A Return To Normalcy: Annualizing Formulas For Interest Rate Disclosure

1. INTRODUCTION AND BACKGROUND

   In our prior legal update "Drafting Interest Rate Calculation Provisions in Corporate Finance Transactions", we discussed the implications of the Ontario Superior Court of Justice decision in Solar Power Network Inc. v. ClearFlow Energy Finance Inc. 1 with respect to provisions for calculating interest rates in finance documents and how to comply with Section 4 of the Interest Act (Canada).

   Section 4 states:

   Except as to mortgages on real property or hypothecs on immovables, whenever any interest is, by the terms of any written or printed contract, whether under seal or not, made payable at a rate or percentage per day, week, month, or at any rate or percentage for any period less than a year, no interest exceeding the rate or percentage of five per cent per annum shall be chargeable, payable or recoverable on any part of the principal money unless the contract contains an express statement of the yearly rate or percentage of interest to which the other rate or percentage is equivalent.2

   The relevant facts in this case were that a lender, ClearFlow Energy Finance Corp. ("ClearFlow"), had provided short-term financing to a borrower, Solar Power Network Inc. ("Solar Power"). The loans carried interest payable at 12% per annum, compounded and calculated monthly, with a step-up to 24% per annum on default. The loan documents also provided for two "fees": an "administration fee" and a "discount fee". Solar Power brought an application arguing that the loan documents did not comply with Section 4, notwithstanding the inclusion of an annualizing formula in the loan agreement. The annualizing formula set out how to calculate the annual rate for both the administration fee and the discount fee.

   The application was heard by Justice McEwen of the Ontario Superior Court of Justice. He held that the "administration fee" was properly characterized as a fee and not interest for the purpose of Section 4 – a finding affirmed by the Ontario Court of Appeal. However, Justice McEwen held that the "discount fee" was actually interest, but failed to comply with Section 4 because the annualizing formula: (1) could not satisfy the purpose of the statutory requirement for an express, annualized statement of interest as "[f]ormulas can be confusing and even misleading"3 and (2) did not provide the information required by Section 4 as it failed to take into account compounding of interest. As a result of these findings, Justice McEwen found that the appropriate remedy was to reduce pursuant to Section 4 all interest...