Legislators Jump the Shark: Proposed Reduction of the Criminal Interest Rate Will Have Implications Far Beyond Loansharking
On March 22, 2022, Bill S-239, An Act to amend the Criminal Code (criminal interest rate) went to second reading at the Canadian Senate. The Bill proposes to amend the criminal interest rate in s. 347(2) of the Criminal Code (the “Code”) from 60% per annum to 20% per annum, plus the Bank of Canada's overnight rate on the day an agreement is entered into or renewed (currently 2.5% per annum).
If Bill S-239 becomes law, interest rates would be capped at 22.5% (as of the date of this article). The impact of such a change would be wide-ranging and affect loans that both lenders and borrowers might never have expected to approach an illegal rate of interest.
The Current Criminal Interest Rate
Section 347 of the Code stipulates that everyone who enters into an agreement or arrangement to receive interest at a criminal rate, or receives a payment or partial payment of interest at a criminal rate, is guilty of an offence. Subsection 347(3) sets out that any person who receives a payment of interest at a criminal rate, absent evidence to the contrary, is deemed to know that the payment breached s. 347.
The current criminal interest rate is an effective rate that exceeds 60% per annum. The Code defines interest broadly and includes all charges, expenses, fees, fines, penalties, commissions, etc. Many commercial loans provide that borrowers shall pay the lender’s legal,1 commitment, and standby fees, as well as other fees including fines, penalties, commissions, or similar charges or expenses2 as part of advancing the credit, irrespective of the person who pays or to whom any such charges and expenses are to be paid. The sum of these fees can turn an otherwise innocent agreement into one that exceeds 60% per annum effective interest, in breach of s. 347.
The original purpose for enacting s. 347 appears to have been to address loansharking – unlicensed street lenders offering credit at exorbitant interest rates and employing intimidation and violence to enforce their contracts.3 Bill S-239 sponsor Senator Pierrette Ringuette’s speech at second reading in the Senate, however, did not clarify whether loansharking remains the underlying policy reason behind the proposed amendment.
The Court’s Response to Illegal Contracts in the Civil Context
Usually, in the civil context, the Court will not enforce illegal agreements on public policy grounds. In Wojnarowski, et al v. Bomar Alarms Ltd.,4 for example, the Court refused to enforce an obviously illegal agreement which permitted a creditor to avoid income tax on payments of interest it received from the debtor.
An agreement that provides for an effective interest rate over 60% would similarly be illegal. So the question becomes, how does s. 347 affect civil claims where interest is alleged to be greater than 60% per annum?
With respect to otherwise innocent loan agreements that provide for effective interest over 60%, refusing to enforce the entire agreement would result in a windfall for the borrower. Historically, notwithstanding the potential windfall, the Court took the same approach it did with respect to other illegal agreements: contracts which provided for interest rates exceeding the allowable rate in the Code were void and unenforceable.5
Over time, courts recognized the inappropriateness of this response and moved towards an approach where contracts in violation of s. 347 are resolved by notionally severing the illegal provisions of the agreement. Notional severing or “reading down” the offending interest rate means that the Court will reduce the interest payable under the contract to a lower amount, often the highest permissible rate. In other words, if the circumstances of a case meet the enumerated criteria, the Court will “rewrite” the contract to have an effective interest rate that does not offend the Code. The rationale for “rewriting” the contract (i.e. changing it from what the parties intended originally) is that doing so actually ensures that the contract remains more consistent with the parties’ initial intentions, whereas removing interest entirely or declaring a contract void would be much further from what the parties intended.
The decision to sever or “read down” an otherwise illegal interest rate in a contract is based on a four-part test outlined by the Supreme Court in Transport North American Express.6 Judges are to consider:
- Whether the purpose or policy of s. 347 would be subverted by severance;
- Whether the parties entered into the agreement for an illegal purpose or with an evil intention;
- The relative bargaining positions of the parties and their conduct in reaching the agreement; and
- The potential for the debtor to enjoy an unjustified windfall.
With respect to the first factor, where violations of s. 347 clearly do not involve loansharking, courts should keep in mind that there is no need to deter effective interest rates of up to 60% per annum.7 With respect to the third factor, where a criminal interest rate was arrived at inadvertently, or under a misapprehension of the law, the obligation to repay at least some of the interest should be upheld. The Supreme Court held that the maximum permissible rate would best reflect the intention of the parties while remedying the illegality.8
In most cases, courts find that parties did not intend to break the law, were sophisticated and legally advised, and that by not requiring the repayment of the principal, the borrower would be unjustly enriched. Under these circumstances, courts typically sever the criminal interest provision from the remainder of the contract.
This trend of severing criminal interest provisions does not mean that courts will treat particularly offensive contracts lightly. In Ikpa v. Itamunoala,9 for example, the Court applied Transport North American Express and held that the plaintiff lender was not entitled to enforce a contract with loan terms facilitating a 570% interest rate over a 20-month period. The Court found that the parties had contracted for an illegal purpose and that there had been an imbalance of bargaining power between the plaintiff and the borrower, who was “desperate” and had “submitted to usurious terms.”
Whether an agreement breaches s. 347 of the Code is sometimes a moving target, as illustrated by the following example:
Suppose that Annie loans Bob $100, with the condition that Bob pay Annie an extra $10 for her trouble. Bob accepts the loan and repays Annie $110 at a later date. How long does Bob have to repay Annie before the loan becomes criminal?
