The Test For Unconscionability In Loan Agreements

Not surprisingly, borrowers often view certain terms in loan and credit agreements as harsh, over-reaching or unusually generous for the lender. But at what point does a specific term cross the line? When does it reach the stage of being considered unconscionable?

In Phoenix1 , the Ontario Court of Appeal was called upon to interpret the calculation of a bonus payable to a subordinated lender [Alterinvest] under a loan agreement upon the occurrence of several different triggering events, one of which was a sale of any of the borrowers.2

At issue were, among other things, (1) the base amount upon which the 1% bonus would be calculated, and (2) whether the provisions of the Loan Agreement were unenforceable due to unconscionability, or as contravening the criminal interest rate provisions in Section 347 of the Criminal Code.

The original principal amount of Alterinvest's loan was only $2.25 million, and the purchase price under a sale agreement negotiated by the borrower [Phoenix Interactive] with a purchaser exceeded $92.5 million. At stake were several hundred thousand dollars in the amount of the bonus payment that was triggered. Phoenix Interactive was not willing to pay the bonus to Alterinvest because the fee would be disproportionate to the amount outstanding on the loan, and sought relief from the Court on the grounds that the bonus provision was both unconscionable and contrary to Section 347.3

The Court concluded that the bonus was to be calculated in accordance with the clear terms of the Loan Agreement on the whole consideration received by the borrower on the sale. It refused to allow the borrower to benefit from a pre-sale internal reorganization, stated to be for dividend purposes and involving several tax minimization manoeuvres, to reduce the sale proceeds upon which the bonus was calculated.

In Phoenix, the Court reconfirmed its earlier decision in Titus4 that the conditions required to establish the defence of unconscionability in the enforcement of a document were as follows:

(a) a grossly unfair and improvident transaction;

(b) a victim's lack of independent legal advice or other suitable advice;

(c) an overwhelming imbalance in bargaining power caused by the victim's ignorance of business, illiteracy, ignorance of the language of the bargain, blindness, deafness, illness, senility, or similar disability; and

(d) the other party's knowingly taking advantage of this vulnerability.5

This defence raised by the borrower was...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT