Limits on Interest Rates in Loan Agreements
Loan agreements governed by Ontario law commonly include a provision that is intended to address the maximum effective annual rate of interest that is chargeable thereunder without contravening the usury provisions of the Criminal Code (Canada). For purposes of the Criminal Code (Canada), “interest” is defined as including ordinary commercial interest, fees (other than those required to be paid to governmental authorities in connection with perfecting security) and expenses (such as legal expenses, including a lender’s legal expenses if the borrower has agreed to pay them) and, therefore, is not limited to what most bankers think of when they refer to “interest”.
In U.S. law governed loan agreements, the provision limiting interest is usually framed that if interest at the stated rates would result in unlawful rates, then the interest rates shall be reduced to the maximum lawful rates. Canadian courts have refused to enforce such a provision on the basis that they would be required to rewrite the contract by determining which, and in what sequence, element(s) of “interest” should be reduced in order to attain an effective annual interest rate that does not exceed the lawful rate. The result of the Canadian courts’ refusal to enforce such provisions has been, in some cases, that lenders have been denied all “interest”.
Accordingly, to be enforceable, provisions limiting interest should specify the order in which the elements of “interest” shall be reduced so that the effective annual rate of interest provided for in the loan agreement will not be in contravention of the Criminal Code (Canada) (for example, the interest rate on the loan shall be reduced first, then fees shall be reduced etc. until the lawful effective annual rate of interest is attained).
