## Canada Interest Act - Preliminary Background Paper 2007

**Part III: Non-Mortgage Loans and s. 4 Disclosure**

*a) Origins of s. 4 *

[53] Section 4 was the last major component added to the Interest Act. Passed in 1897,[137] s. 4 provides for a disclosure regime for non-mortgage loans. Where any interest is, by the terms of a written contract, made payable for a period of less than a year, no interest exceeding the default rate of 5 per cent per annum shall be chargeable unless “the contract contains an express statement of the yearly rate or percentage of interest to which such other rate or percentage is equivalent.” The default rate of 5 per cent has not been altered since 1900.[138]

[54] The Parliamentary debates in 1897 reveal numerous references to interest rates being charged on a daily or weekly basis. The Solicitor General set out the aim of the Bill:

The object is to prevent people from charging so much interest for a short time, for instance a day or a week or a month, without the person who is undertaking to borrow the money and pay the interest knowing the exact nature of the obligation he has contracted.[139]

[55] The weekly or daily rates made it difficult for the borrower to understand the true cost of the loan:

[I]t is a covert act on the part of the building society which have the rate of interest so covered up that it is almost impossible for an educated man, an actuary and bank manager to understand the rate of interest these societies are charging.[140]

[56] Not all Members of Parliament agreed that the Bill would be an effective disclosure regime. One Senator questioned whether a borrower would understand a per annum rate any better than a daily, weekly, or monthly rate.[141] One Member of Parliament described the Bill as a “piece of rather useless legislation.”[142] Another Member warned that “this law will be evaded every time and that the borrower will be practically left where he is.”[143]

*(b) The Interpretation of Section 4 *

[57] Numerous courts have emphasized the importance of disclosure,[144] however, there is an underlying disagreement in the case law as to whether s. 4 should be restricted to the protection of consumers or whether it should also cover sophisticated borrowers. The Alberta Court of Appeal was of the view that s. 4 “seems to recognize that ordinary consumers might be misled into binding themselves to excessive rates of interest through ignorance of the multiplying effects of a rate quoted monthly or weekly.”[145] The Supreme Court of Canada also emphasized the consumer aspect of s. 4. In *V.K. Mason Construction v. Bank of Nova Scotia, *Wilson J.* *concluded that s. 4 is “consumer protection law in the sense that, with respect to loans other than real estate mortgages, consumers are entitled to know the annual rate of interest they are paying.”[146] The sophisticated borrower in *Mason *was in “scant need of protection by being informed of his rate of interest at the annual, rather than the 360-day, rate.”[147]

[58] The Ontario Court of Appeal in *Elcano Acceptance Corp. v. Richmond, Richmond, Stambler & Mills *did not accept this proposition*. *The Court* *concluded that s. 4 “must be construed as applying to all borrowers regardless of the degree of sophistication.”[148] However, in a subsequent case the Ontario Court of Appeal was of the view that Wilson J.’s interpretation should prevail and that the Act should be confined to consumer protection.[149] Although the wording of s. 4 does not distinguish between consumer and commercial borrowers, whether s. 4 should protect consumers as well as sophisticated borrowers continues to remain an issue with recent decisions reaching opposite conclusions.[150]

[59] The courts have demonstrated a willingness to rely upon s. 4 to impose a 5 per cent interest rate where there has not been proper disclosure (usually in the event of a monthly interest rate).[151] Indeed the Saskatchewan Court of Appeal emphasized that where s. 4 applied the default rate of 5 per cent “cannot be avoided merely because the party to whom the money is owed suffers damage as a consequence of the enforced application of this rate.”[152] However, limitations of the section itself and the case law have undermined Parliament’s original intention of an understandable disclosure regime.[153]

[60] Although s. 4 would appear to have broad application to all kinds of non-mortgage loans the case law has found a number of exceptions which restrict the scope of the provision. Thus it has been held that where the contract provides for interest expressed in terms of a lump sum dollar amount rather than a percentage the Act does not apply since the contract did not contain a rate of interest.[154] Where interest is set out as a lump sum and included in the principal s. 4 will not apply.[155] Although the lump sum total payments contain a built in component for interest there is “no specification of a rate or percentage of interest for any period of less than one year” and thus s. 4 has no application.[156] Ironically, where the borrower is faced with a lump sum payment, including hidden interest charges that may be impossible to calculate, the Act will not apply.[157]

[61] Section 4 does not apply where there is no “interest”. In *Mitsui & Co. Ltd. v. Ocelot Industries Ltd.[158]* the Alberta Court of Appeal considered whether overdue invoices bearing the rate of 1.5% per month were governed by s. 4. The Court concluded s. 4 did not apply to the overdue invoice. It drew a distinction between a charge arising for a loan or forbearance of a debt and a stipulation for a pre-assessment of damages by the parties. Although both categories might be expressed in the form of an interest rate, the Court concluded that only the first category qualified as interest under s. 4. In the first category the parties agree that a loan is to be extended in return for the payment of interest. In this particular case, the monthly rate of 1.5% was not interest on a loan but rather a pre-assessment of damages and thus not interest for the purpose of s. 4. This distinction has been followed in subsequent Alberta cases.[159]

[62] The *Mitsui *distinction however has not been followed in other jurisdictions.[160] A recent Saskatchewan Court of Appeal decision has refused to follow the *Mitsui *distinction concluding that “when a word such as ‘interest’ is used, one must take its full and usual meaning.”[161] The Ontario courts have not accepted the *Mitsui *principle with the most recent decision concluding that s. 4 will apply to the following scenarios: (i) where money is borrowed; (ii) where goods or services have been provided for but not yet paid for; (iii) where the damages for non-performance are quantified by a rate of interest.[162] A recent Saskatchewan Court of Appeal also suggests a broader functional approach to the definition of interest for purposes of s. 4. The Court concluded that a term which provided for a “service charge of 1.5% compounded monthly” did not comply with s. 4. The fact that “it was called a service charge rather than interest cannot change the substance of the provision which required the payment of interest.”[163]

