "Loan Agreement"). In the Walia Case scenario, the mortgagee had signed and one of two signatories of the corporate mortgagor had signed. The mortgagor argued that because the corporate mortgagor's "internal" rules required a second authorized signatory to sign the Loan Agreement, the Loan Agreement was not duly executed, and thus not binding on the mortgagor. The mortgagee counter-argued that based on the "indoor management rule", the mortgagee was entitled to assume that the mortgagor's "internal" corporate rules had been followed. The classic judgement dealing with this concept was Royal British Bank v. Turquand, 119 ER 886. The Court acknowledged the continuing validity of the indoor management rule, but pointed out that the rule "…was not intended to protect parties who knew or ought to have known that the person signing on behalf of the corporation did not have authority (or sufficient authority) to do so.".
The Court noted that in this situation, the mortgagee knew that a second signatory was required in order to entitle and obligate the mortgagor to become indebted/borrow funds. Additionally, it was acknowledged that the lawyers for the mortgagor and the mortgagee were father and son and that they worked out of the same office space; the Court concluded that both lawyers must have communicated with each other on an ongoing basis. Additionally, the Loan Agreement had been prepared by the mortgagee's lawyer "…at the (mortgagee's) direction, with a place for both (the two authorized signatories of the mortgagor) to sign.". Further, the mortgagee had provided documentation pertaining to various transactions entered into by the mortgagor and the mortgagee, and in almost all cases, the documents were signed by the two (required) authorized signatories of the mortgagor. As the Court stated: "The glaring exception was the (Loan Agreement). It contained two signature lines, one for (the authorized signatory of the mortgagor who did sign)" with the other signature line having been left blank. Accordingly, the Court held that the mortgagee was not protected by the "indoor management rule".
The Walia Case suggests that:
- If you choose to act for both parties to a transaction, you will most likely diminish both of your clients' potential ability to rely - where a dispute later erupts - upon the indoor management rule;
- The current practice amongst experienced commercial practitioners is to require one or both of the following from the "other side":
- a certificate or statutory declaration containing statements by a knowledgeable representative of the party making the statements therein which contain positive statements pertaining to the due authorization, due execution and due delivery of documents by that party; and
- a legal opinion from counsel for that party which confirms due authorization, due execution and due delivery.
- If counsel for one party to a transaction has actual knowledge - or arguably, constructive knowledge - that something may be "amiss" with respect to the other side's authorization, delivery and/or execution of its documents, that lawyer will not likely be able to rely on the "indoor management rule". The writer would go as far as to suggest that if you and I are opposite counsel in a commercial transaction and I get one or more of a "comfort assurances" certificate or statutory declaration from your client and a legal opinion from you, but I know that one or more of the material statements in such documentation is incorrect - or I have reasonable suspicions as to the correctness thereof or it can later be proved that I should have had the knowledge of the inaccuracy of such statements - I would not likely be able to be able to rely on the indoor management rule. In most cases, my knowledge - or lack of knowledge - is, from a legal perspective, fastened on to my client.