Uncertainty after ruling over disclosure requirements

Despite the Ontario Court of Appeal’s favourable ruling last September in Solar Power Network Inc. v. ClearFlow Energy Finance Corp., the uncertainty regarding the disclosure requirements under s. 4 of the federal Interest Act continues to hover over the lending community.

Just how long that uncertainty persists depends on whether or not the Supreme Court of Canada grants leave to appeal from the unanimous decision. The leave application was filed in November.

“We expect a decision on the leave application in the spring,” says David Outerbridge, a partner in Torys LLP’s litigation department in Toronto, who with his litigation partner Patricia Jackson represented the Canadian Bankers’ Association, interveners in the case.

The importance of the issues in Solar Power — whether annualizing formulas, a common mechanism in commercial contracts, satisfy s. 4 and whether inadequate disclosure reduces all interest payable to the statutory five per cent — is apparent from the expedited hearing granted by the OCA as well as the intervention of the CBA.

“Aspects of this case could have far-reaching effect into the Canadian lending industry,” says Simon Bieber, co-founder and a commercial corporate litigation partner at Adair Goldblatt Bieber LLP in Toronto, who with his commercial litigation partner Nathaniel Read-Ellis represented ClearFlow. “Our banking industry doesn’t always want to annualize interest rates with a precise percentage and has come to rely on formulas and calculations from time to time.”

The appellate ruling overturned the first instance decision of Justice Thomas McEwen of the Superior Court of Justice, released in January 2018.

McEwen ruled that the “discount fee” provided for in the loan agreements between Solar Power Network Inc., the borrower and an installer of solar panels, and ClearFlow, the lender, was in fact “interest” for the purposes of s. 4; that the annualized formula provided for in the lending agreements fell short of statutory requirements; and that the shortcoming limited interest payable under the agreements to five per cent.

McEwen reasoned that the “discount fee” in the agreements was in fact interest, because it featured the three essential elements required for that designation: It was compensation for use of money owed, related to a principal amount and accrued over time.

The amount of the discount fee, payable in the event of default, was expressed as 0.003 per cent charged daily on the outstanding principal. If a balance remained outstanding after 90 or 180 days, depending on the particular loan, the loan would “roll over” into a new loan and the discount fee would compound.

Section 4, however, forbids interest charges beyond five per cent unless the contract contains an “express statement of the yearly rate or percentage of interest to which the other rate or percentage is equivalent.”

The agreement between Solar and ClearFlow attempted to address this requirement by including a common “conversion” provision. This provision consisted of a formula that converted any interest rate not expressed as an annual rate, such as the “discount fee” daily rate, into an equivalent nominal annual rate.

ClearFlow’s position was that Solar could easily determine the annual rate to which the discount fee was equivalent by using the formula in the conversion provision. Solar disagreed, and it brought an application for a declaration that the total interest payable could not, in accordance with s. 4, exceed five per cent.

McEwen sided with Solar.

He reasoned that the conversion formula was not an “express statement” of the annual rate. In particular, the formula did not take the compounding features of the agreement into express account. 

“[Section 4] is designed to avoid the exact type of mischief that can occur when rates are not annualized and the borrower, therefore, does not have a clear understanding of its obligation to pay interest,” McEwen wrote. “A formula does not necessarily allow for this clear understanding to occur. Formulas can be confusing and even misleading.”

In the Court of Appeal, Justice Robert Sharpe, writing also for justices David Brown and Gary Trotter, agreed that the “discount fee” was in fact interest. But he observed that the parties could not know with certainty when the compounding would occur because it depended on whether and when the parties agreed to have the loans roll over. The upshot was that the documentation could not possibly set out an effective rate of interest.

“It cannot be the case that s. 4 is engaged when a lender fails to provide information that it is impossible to provide,” Sharpe concluded.

Section 4, Sharpe reasoned, “must be interpreted in the light of modern commercial reality.” That reality included considering the now common practice of calculating interest on the basis of a 360-day year or 12 months each of 30 days each, with a formula used to convert the rate to an annual rate based on a calendar year.

“By requiring an equivalent ‘rate or percentage’ (emphasis added) instead of just employing the word ‘percentage’ [in s. 4], Parliament has used language indicating that the effective annual interest need not be expressed as a numerical percentage,” Sharpe wrote.

The Court of Appeal also ruled that certain promissory notes that featured the discount fee and the daily rate but did not include an annualizing formula attracted s. 4.

Sharpe concluded, however, that McEwen had erred in limiting the whole of the interest payable on the promissory notes to the statutory five per cent, instead of applying the five per cent solely to the discount fee.

Although McEwen had acknowledged that this result might seem “draconian,” he felt compelled to that conclusion by what he called the “plain language” of s. 4, which states that if disclosure is inadequate, “no interest shall be charged” at more than five per cent “on any principal money.”

In Sharpe’s view, Mc­Ewen had failed to consider the “entire context” of s. 4 before settling on its plain meaning, which should have taken “modern commercial realities” into account.

These realities, in Sharpe’s view, required the reduction to five per cent to apply only to the non-compliant discount fee, thereby avoiding “a harsh and draconian result where ‘there plainly was no attempt to subvert the law’ in a case involving “a commercial transaction between parties of equal bargaining power who inadvertently and only marginally ran afoul of s. 4.”

If the SCC denies leave or arrives at the same result, then, it appears that far greater certainty respecting loan agreements will prevail.

“The Court of Appeal overruled two very problematic findings relating to s. 4,” Outerbridge says.

Barry Bresner, senior counsel in the commercial litigation group at Borden Ladner Gervais LLP’s Toronto office, who with associate Graham Splawski represented ClearFlow, would not comment as the leave application was still before the court.