Canada Interest Act - Preliminary Background Paper 2007

Part I: Sections 2 and 3

1. Freedom of Contract and Section 2

[5] The Interest Act adopts a laissez-faire policy in relation to the rate of interest charged.[10] The policy underlying s. 2 can be traced back to nineteenth century concerns about usury legislation.[11] Usury legislation, which had the effect of limiting the rate of interest, was in force in some provinces at the time of Confederation. When Parliament enacted the original version of s. 2 in 1886 it did so with the goal of abrogating usury laws then in force in some of the provinces.[12]

[6] Much of the modern case law emphasizes that s. 2 represents freedom of contract.[13] Freedom of contract is not, however, absolute. A lender will be required to comply with other relevant sections of the Interest Act. Non compliance with other parts of the Act will affect the interest rate charged. Thus the rate may be fixed by s. 4 at 5 per cent or the interest component may be eliminated altogether by s. 6. In addition, the lender must comply with other Acts of Parliament which affect interest rates. To some extent Parliament’s original intention to abolish usury legislation has not been maintained. As s. 2 is limited by other Acts of Parliament, this must include s. 347 of the Criminal Code, which according to the Supreme Court of Canada in Garland v. Consumers’ Gas Co. “created Canada's first general anti-usury provision since Confederation.” Before the enactment of s. 347, “lenders and borrowers enjoyed absolute freedom under federal law to agree upon any rate of interest, subject only to the contractual restraints imposed at common or civil law and the special disclosure requirements arising under the Interest Act.”[14]

2. The Default Rate: Section 3

[7]Section 3 provides a default rate of 5 per cent. The provision applies “[w]henever any interest is payable by the agreement of parties or by law, and no rate is fixed by the agreement or by law.” The default rate was originally established at 6 per cent in 1886 and had been derived from the Province of Canada statute of 1858.[15] The rate was reduced to 5 per cent in 1900[16] and has remained unchanged since that time. Commentary from the case law suggests that Parliament chose 5 per cent as a reflection of the financial conditions at the turn of the century.[17] The Alberta Court of Appeal in Bank of Nova Scotia v. Dunphy Leasing Enterprises Ltd. noted that in 1900 Province of Ontario bonds bore interest at 3.51% and that “an interest rate of 5% would appear to be in line with lending rates at financial institutions at that time.”[18]

[8] While s. 3 appears to have broad application, the utility of the section has been significantly reduced since it was initially enacted in 1886.[19] The Supreme Court of Canada in British Pacific Properties Ltd. v. Province of B.C. concluded that s. 3 only applied “when there is no provision made in an applicable statute or in an agreement and no mechanism is provided by which a rate can be fixed.”[20] Several courts have made use of contractual terms as an appropriate mechanism to calculate an interest rate and thereby exclude the default rate. According to the Ontario Court of Appeal, even where the terms of the agreement do not provide for interest at any specified rate, the default rate in s. 3 will not apply where the interest component of an instalment payment was “capable of precise calculation.”[21]

[9] Apart from private agreements, the default rate has potential scope to apply where “interest is payable… and no rate is fixed …law.” However, the growth of provincial prejudgment interest legislation since the initial adoption of the Interest Act has limited the scope of this aspect of s. 3.[22] In the 1977 decision of Prince Albert Pulp Co. v. Foundation of Canada Co. Martland J. concluded that where prejudgment interest is awarded under provincial law, “the rate which [the court] fixes is payable by law and the rate is fixed by law. In such a case…section [s. 3] would not be applicable.”[23]

[10] In 1980, the Supreme Court further limited the scope of s. 3 in British Pacific Properties Ltd. v. Province of B.C.[24] In that case Laskin C.J. adopted a liberal construction of the words “fixed by law”. This liberal interpretation included a rate fixed by statute or the fixing of a rate where the statute permits delegation. Laskin C.J. concluded: “[w]hether a statute under which interest is payable… itself prescribes the rate or remits the award and the rate to a judge or to an adjudicator or adjudicative agency or provides a rate formula, the rate arises under law and is, accordingly, fixed by law.”[25]

[11] The Ontario Court of Appeal in Pizzey Estate v. Crestwood Lake Ltd. recently summarized the underlying rationale in Prince Albert Pulp and British Pacific: “That rationale is to narrow the scope of s. 3 to the rare case, if any, where a court or statutory body cannot legitimately award interest.”[26] These situations may be rare indeed. Professor Waldron concludes that the expansion of prejudgment interest legislation and the Supreme Court jurisprudence may mean that a mechanism to fix an interest rate could be found in “virtually every case in which a court or statutory body can legitimately award interest.”[27]

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