Are Interest Penalties Prohibited on Mortgage Arrears?

Written by Jennifer McBlain, Articling Student

Introduction

The case of Benson Custodian Corporation v Situ et al, 2019 ONSC 3077 (“Benson”) was recently released by the Ontario Superior Court of Justice, wherein the court found a mortgage provision that charged three months worth of interest on arrears was invalid. This case expanded and confirmed previous case law that interpreted section 8 of the Interest Act.exp

Facts

In Benson, the parties had signed a mortgage against the defendant’s property in Scarborough, and the mortgage had been renewed by the parties twice. Prior to the expiration of the last mortgage renewal, the plaintiff advised the defendant that there would be no further renewals. 

The plaintiff demanded that the principal and interest owing be paid in full upon the expiration of the mortgage term. 

The defendant failed to pay the amounts owing in full and therefore defaulted under the mortgage. In turn, the plaintiff issued a Notice of Sale Under Mortgage and a Statement of Claim to enforce its rights under the mortgage. 

The court in Benson was required to address a motion for summary judgment brought by the plaintiff seeking judgment for the various amounts owing, including principal and interest. The defendant contested three of these amounts: the administrative fees, legal fees, and the additional three months of interest. 

The mortgage provided that the plaintiff would be entitled to three months of interest on the principal amount owing in the event that a Notice of Sale Under a Mortgage or a Statement of Claim were issued. Put another way, the lender could charge this interest once the borrower defaulted under the mortgage and steps were taken to enforce the lender’s mortgage rights. This interest charge was categorized as “liquidated damages” under the terms of the mortgage and equalled $21,750.00. The defendant contested the validity of this charge and relied on section 17 of the Mortgages Act and section 8 of the Interest Act.

Three Months of Interest Not Permitted

The court granted summary judgment for most amounts claimed by the plaintiff, including the administrative and legal fees which were found to be permitted reimbursements. However, the judge found that the additional three months of interest charged by the plaintiff was not permitted by section 8 of the Interest Act, as discussed below.

The judge in Benson first explained why section 17 of the Mortgages Act did not prohibit the interest charge. This section of the Act provides a mechanism for the borrower to cure a default by (a) paying three months’ interest, or (b) by providing three months’ notice to the lender of their intention to pay said interest. The borrower only has this option if the lender has not taken steps to realize on the mortgage. Once the lender initiates the enforcement of their rights under the mortgage, the lender can only collect the actual interest owing and is not entitled to the additional three months of interest which the borrower can pay to cure the default. Accordingly, the court found this was not applicable since it is a statutory allowance to pay an extra amount to correct the default, rather than a contractual obligation to pay a penalty upon default. 

Since the three months of interest charge was found in the mortgage contract in Benson, the court used section 8 of the Interest Act to determine that the contractual term was prohibited. 

Section 8 of this Act provides the following: 

(1) No fine, penalty or rate of interest shall be stipulated for, taken, reserved or exacted on any arrears of principal or interest secured by a mortgage on real property or hypothec on immovables that has the effect of increasing the charge on the arrears beyond the rate of interest payable on principal money not in arrears.

(2) Nothing in this section has the effect of prohibiting a contract for the payment of interest on arrears of interest or principal at any rate not greater than the rate payable on principal money not in arrears.

This section has a protective purpose, and where it is found that a fine, penalty, or rate of interest has the effect of increasing the charge on arrears beyond the interest rate that the parties to the mortgage contracted, the fine, penalty, or rate of interest will be prohibited. The court emphasized that this will only be prohibited where it is applied to amounts in arrears. 

In contrast, a three-month interest charge to retire a mortgage early has been deemed acceptable by courts. The distinction arises because the charge to retire a mortgage provides the borrower with the privilege of ending the contract early.

 Conversely, the charge on an amount in arrears is a penalty and is, therefore, invalid based on the Interest Act. This was the situation in Benson, where the borrower was being punished for their default under the mortgage, and the “liquidated damages” provision had the effect of increasing the interest rate contrary to section 8 of the Interest Act.

Conclusion

Benson expanded and confirmed previous case law by determining that three months of interest penalty was prohibited by section 8 of the Interest Act where it had the effect of increasing the interest rate on amounts in arrears under a mortgage. A distinction was drawn between a penalty on arrears and an amount charged for the privilege of retiring a mortgage early. If you believe you may have been improperly charged such a penalty on mortgage arrears or if you have any questions, please do not hesitate to contact one of our Real Estate lawyers.

If you believe that you may have been improperly charged such a penalty on mortgage arrears or if you have any questions, please do not hesitate to contact one of SV Law’s Real Estate