Lender disclosure obligations confirmed

On March 28, the Supreme Court of Canada dismissed the application for leave to appeal in Solar Power Network Inc., et al. v. ClearFlow Energy Finance Corp. The Ontario Court of Appeal’s 2018 decision stands. This is welcome news for lenders. It confirms that longstanding and widely used interest rate disclosure practices satisfy the requirements of section 4 of the federal Interest Act.

What you need to know

• Formulas can satisfy the requirement to disclose an equivalent yearly interest rate. Where a contract specifies that interest is payable at a rate for “any period less than a year,” section 4 of the Interest Act requires disclosure of an equivalent annual rate. The application judge’s decision in Solar Power cast doubt on whether annualizing formulas—widely used in the lending industry—could satisfy this requirement. The Court of Appeal has confirmed that a formula which converts a daily interest rate to an equivalent annual rate can satisfy section 4.¹
• Section 4 does not require disclosure of the annual effective interest rate where that rate cannot be calculated in advance. Under many commercial agreements, interest is compounded only in the event that payments are not made when due. In such circumstances, it is mathematically impossible to state a numeric effective annual rate—one that takes into account compounding—in advance. The Court of Appeal has confirmed that “the laws of mathematics bow to no one” and disclosure of a nominal rate, by way of an annualizing formula, can satisfy section 4.
• The remedy in section 4 applies only to non-compliant interest rates. The application judge in Solar Power had held that all interest payable under a contract should be reduced to the statutory maximum of 5% per annum, even if all but one of the interest rates in the contract satisfied section 4. The Court of Appeal overturned this “draconian” result and held that only non-compliant interest rates are reduced by section 4.

The implications of Solar Power for lenders

The Court of Appeal’s decision in Solar Power confirmed that old statutes like the Interest Act should be interpreted in light of modern commercial realities. Lenders should take comfort in the Court’s approval of industry-wide interest rate disclosure practices, particularly in agreements under which interest is calculated by reference to the London Interbank Offered Rate (LIBOR).

LIBOR-based lending agreements can comply with section 4

It is common for USD-denominated lending agreements to specify that interest is calculated by reference to LIBOR. This is a benchmark rate for international short-term interest rates that is referenced to a 360-day period, based on twelve 30-day “months,” rather than a calendar year. LIBOR-based lending agreements typically include an annualizing formula that permits calculation of an equivalent annual interest rate.

The application judge’s decision in Solar Power cast doubt on whether such formulas—used in Canada for over two decades—were sufficient to satisfy the disclosure requirements of section 4 of the Interest Act. The Court of Appeal confirmed that section 4, though drafted in 1897, “must be interpreted in the light of modern commercial reality.” Referencing obiter statements in earlier cases,² the Court of Appeal questioned whether section 4 even requires annualizing formulas for LIBOR-based agreements—but confirmed that if it does, a properly drafted formula is sufficient to comply with the provision.

No requirement to disclose an effective annual interest rate if it cannot be calculated in advance

There are various types of commercial agreements under which it may be mathematically impossible to calculate an effective annual interest rate. These include agreements:

• where interest is calculated by reference to a rate for a period of less than a year that varies over time;
• that provide for “running credit,” where the borrower’s draws and repayments each month are unknown in advance; and
• under which interest is compounded only in the event that payments are not made when due.

The latter type of agreement was at issue in Solar Power. The borrower failed to make payments at term and the “discount fee” at issue was compounded each time the loan rolled over. The application judge nonetheless held that an “equivalent” annual interest rate, for the purposes of section 4, must be an effective rate that takes into account the effects of compounding of interest.

The Court of Appeal, recognizing that Parliament could not have “intended that which might be mathematically impossible to still be done” overturned this decision. It confirmed that section 4 does not require disclosure of an effective annual interest rate where it is mathematically impossible to calculate that rate in advance.

In sum, the Court of Appeal’s decision in Solar Power represents a very positive outcome for the lending industry. The court has confirmed that industry-wide interest rate disclosure practices in common types of commercial agreements satisfy section 4 of the Interest Act, and that old legislation should be interpreted in light of modern commercial realities.

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¹ It is important to note that federal and provincial consumer protection legislation may contain more specific requirements about the calculation and disclosure of interest for loans to consumers and others to whom that legislation applies.

² V.K. Mason Construction Ltd. v. Bank of Nova Scotia, [1985] 1 S.C.R. 271 at p. 287, 1985 CanLII 608 (SCC).