*(c) What must be disclosed?*

[63] Section 4 requires that all contracts must contain an “express statement of the yearly rate or percentage of interest to which such other rate or percentage is equivalent.” Perhaps one of the most controversial aspects of what must be disclosed arose in *Bank of Nova Scotia v. Dunphy Leasing.*[164]* *In *Dunphy *interest was set at 3/4% per annum over the Bank’s prime lending rate. Interest was calculated and payable monthly. At trial the judge held that s. 4 applied since the contracts required monthly payments of interest. The trial court imposed the default rate of 5%. The Court of Appeal overturned the ruling of the lower court holding that s. 4 did not apply. Fraser J.A. concluded that “what would be required to trigger s. 4 is not the fact that interest is required to be paid monthly. Section 4 applies only if interest is made payable at a monthly rate or at any rate for any other period of less than a year.”[165] Section 4 did not apply since the contracts did not specify a rate of interest for a period of less than one year. The Bank could rely upon its contractual interest rate.

[64] If Parliament intended borrowers to be able to understand the true cost of loans without a financial expert surely this aspect of the Interest Act has been a failure. Does s. 4 require the disclosure of a nominal rate or the effective annual rate? Thus if a contract provides for 2% per month would disclosure of a 24% nominal rate suffice? As the Alberta Court of Appeal noted in *Bank of Nova Scotia v. Dunphy Leasing*[166]* *the nominal rate by itself tells the borrower “almost nothing.” In order to compute the actual interest on the loan the borrower would need to know “the frequency of the period of calculation of interest, the frequency of payment of interest, whether interest is to be calculated in advance, and whether the lender has the right to compound interest.”[167] Even with all of this information the Court of Appeal questioned “whether the average borrower would have the vaguest idea how to use the information to calculate the real costs of a loan.”[168]

[65] Alternatively does the section require the disclosure of the equivalent effective annual rate which takes into account compounding? Thus the equivalent effective rate in the 2% monthly rate is 26.8% annually.[169] If *Dunphy *reduces one’s confidence in a nominal rate so too does Winkler J.’s discussion of the effective annual rate in *Canadian Tire Acceptance Ltd. Card Holders v. Canadian Tire Acceptance Corp.*[170]* *In *Canadian Tire *the monthly rate was 2.4% leading to a 32.9% effective annual rate. However, Winkler J. noted that the 32.9% rate assumed that no payments had been made during the year. Given this assumption “the effective annual rate of interest of 32.9% is no more than a theoretical abstraction…Conceptually, to assert this effective rate as an equivalent is a denial of the reality of credit cards and revolving credit.”[171] Winkler J. concluded that the insertion of an effective annual rate in an agreement would be impossible. The effective rate of interest for each customer would vary.

[66] The case law on whether the effective annual rate or nominal rate is required is inconsistent. The Alberta Court of Appeal in *Dunphy, *although criticizing the nominal rate, expressly refrained from answering the question of what kind of rate must be disclosed. Some cases have suggested that a statement of a nominal rate will be sufficient disclosure for purposes of s. 4. Thus the British Columbia Court of Appeal in *Nedco (1975) Ltd. v. Eades Electric Ltd. *[172] concluded that where a 2% monthly rate was set the disclosure of a 24% annual rate was adequate to comply with s. 4 even though counsel agreed that the rate as compounded was 26.8%.

[67] The distinct views of the trial judge and the Ontario Court of Appeal in *Elcano Acceptance Ltd. v. Richmond, Richmond, Stambler and Mills[173]* demonstrate the confusions that surround the calculation of periodic interest. The trial judge stated that:

if a debtor is so lacking in mathematical knowledge that he cannot appreciate that 2% per month is the equivalent of 24% per annum, then he is so probably lacking mathematical concepts that he does not know that 100% equals a whole, and will not realize what a large portion 24% is of that whole.

[68] The Court of Appeal however concluded that “to simply multiply the 2% by twelve months and show 24% as an annual rate would not correctly describe the true annual rate intended. The annual rate of interest when compounded monthly would be 26.8% per annum.”[174] Other courts have suggested that the overriding intention of the parties should govern as to whether a nominal or effective rate is to be disclosed.[175]

[69] In *Canadian Tire Acceptance Ltd. Card Holders v. Canadian Tire Acceptance Corp.[176] *Justice Winkler specifically addressed whether s. 4 required a nominal or effective rate. The card holders argued that to comply with s. 4 the effective rate of interest must be disclosed. Here the agreements contained a nominal rate of interest. Winkler J. held that the nominal rate of interest is an equivalent rate of interest for purposes of s. 4 and was an acceptable measure of disclosure. In reaching his conclusion Winkler J. rejected the 1897 Parliamentary debates as a source of interpretation noting that the role of credit in society had changed “dramatically.”

If, in this age of credit cards and the notion of revolving credit, the plaintiffs wish to address that which they perceive to be a social ill in the area of consumer protection by requiring stipulation of effective rates of interest, they must do this through legislative means rather than through the application of an aged statute which, when given its plain meaning, cannot redress their concerns.[177]

[70] Most recently the Saskatchewan Court of Appeal concluded that the term “2% per month or 24% per annum (26.8% effective rate)” complied with s. 4. Without expressly showing a preference for the nominal or effective rate the court concluded that the credit agreement provided for a stated annual interest rate of 24% and that to give meaning to the words “26.8% effective rate” the entire interest phrase had to be read “constructively.”[178]