April 15th 2024
In our last article, we showed how s.8 of the Interest Act prevents lenders from imposing a penalty on borrowers who have defaulted on their mortgage. In this second part, we will dig into the case law surrounding this issue, and hopefully solidify once and for all that it is illegal for lenders to impose default penalties on the default of borrowers.
The leading case on the issue of 3-months penalties was first described in Ialongo v Serm Investments Ltd., 2007 CarswellOnt 1246. In this case, the court confirmed that once a lender issues its Notice of Sale, the lender is "not entitled to demand payment of three months' interest under section 17 of the Mortgages Act." Lenders have attempted to position this attempt at collecting an extra three months of interest payments on default as simply being "a part of the mortgage terms". However, s.8 of the Interest Act prohibits a lender from creating a situation where the effective interest rate on arrears owing becomes higher than the monies lawfully owed when the borrower was not in arrears. This “triggering event” of default means the lender has added a lump sum amount owing to the principal. This creates an effective rate of interest that was higher than before. This is clearly a violation of s.8 of the Interest Act, a point which was reinforced clearly in the case of Benson Custodian Corporation v Situ, 2019 ONSC 3077 (CanLII). Here, Justice Shabas held that "s.8 [of the Interest Act] is applicable …and the three months' interest provision is invalid and unenforceable."
Consider the findings of Justice Sharma who has stated in the case of We Care Funding Limited Partnership v LDI Lakeside Developments Inc. et al, 2021 ONSC 7466 (CanLII), "the weight of authority suggests that once a mortgagee takes enforcement proceedings, it has removed the option from the mortgagor of redeeming the mortgage. … [T]he plaintiff is entitled to receive the whole of the income stream it contracted for. If it were also entitled to collect a three-month interest bonus, that would constitute a penalty and would offend the Interest Act." Simply put, parties cannot contract out of legislation. The imposition of a penalty that is triggered on the default of a borrower runs contrary to s.8 of the Interest Act, which requires that an interest rate for a borrower does not change, just because there is default.
The case of BMMB Investments Limited v Naimian, 2020 ONSC 7999 also joins a growing list of cases that hold the three-month interest payment to be unlawful. Justice Myers wrote in BMMB Investments that, "In other words, on default of payment on the due date, the mortgagor is required to pay an extra three months’ interest. This is a clear violation of s.8 of the Interest Act as described by the Supreme Court of Canada in Krayzel Corp. v Equitable Trust Co., 2016 SCC 18. This is not an increase in interest caused by the effluxion of time. It is a straight-out addition of an amount to be paid after maturity due to a payment default without any reference to any additional costs or losses suffered by the mortgagee." A more clear statement on the topic does not exist!
It is important to consider some of the recent cases that law firms representing lending interests have attempted to cite in claiming 3-months interest payments from borrowers. In the case of Devi Financial Inc. v Everwood Place Ltd., 2022 ONCA 104 (CanLII) [iv], the Court of Appeal found that the mortgagee was entitled to an enhanced award, which included the payment of bonus provisions. It is interesting to note this case cited very few precedents, nor was the Interest Act even referenced. Commentators on this case confirm that if Devi Financial Inc. stands for any precedent, it is that “the Court [has] little patience for sophisticated parties that advance obviously meritless defences”.
Law firms that represent lenders may attempt to cite the case of New Haven Mortgage Corporation v Codina, 2022 ONSC 7036 as 
the basis for imposing a three-month penalty. In this case, a motions judge found that “the imposition of the three-month interest provision [is lawful] so long as it is calculated at the rate of interest defined in the mortgage”. However, based upon the reasoning of other judges, New Haven does not present a clear description of the rights of borrowers and should not be relied upon as precedent. If New Haven Mortgage Corporation were rightly decided, it would create an absurd outcome whereby a penalty term could be imposed by a lender seeking to collect not just three months, but thirty-three (33) months interest in the event of default. Clearly, if three (3) months penalty is valid, then why stop there? Edward Conway, a lawyer who offers commentary on this issue, asked the following rhetorical question – “why doesn't the mortgagee demand 6 months, or 9 months or 1 month? …lawyers forever gravitate to that [3 months] as though it has some magic meaning.” Simply put, three (3) months has no “magic meaning”, other than the number three (3) appears in s.17 the Mortgages Act. This number has no bearing on the enforceability of s.8 of the Interest Act, which prevails and renders unenforceable any mortgage provisions that seek to vary from its terms.
I hope this newsletter has been informative for all readers. I hope that the unlawful attempts by mortgage lenders at collecting three-month interests on a power of sale will be put to rest.
If you are selling or refinancing your home, do not hesitate to contact Liddiard Law today!
Michael C. Liddiard, BA MA JD
michael@liddiardlaw.ca