- At the current criminal interest rate of 60%, if Bob repays the loan in 73 days or more, the total annual interest accrued will not exceed the criminal rate.
- If Bob repays the loan in 72 days or less, the interest rate will exceed the criminal rate, making the loan criminal.
In this respect, Courts often adopt a wait-and-see approach to determining if a contract breaches s. 347.10 Determining whether the effective interest (as defined in the Code) in an agreement exceeds 60% per annum often requires expert actuarial evidence, particularly where interest is compounded.
Lenders and Borrowers Beware
The proposed changes under Bill S-239 seek to reduce the permissible interest rate to just over 20% per annum. Using the current Bank of Canada's overnight rate, the limit would be 22.5% per annum. In the example above involving Bob and Annie, the impact of the change would be significant:
- At a criminal interest rate of 22.5%, if Bob repays the loan in 172 days or more, the total annual interest accrued will not exceed the criminal rate.
- If Bob repays the loan in 171 days or less, the interest rate will exceed the criminal rate, making the loan criminal.
As illustrated above, the duration of a loan is critical to the determination of whether it violates s. 347. Assuming that the amount due remains constant, loans repaid within relatively brief periods of time are more likely to offend s. 347 than those repaid over a longer duration.
Although s. 347 was enacted to address problems associated with loansharking, it is rarely used for that purpose.11 Civil cases dealing with s. 347 often involve otherwise legitimate commercial transactions where borrowers sought to escape the enforcement of contract provisions on grounds of illegality. The proposed reduction in the criminal interest rate could see a renewed wave of borrowers relying on s. 347 to invalidate interest provisions when lenders attempt to enforce their rights to be paid.
Credit Card Interest Rates
In Canada, the average credit card purchase interest rates fall somewhere between 19.45% and 20.99%. This average is higher for balance transfer interest rates and cash advance interest rates, which generally fall in the 21.99% to 23.99% range. Given the broad definition of “interest” for the purposes of s. 347 and how easily fixed fees in some agreements can bring the effective rate well over the current criminal interest rate, a new criminal interest rate of 22.5% could mean that credit card companies across the country could find themselves receiving payments or partial payments of interest at criminal rates.
The question to consider on the litigation side is whether these agreements will be enforceable, what rate of interest/fees will be allowed, and to what extent credit card companies will need to rework the entirety of their agreements to ensure that the rates charged do not exceed the new criminal interest limit.
Application of the New Criminal Interest Rate
It remains unclear whether the new criminal interest rate would apply retroactively. In Degelder Construction Co. Ltd. v. Dancorp Developments Ltd.,12 the Court stated with reference to then ss. 347(1)(a) and 347(b)13 that in some cases, a wait-and-see approach to illegality under s. 347 is required. The Court stated that a payment of interest may be illegal under s. 347 even when the contract under which that payment is made did not itself violate s. 347 at the time it was entered into.
Bill S-239 was introduced in the Senate and, if passed by the Senate, will require the approval of the House of Commons before it becomes law. We will continue to monitor Bill S-239 and any other proposed changes to the criminal interest rate.
1 Legal fees (Court costs) incurred in connection with enforcing loan agreements are not considered interest: C.M.T. Financial Corporation v. David McGee, 2015 ONSC 3595 at para 46.
2 I.e. processing, brokerage, or late fees: Garland v. Consumers’ Gas Co.,  1 S.C.R. 629; Degelder Construction Co. v. Dancorp Developments Ltd.,  3 S.C.R. 90. Practically, treating all of these amounts as interest makes sense and furthers the purpose of s. 347. It wouldn’t be effective to prevent a lender from charging what most would consider interest (a percentage of the loan amount, which accrues over time and is added to the indebtedness) if the lender can make up those charges in other ways, including tacking on exorbitant fees.
3 Section 347 was enacted with the repeal of the Small Loans Act in 1980. Before this, loan sharks were prosecuted under a variety of criminal offences, as well as the Small Loans Act. The repeal of the statute, coupled with the absence of any other legislative mechanisms directly targeting loan sharks, meant that illicit lenders were left unchecked. Section 347 addressed this statutory void; See also Garland v. Consumers' Gas Co.,  3 SCR 112 at para 25.
4 Wojnarowski, et al v. Bomar Alarms Ltd., 2010 ONSC 273.
5 Transport North American Express Inc. v. New Solutions Financial Corp., 2004 SCC 7, at para 53.
6 Transport North American Express Inc. v. New Solutions Financial Corp., 2004 SCC 7, at para 42.
7 Transport North American Express Inc. v. New Solutions Financial Corp., 2004 SCC 7, at para 44.
8 Transport North American Express Inc. v. New Solutions Financial Corp., 2004 SCC 7, at para 37.
9 Ikpa v. Itamunoala, 2018 ONSC 3974 at paras 51-59.
10 Degelder Construction Co. Ltd. v. Dancorp Developments Ltd.,  3 S.C.R. 90 at para 30.
11 Garland v. Consumers' Gas Co.,  3 SCR 112 at para 25.
12 Degelder Construction Co. Ltd. v. Dancorp Developments Ltd.,  3 S.C.R. 90 at para 30.