Almost all mortgage agreements provide that if a mortgage goes into default, the borrower will be responsible for paying various fees and charges above the principal and interest. Common among these is a fee equal to three months’ interest on the amount in arrears, which often appears on discharge statements when a mortgage is in default.
However, apart from fees and charges that are genuine pre-estimates of reasonable administrative costs that will be actually incurred by the lender, such fees and charges are not enforceable, as they are considered by the courts to be penalties.
The three-month interest fee, in particular, has been found by the courts, time and time again, to be a penalty (whether it is described as a “fee”, “charge”, “bonus” or otherwise), and in breach of section 8 of the Interest Act.
So why do lenders keep trying to impose it? Perhaps, because it seems there is just enough confusion created by section 17 of the Mortgages Act and the case law to keep lenders’ hopes alive. And in some limited circumstances, such a fee will indeed be enforceable.
Section 8 of the Interest Act
It is settled law that a mortgage lender cannot seek payment of any amounts that run afoul of s. 8 of the Interest Act. No fine, penalty or rate of interest may be charged on arrears secured by a mortgage on real property that has the effect of increasing the charge on the arrears beyond the rate of interest payable under the mortgage otherwise.
The courts have made it clear that when a lender is seeking to enforce its mortgage, a three-month interest fee charged to borrowers in default has that effect and is therefore unenforceable.
In Krayzel Corp. v. Equitable Trust Co. the Supreme Court of Canada explained that the purpose of s. 8 is to protect landowners from charges “that would make it impossible for [them] to redeem, or to protect their equity” (also see Justice Schabas’s reasons in Benson Custodian Corporation v. Situ, for a good summary of the line of cases holding that such fees violate s.8 of the Interest Act).
If that is the case, what is the genesis of the three-month interest charge so often found in mortgage agreements? The case law and legal commentary point to Section 17 of the Mortgages Act.
Section 17 of the Mortgages Act
Section 17 allows a mortgagor (i.e. the borrower) to give the mortgagee (the lender) three months’ notice of his or her intention to repay the mortgage debt or, in the alternative, pay three months’ interest on the amount in arrears without any notice after a default.
However, this provision is only at the borrower’s option. Courts have described s. 17 as “mortgagor centric”. That is, it may be used by the mortgagor to his or her advantage but not by the mortgagee.
Arguably, the rule has no application where the lender seeks to realize on the security after a default.
Lingering Uncertainty in the Law
However, the seeming inapplicability of s. 17 of the Mortgages Act to lenders that has not stopped mortgagees from attempting to rely on such terms when enforcing mortgage rights. As described by Justice Dunphy in a 2018 decision involving a mortgagee’s entitlement to charge an amount equal to three months’ interest, “There has been a simmering dispute over a number of years” as to whether s. 17 claims by mortgagees will be allowed.
In 1993, the Court of Appeal in Mastercraft Properties Ltd. v. EL EF Investments Inc. confirmed that s. 17 of the Mortgages Act could be reconciled with s. 8 of the Interest Act where the mortgage covenant mirrored s. 17 and permitted the borrower to either give three months’ notice of redemption or pay an amount in lieu of notice. Such a payment would not be a “fine” or “penalty” (and thereby contravene s.8 of the Interest Act), but rather is a payment for the privilege of paying arrears without the necessity of giving the three months’ notice contracted for.
The 1995 Divisional Court decision, O’Shanter Development Co. v. Gentra Canada Investments Inc., which cited Mastercraft as authority, continues to resonate with those in favour of allowing mortgage lenders to enforce contractual entitlements to fees equal to three months’ interest in circumstances of a default.
In that case, the court permitted a first mortgagee to insist that a second mortgagee, who sought to repay the first mortgage after selling the property under power of sale, had to pay the three months’ interest fee required under the first mortgage. Once the 35-day period set out in the notice of sale had elapsed, the first mortgagee was no longer bound to accept the amount of monies set out in its notice of sale (as required by section 43 of the Mortgages Act), but instead could insist on payment of all contractual entitlements under the mortgage agreement.
Relying on historical equitable grounds, the Divisional Court identified an unfairness that a borrower could deliberately allow a mortgage to go into default and force the lender to take steps to realize on its security, and end up with a better result (i.e. not having to pay the fee equal to three-month’s interest) than by paying off a mortgage early. Ultimately, the court held that “A mortgagor should fulfil his [or her] proper contractual obligation as a condition of redemption.”
As for the potential violation of s.8 of the Interest Act, the Divisional Court found that such payments have long been recognized by equity and should not be considered a fine, penalty or interest, thereby skirting the conditions of that provision.
Courts have relied on O’Shanter when permitting lenders to insist on the three-month interest fee to redeem after a default, notwithstanding that such fees seem to have the practical effect that the Interest Act seeks to prohibit (see for example, Piesok v. Johnson).
The O’Shanter decision remains good law, despite lower courts often stretching to distinguish it. Some more recent cases have gone so far as to suggest that only Mastercraft can be followed.
In a 2017 decision where a plaintiff was successful in recovering a three-month interest charge it had paid under protest after power of sale proceedings had been commenced, the court noted that commentators have criticized the O’Shanter decision and have argued that it was either wrongly decided, erroneously applied in subsequent case law, or has limited application.
At the time of writing, the latest case to reference O’Shanter appears to be We Care Funding Limited Partnership v. 1569635 Ontario Limited, decided in October 2023. In that case, Justice Emery declined to grant a three-month interest claim on the basis that it would be inequitable to allow it in the specific circumstances of that case. The court nevertheless acknowledged that O’Shanter is authority for making such a claim.
Still more recently, in Greenpath Capital Partners Inc. v. 1903130 Ontario Ltd., the Ontario Court of Appeal cited We Care in upholding an application judge’s finding that a “default fee” sought by the first mortgagees was offside s.8 of the Interest Act. The court confirmed that once a mortgagee undertakes enforcement proceedings, it can no longer collect a three-month interest bonus as doing so would constitute a penalty and therefore offend the Interest Act. The Court of Appeal did not refer to O’Shanter.
Practical Conclusions
The upshot of the ambiguity in the cases seems to be that a mortgage lender cannot insist on a contractual requirement that a borrower in default pay a fee equal to three months’ interest to redeem the mortgage. But, if the borrower actually can and wants to redeem the mortgage, and requests to do so after the default, the lender may be entitled to insist on that same fee.
In other words, the validity of a three-month interest charge in a mortgage agreement might depend on whether the borrower is seeking to repay after a default, or the lender is enforcing its mortgage under a power of sale or other mortgage enforcement proceeding.
Two key practical recommendations flow from the above analysis:
- A mortgage lender should NOT include a three-month interest charge in a Notice of Sale when a borrower is in default, even if the mortgage agreement provides for such a charge;
BUT
- After issuing a Notice of Sale, and the statutory 35-day notice period has passed (and the lender is no longer bound to accept for payment the amounts indicated in the Notice of Sale), if the borrower seeks to redeem the mortgage, the mortgage lender can insist on the three-month interest charge.
Although still not certain of success, this approach would appear to be the best way to take advantage of this lingering gray area in Ontario mortgage enforcement law.
Alastair McNish