In the July issue of the ACIC Private Notes, we discussed the implications of the Ontario Superior Court of Justice’s decision in Solar Power Network Inc. v. ClearFlow Energy Finance Corp., 2018 ONSC 7286 with respect to whether using nominal annual rate conversion formulas in loan agreements complies with Section 4 of Canada’s federal Interest Act, RSC 1985, c I-15 (the “Act”).
The highly anticipated Ontario Court of Appeal (the “Appeal Court”) decision in Solar Power Network Inc. v. ClearFlow Energy Finance Corp., 2018 ONCA 727 was released on September 4, 2018. A unanimous panel of the Appeal Court allowed the appeal and found in favour of the lender, ClearFlow Energy Finance Corp. (“ClearFlow”) and the Canadian Bankers’ Association, who participated as an intervener.
Background and Ontario Superior Court of Justice Decision
Section 4 of the Act essentially provides that if interest rate is payable at a rate for any period less than one year, the maximum rate payable on the principle sum is 5% unless the agreement provides an express statement of the annual rate to which the other rate is equivalent.
The relevant facts of this case were that Solar Power Network Inc. (“Solar Power”), as borrower, entered into a number of loan agreements with ClearFlow, as lender. The loan agreements contained a base interest rate of 12% per annum which was compounded and calculated monthly. The loan agreements also provided for an “administration fee” and a “discount fee”. Solar Power defaulted on its payments to ClearFlow and brought an application arguing that the loan agreements, which contained a formula for converting non-annualized fees and other amounts payable under the loan agreement into annualized terms, did not comply with Section 4 of the Act as the formula failed to disclose an effective annual interest rate which factored in the effect of compounding on the overall interest rate. While the Ontario Superior Court of Justice held that the administration fee was properly characterized as a fee, the discount fee was found to be interest for the purpose of the Act and contravened Section 4 of the Act as the formula provided in the loan agreements did not contain an express statement of the yearly rate or percentage of interest to which the discount fee was equivalent. ClearFlow was therefore limited to collect only 5% of interest on the outstanding principal amount under the loan agreements, and consequently was denied approximately Cdn. $10 million in accrued interest that it otherwise would have been entitled to. This decision created much confusion and uncertainty for lenders and their counsel in Canada.
Court of Appeal Decision
The Appeal Court found that the mathematical formula in the ClearFlow loan documents was sufficient to express a "rate" for the purposes of Section 4 of the Act and rejected the Ontario Superior Court of Justice’s reasoning that formulas can be confusing and misleading and noted that formulas are in fact regularly used to determine variable rates of interest based on some standard external to the agreement such as the prime bank rate. The Appeal Court stated that “there seems to be no question that formulas of this nature comply with Section 4” and “to hold otherwise could cause significant mischief in international commercial arrangements.”
While the Ontario Superior Court of Justice found that the formula in the loan agreements did not satisfy Section 4 because it would only provide a nominal rate of annual interest and not an effective annual interest rate that takes into account the effect of compounding, the Appeal Court rejected the lower court’s reasoning and stated that whether the discount fee would ever compound was entirely contingent on the borrower requesting and being granted an extension of the loan at the end of its term. Thus, the Appeal Court found that it would have been impossible for Clearflow to provide an effective annual interest rate that would take into account the effect of compounding, and it would be absurd to hold a lender in contravention of Section 4 of the Act for failing to provide information that was impossible for such lender to provide. In addition, the Appeal Court stated that Section 4 of the Act must be interpreted in the light of modern commercial reality, where the common practice for many commercial loans is to specify interest to be calculated on the basis of 12 months of 30 days or 360 days and to provide an annualizing formula to calculate the equivalent annual rate.
The Appeal Court further held that the Ontario Superior Court of Justice “inappropriately privileged the consumer protection purpose of Section 4 over the countervailing interpretative principles of fairness to the lender and the need to accommodate contemporary commercial practices.” Solar Power was a sophisticated commercial borrower, the parties had equal bargaining power, and Solar Power’s need for consumer protection was scant. Also, while the Appeal Court held that several promissory loans did not comply with Section 4 as they did not contain an interest formula (underlying the practice point that every contract that makes interest payable should contain a formula that complies with Section 4 of the Act), it decided that only the non-compliant interest rate should be reduced to 5% rather than all the interest payable under the loan agreements (as the Ontario Superior Court of Justice had found).
Overall Remarks and Going Forward
The Appeal Court’s decision came as a great relief to lenders and lenders’ counsel in Canada and has been thought to have restored normalcy and legitimacy to the market practice of providing a formulafor the purposes of satisfying the requirement of an equivalent annual rate in Section 4 of the Act. While the Appeal Court’s decision on the impossibility to provide an effective annual rate that would take into account compounding arose at least in part from the fact that Solar Power had no ability to unilaterally extend or rollover the term loan, in contrast to a committed revolving credit agreement, where the borrower has this ability, one should probably expect that the impossibility argument would extend to the inability to know the effective interest rates upon a rollover as well.
Solar Power sought leave to appeal to the Supreme Court of Canada in early November, and the Supreme Court of Canada will make its decision in whether to grant leave to appeal in December of this year. However, many anticipate that it is unlikely the Supreme Court of Canada will grant leave to appeal to Solar Power.