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Sep 12, 2018
Sunny Day for Lenders: ClearFlow Energy Appeal Successful
Lenders can breathe a sigh of relief: the use of formulas to express annual interest rates can satisfy Section 4 of the Interest Act (Canada).1
The Court of Appeal for Ontario (the “Court”), in reasons written by Justice Sharpe,2 allowed an appeal of a surprising decision by the Superior Court of Justice,3 which held that a common loan agreement interest rate provision contravened Section 4.
Section 4 requires that any written agreement for the payment of interest at a rate or percentage per day, week, month or any period less than one year contain an express statement of the yearly rate or percentage of interest to which the other rate or percentage is equivalent. Justice Sharpe held that an annualizing formula in a loan agreement between borrower Solar Power Network Inc. (“Solar”) and lender ClearFlow Energy Finance Corp. (“ClearFlow”) met this requirement.
We noted in our earlier comment that the Superior Court decision could make Canada look like a difficult place to do business. In the Superior Court decision, the lower court held that the inclusion of the conversion formula did not satisfy the requirement in Section 4 for an “express statement of the yearly rate or percentage of interest to which the other rate or percentage is equivalent” required by Section 4. The interest rate payable under the loan documents was reduced from 12%, plus the discount fee, to 5%.
In overturning the lower court’s decision, Justice Sharpe found that disallowing annualizing formulas “could cause significant mischief in international commercial arrangements.”4 While acknowledging the consumer protection purpose of Section 4, Justice Sharpe referred to case law that accepted the use of formulas more complex and less informative than the formula in the ClearFlow loan agreement. He held that modern commercial reality must inform interpretation of Section 4.
The appeal decision addressed the application judge’s conclusion that the loan agreement annualizing formula did not calculate compound interest. The interest fee at issue, called the “discount fee,” was payable on the due date of the loan and every day thereafter until the loan was repaid. Justice Sharpe noted that the provisions of the loan agreement required Solar Power to request and ClearFlow agree to extend the term of the loan. It followed that the parties could not have known whether the discount fee would ever compound. Justice Sharpe held that, in this circumstance, stating an equivalent nominal rate was sufficient for the purposes of Section 4.
The Court also found that only interest payable on the non-compliant interest provision should be limited to 5%. The promissory notes between Solar Power and ClearFlow did not contain the annualizing formula found in the loan agreement, so were found to be in contravention of Section 4. Whereas the Superior Court decision had reduced all interest, including the base rate of interest of 12% or 24%, to 5%, citing Section 4, the Court disagreed with this analysis. Justice Sharpe found that limiting all interest to 5% would result in a substantial windfall to Solar Power and that reducing only the non-compliant rate took into account ClearFlow’s legitimate expectations. This interpretation meant that Section 4 had no effect on the promissory notes, as the offending fee was already less than 5% when annualized.
This successful appeal greatly reduces the uncertainty caused by the lower court’s January decision. Nevertheless, lenders should continue to exercise caution when they use formulas to express annual interest rates, to ensure that the borrower clearly understands its obligations and that the interest rate provisions of loan agreements adhere to Section 4 requirements.
The Financial Services Group at Aird & Berlis can advise lenders on their obligations under the Interest Act. Details can be found on our Financial Services web page.
1 RSC, 1985, c I-15.
2 Solar Power Network Inc. v ClearFlow Energy Finance Corp., 2018 ONCA 727.
3 Solar Power Network Inc. v ClearFlow Energy Corp., 2018 ONSC 7286.
4 Solar Power Network Inc. v ClearFlow Energy Finance Corp., 2018 ONCA 727 at para 53.