Canada: Modernization Of Prepayment Rights Under Interest Act

Copyright 2011, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Real Estate, November 2011

After several years of work and consultation between key stakeholders and the Federal Department of Finance, the federal government has now published regulations that will come into force on January 1, 2012 that modernize the right of prepayment under the Interest Act. These regulations will allow a broader category of business entities to be able to negotiate their own prepayment privileges on long-term mortgage loans.

Right to Prepay after Five Years

Section 10 of the Interest Act provides for a statutory right of prepayment in circumstances where principal or interest under a mortgage on real property or a hypothec on immovables is payable more than five years after the date of the mortgage or hypothec. If this is the case, the mortgage or hypothec can be prepaid in full, regardless of what it might otherwise provide, after the expiry of the five-year period, together with an additional payment equal to three months' worth of interest. No additional payments or penalties can be charged by the lender. Prior to the enactment of the current federal regulations, this statutory right of prepayment was expressly stated not to apply to mortgages given by corporations. Section 10 of the federal Act is closely paralleled by similar provincial legislation in Ontario and Manitoba. In Ontario, the similar provisions are contained in section 18 of the Mortgages Act.

The policy objective for excluding corporations from a statutory right of prepayment was that a corporation should be capable of negotiating its own prepayment terms and did not need the protection of the government. After all, when section 10 was first enacted in the 1880s, the section was meant to protect farmers from being locked into long-term mortgages at high interest rates.

Additional Business Entities Excluded from Right to Prepay

Modern commerce and finance have evolved significantly. There are many business entities, other than corporations, that carry on business and should be able to negotiate their own prepayment terms, and not be hampered in securing long-term financing by virtue of section 10 of the Interest Act. In recognition of this business reality, the regulations published by the federal government now provide that the statutory prepayment right will not apply to mortgages of real property and hypothecs of immovables granted after January 1, 2012 by any of the following entities: (a) partnerships; (b) trusts settled for business or commercial purposes; (c) unlimited liability companies as defined in the Alberta Business Corporations Act; (d) unlimited liability companies as defined in the British Columbia Business Corporations Act; and (e) unlimited companies as defined in the Nova Scotia Companies Act.

Bare Trustee and Nominee Corporations

Even before the enactment of these federal regulations, there were several Ontario cases in the late 1990s that assisted in narrowing the application of the statutory right of prepayment. The Ontario Court of Appeal determined in Litowitz v. Standard Life Assurance Co. that the right to prepay is determined by the corporate status of the mortgagor. Although individuals or other non-corporate entities (such as a partnership or a REIT) might be the beneficial owners of real property, if they arrange to conduct their business through a nominee corporation which signs the mortgage as mortgagor, the corporate status of the nominee corporation will preclude the ability to prepay the mortgage pursuant to section 10. This is true even if the lender is aware of the existence of the individual or other non-corporate beneficial owners and even if they are parties to the mortgage as "additional covenantors". If the registered title to real property is registered in the name of a corporation, the right of a non-corporate beneficial owner to prepay any mortgage given by that corporation will not apply pursuant to section 10.

Quebec Civil Law Position

In the Province of Quebec, prior to the enactment of the new regulations, the application of section 10 of the Interest Act was problematic in situations where a mortgage was granted by a limited partnership, by a corporation acting as a trustee or by a corporation acting as a nominee for a natural person or a non-corporate entity.

The application of section 10 of the Interest Act to a mortgage given by a limited partnership was linked to the concept of the legal personality of, and the ownership of assets by, a limited partnership, both of which are still uncertain under Quebec law. Not being a corporation, however, the limited partnership could benefit from the right to prepayment under section 10 of the Interest Act. With the coming into force of the new regulations, this issue will be resolved.

In addition, the application of the rule in Litowitz was somewhat uncertain in the Province of Quebec. This mostly stemmed from the fact that civil law does not divide ownership between legal and equitable title in the same manner as the common law. Where a corporation acquires title to a property in Quebec on behalf of another, it is doing so as a prete-nom or mandatary (the civil law equivalent of an agent). The prete-nom has no rights of any nature whatsoever and cannot perform any act without the true owner's permission. According to the Civil Code of Quebec, a Quebec hypothec may only be granted by the person having the capacity to alienate the hypothecated property, leading most practitioners to believe that the true owner must hypothecate (which it often does by way of intervention to the hypothec). While many in Quebec thought the better view was that the rule in Litowitz did apply in Quebec, there remained a degree of uncertainty that often led to additional and expensive legal structuring to find ways to qualify under the existing exemptions. The new regulations that come into force on January 1, 2012 will eliminate this uncertainty and be very welcome in Quebec.

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