Feb 2, 2020

Can interest rate penalties hidden in the fine print be enforced in failed real estate deals?

Forest Hill Homes v Ou, 2019 ONSC 4332 (CanLII)

As I noted in a previous blog post, Canadian real estate law is tough on buyers who fail to carry through on real estate agreements. The buyer who fails to complete an agreed house purchase almost always loses the deposit. She may also be sued and forced to compensate the seller for additional damages. This would include compensation if the house ends up being sold at a lower price, as well as any extra expenses incurred by the seller.

In some years of financial turbulence, there have been many cases of new home purchases from builders where the buyer had to back out. One painful factor in the contracts used by new home builders is a requirement that the buyer compensate the builder for interest from the date of the original completion to when the house is eventually sold to a new buyer.

The interest rate penalty is hidden in a page of dense print in a tiny font. It is sometimes at an interest rate far above the current low market interest rates. In the cases discussed below, it ranged as high as 20 percent. If it takes several months to resell the house, a penalty at these rates could easily amount to tens of thousands of dollars. But is such a penalty legally enforceable, if it was not brought to the attention of the buyer before signing?

Standard Form Contracts Should Not be Traps for the Unwary

People who sign contracts ought to read them, but the reality is that many written contracts are very long. Much of it is standard “boilerplate,” sometimes covering dozens of pages, that no ordinary person is likely to read.

Contract law allows for human frailty and foibles, and contracts that are written in an unfair manner may not be enforceable.

Where a party puts forward a very long, standard form contract, there is an obligation to highlight any provision that is unusual and onerous. Lord Justice Denning, the celebrated English “people’s judge,” famously laid down a “red hand” principle: "Some clauses which I have seen would need to be printed in red ink on the face of the document with a red hand pointing to it before the notice could be held to be sufficient." The general principle that he laid down was that "we do not allow printed forms to be made a trap for the unwary."

These principles have been accepted into Canadian law. One of the leading cases is the Ontario Court of Appeal’s decision in Tilden Rent-A-Car Co. v. Clendenning, 1978 CanLII 1446 (ON CA), which cited Lord Denning several times. That was a case in which a clause that was not brought to the attention of the renter would have invalidated his insurance. The majority of the court ruled that it was unenforceable. As stated by Dubin J.A:

In modern commercial practice, many standard form printed documents are signed without being read or understood. In many cases the parties seeking to rely on the terms of the contract know or ought to know that the signature of a party to the contract does not represent the true intention of the signer, and that the party signing is unaware of the stringent and onerous provisions which the standard form contains. Under such circumstances, I am of the opinion that the party seeking to rely on such terms should not be able to do so in the absence of first having taken reasonable measures to draw such terms to the attention of the other party, and, in the absence of such reasonable measures, it is not necessary for the party denying knowledge of such terms to prove either fraud, misrepresentation or non est factum.

This principle has been widely applied in later cases. However, there is no hard and fast rule as to when it will be decided in favour of the purchaser who signed the contract. The question of what is unusually “stringent and onerous” is something to be decided on the specific facts of each case.

Application to Borrowing Cost Damages in Real Estate Agreements of Purchase and Sale

In the case of Forest Hill Homes v Ou, 2019 ONSC 4332 (CanLII), the builder’s contract called for the buyer to pay a 20% interest rate, which is remarkably high in an environment where bank mortgage rates are around 3%. Justice Morgan ruled that it was unenforceable, because it was “surprisingly onerous” and had not been drawn to the buyer’s attention:

[19] It has been four decades since the Ontario Court of Appeal held that a surprisingly onerous term of a contract may be unenforceable if it cannot be presumed that the non-drafting party had actually agreed to it: Tilden Rent-a-Car v Clendenning, (1978)…

[20] I am not convinced that a party in the Plaintiff’s position – a subdivision builder with a standard form of contract for each of its purchasers – can enforce a surprisingly onerous and unexpected term in that contract without at least drawing it to the other party’s attention….

[21] As this court stated in Aviscar Inc v Muthukumaru, 2009 CarswellOnt 4003, at para 23, “The law is that if a person signs a contract without reading it, that person is bound by the terms of the contract. That is the general rule. There are exceptions if the signing person can establish that there was fraud, misrepresentation, or there was a very onerous term that a reasonable person would not expect to be in the contract.” In my view, this is one of those cases that falls into the latter category.

In the above case, Justice Morgan invalidated the interest clause in the contract, and ruled that the defendant should instead pay the much lower market-based rates prescribed by the Courts of Justice Act, which were in the range of 2 to 3 percent.

A buyer in another case later the same year had the same issue, but with a different outcome, in Arista Homes (Kleinburg) Inc. v. Sarah Igbinedion, 2019 ONSC 7086 (CanLII). In that case, the interest rate specified in the contract was a lower, but still high, rate of 12%. The judge did not rule that it was unenforceable in that case, as no evidence had been presented as to whether this rate represented “stringent and onerous provisions” or “that the party signing [was] unaware.” Anybody going to court on this issue would be well advised to present evidence, instead of relying on the court to accept it based on common knowledge.

The core principle of damages for breach of contract is that the innocent party is compensated for the actual losses suffered. In ordinary circumstances, breach of contract is not compensated by any punitive damages. A seller is entitled to compensation for its actual borrowing costs when a delayed closing forces it to borrow. If builders try to collect penalty interest rates that are well above their actual borrowing costs, that is punitive and likely to be unenforceable.