A rare victory for mortgage borrowers in a class action against a bankJordan v. CIBC Mortgages Inc., 2019 ONSC 1178 (CanLII)
Mortgage prepayment penalties are an expensive problem for borrowers in Canada. It is perhaps surprising that it has taken so many years for the class actions bar to bring an action on behalf of consumers.
For whatever reason, the initial target of complaint is one specific bank, the CIBC. Class action claims against CIBC for prepayment penalties have been certified in British Columbia, Quebec, and now Ontario. The Ontario class action has been brought on behalf of all Canadian consumers outside of BC and Quebec.
The Problem of Mortgage Prepayment Penalties
The prepayment penalty is particularly onerous because the standard mortgage contract used by all the banks contains a “due on sale” clause. This means that the buyer of the house is not allowed to assume the existing mortgage. Instead, the seller must pay off the mortgage when the house is sold.
That standard contract also includes a prepayment penalty. In all of the banks’ contracts, there is a minimum penalty of at least three months’ worth of interest. The penalty can be considerably higher if current market interest rates are lower than they were at the time of the original loan.
In that case, a formula is used to calculate an “interest rate differential” (IRD). It is the measure of how much interest income the bank is losing due to the early breaking of the contract. The borrower must pay the penalty to compensate the bank for the remaining term of the mortgage. That can be very substantial, e.g., if somebody sells a house after one year, with four years left on a five-year mortgage.
This compensation for the bank is not necessarily unfair (assuming that the IRD is calculated correctly, which is another issue). It is fair when the bank has suffered an actual loss due to the breaking of the contract.
There is an asymmetry in the contract that creates unfairness.
If interest rates have fallen, the bank is fully compensated through the IRD for any loss from having to re-lend the money at a lower rate. In the converse situation, where market interest rates have risen, the bank is actually better off due to the prepayment, as they can re-lend the money at a higher rate.
In an earlier article, I argued that based on the principles of contract law, a penalty that is not matched by a cost to the lender should be unenforceable. A penalty built into a contract may be permissible if it is a reasonable pre-estimate of the damages from breaking the contract. However, the three-month penalty results in a highly variable figure which bears no clear relation to the actual cost to the lender, and may be many thousands of dollars in some instances.
The three-month prepayment penalty is by far the most common over the period covered by the class action. The information revealed in the current case shows the following:
 Of the 389,364 borrowers, approximately 300,184 paid a prepayment penalty of three months’ interest. Approximately 89,180 borrowers paid a prepayment penalty based on the IRD calculation.
It should be remembered that these figures are only for CIBC, which is just one out of Canada’s “big five” banks. The total of prepayment penalties paid to all the banks would number well over a million during this time period.
Trouble establishing a cause of action
There are five criteria listed in s. 5(1) of Ontario’s Class Proceedings Act that must be met for a claim to be certified as a class action. Justice Raikes went through them in varying degrees of detail.
The one to which he devoted the greatest attention was the “cause of action.” That is the requirement to show that there is a principle of law that the defendant has violated to justify a claim for damages. In undertaking this analysis, the judge is required to assume that all the facts that are alleged by the plaintiffs are true. If there is nothing in the defendant’s stated behaviour that represents a violation of the plaintiffs’ legal rights, the plaintiffs have no legal cause for complaint (however unfairly they feel they may have been treated). The court will not assist them, and the claim is thrown out.
In the present case, the borrowers’ lawyers argued that there were six different causes of action. Among other things, the borrowers argued that CIBC was in violation of statutory restrictions. They also argued that CIBC’s contract allowed it to make arbitrary decisions about what interest rate comparators to use. They argued that this should make the contract void because of uncertainty about how to calculate the penalty, and therefore no penalty was enforceable.
The judge rejected five out of the six cause of action arguments. The only one that he accepted was a rather narrow technical argument about the mathematical calculation of the interest rate differential. Even if a claim about that succeeds at trial, it might lead to only a modest damage award. The facts may show that the alleged error in the IRD calculation did not impose a large dollar cost for most of the borrowers.
An unconscionable contract?
One other cause of action, the broad claim that the mortgage contract was so unfair as to be “unconscionable,” was left open. The judge ruled that the plaintiffs had not made an argument that was good enough to justify that cause of action. However, he did not reject it outright, and has given the plaintiffs permission to try to correct that aspect of their claim to see if they can come up with a better justification for it. If a contract is found to be unconscionable, then its terms are void, and in principle it could lead to the entire prepayment penalty being refunded.
One reason why Justice Raikes appears to have left the unconscionability argument open is that he cast an eye on the BC class action certification, where is was accepted as a cause of action. However, he held that the relevant law in BC may be different than in Ontario:
 I note that the plaintiff in Sherry pleaded and relied upon the provisions of s. 8 of the BPCPA which provides a statutory test for unconscionability that differs from the test in Titus. The decision of the motion judge did not specifically address the doctrine of unconscionability distinct from the BPCPA. Accordingly, the decision of the courts in Sherry is of limited assistance to the analysis under s. 5(1)(a) of the CPA.
It is interesting, on the other hand, to consider the statement of the British Columbia Court of Appeal on this subject, which might suggest that in their view the BPCPA (British Columbia’s Business Practices and Consumer Protection Act, S.B.C. 2004) was not actually necessary to establish the claim of unconscionability. In Sherry v. CIBC Mortgages Inc., 2016 BCCA 240, the appeal ruling on the BC certification, that court stated:
 CIBC submits, and the appellant did not disagree, that the meaning of unconscionability at common law is essentially the same as under the BPCPA: see Loychuk v. Cougar Mountain Adventures Ltd. 2012 BCCA 122 (CanLII).
If the BPCPA is no different than the common law, it suggests that what is certifiable in BC should be certifiable in Ontario.
It is true that the BCCA did go on from here to cite various aspects of the BPCPA as justification for upholding the chambers judge’s decision to certify based on unconscionability. Nevertheless, it may be possible to suggest that the concept of unconscionability could be expanded in Ontario, even in the absence of some elements from BC’s legislation.
First level certification decisions are frequently appealed. Justice Raikes’ initial decision is unlikely to be the last word on the cause of action issue. It is possible that it will be expanded to allow for a greater range of damages, either through an appeal or an amended statement of claim.
However, the difficulty of enforcing fairness to consumers in this realm is apparent. A strong argument could be made that there is a serious imbalance of bargaining power between the oligopolistic banks and individual borrowers. Legislative action to provide better consumer protection would be desirable.