Feb 28, 2020

The interest rate penalty clause for breaching the contract: the latest Ontario case

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

A healthy tension runs through English common law of contract on the subject of whether a particular clause is unenforceable because harsh and onerous. Is a 20% interest rate, on breaching a contract, too onerous to be enforceable?

Ontario Superior Court Judge E.M. Morgan thinks so. (para 20).

Morgan J. analogizes the purchaser of a million dollar real estate new-build to the renter of a car in the well-known ticket case Tilden Rent a Car v. Clendenning (1978) CanLii 1446 (ONCA). Apparently, a red hand needs now be pointing to a 20% interest rate clause in a commercial transaction between professional parties. (para 19).

The decision is wrong and inefficient.

Wrong because Morgan has no business applying the ‘ticket’ cases (where an unsophisticated party buying a relatively trivial product in a rushed atmosphere where careful mutual bargaining is not possible will not be held to unexpected and onerous terms) to the interest rate penalties in commercial agreements between professional parties.

Wrong because there is already a statutory prohibited interest rate of 60% around which the entirety of the interest rate penalty jurisprudence equilibrates.

Wrong because the Ontario Court of Appeal in Miliani v. Banks (1997) 145 DLR (4th) 55 (cited with approval by the SCC) has upheld an 18% interest rate penalty in the very case where it struck down an additional lump sum penalty. (The point being: if 20% were especially onerous and intolerable what’s the Court of Appeal upholding an 18% rate?)

Wrong because the supreme court of Canada has explicitly stated that remedies available to a trial judge striking down an interest rate above 60% include setting the interest rate at 60% (Transport North American Express Inc. v. New Solutions Financial Corp [2004] SCJ No.9, para 32).

Wrong because if Morgan’s personal whim, that 20% is too onerous, were a valid reason for striking down a 20% interest rate, what’s Arbour J. doing upholding a 60% interest rate? (Transport North American Express Inc. v. New Solutions Financial Corp [2004] SCJ No.9, para 33). Why wouldn’t she get with the program and strike down 60% interest on the basis of the ‘ticket’ cases?

In particular, Morgan’s resolution, of reducing the rate to the Courts of Justice rate (2%), is arbitrary. (para 26).

Where a group entered into a criminal agreement, clearly containing interest rates above 100%, in that case, the Ontario Superior Court though it justifiable to reduce to zero the interest rate chargeable on the contract. (Golden Oakes Enterprises (Trustee of) v. Scott [2019] O.J. No. 4446 at para 466. How is it consistent to reduce a 20% interest rate to 2%? Or is this part of the randomness of justice and whatnot?

Efficiency

Assuming Morgan’s prohibition of 20% interest rate becomes the new norm in Ontario contract law, what could be expected to be the result?

One starts with the purpose of the 20% penalty. The prevailing critique is that it has no purpose. That it is a ‘windfall’. That type of Merchant of Venice talk is always very popular and always very wrong.

Assuming there is a purpose for the interest rate of 20% applying to the failed transaction. The first rule of economics (not of law) is humility. We can’t know the complex rationale of a 20% penalty interest rate. But there is a purpose and the need (fulfilled by this penalty) will demonstrate itself elsewhere in the transaction chronology.

In the Merchant of Venice, Shylock is the villain, the usurer. A 35% lender in a commercial environment which pretended to say that interest rates were dishonourable. In such an environment, how did commercial transactions take place? Antonio is the embodiment of the righteous and good zero-interest commercial party. Instead of lending money to the third party ship owners, to acquire trade goods in other countries, Antonio must own the ships and the cargo. The law against usury turns the would-be lender into an owner. Is this efficient?

So what will the Morgan-doctrine do to new-builds in Ontario?

I suspect that the ease of acquisition by low-income buyers will become less easy. The injured builder, denied the risk-protection tool of a 20% penalty rate, will manifest his risk aversion the old fashioned way, the way commercial banks do it – by front-loading the risk analysis.

Builders will now take more care at the front-end and eliminate from the pool of people who are permitted to sign a purchase and sale agreements, any who are likely to breach – that is to say any who do not have pre-arranged finance or other letter of credit.

The countervailing winds of easy credit generally will make the Morgan-effect impossible to isolate in an empirical setting. Identifiable or masked, the effect will be there if the Morgan-doctrine becomes the norm.

John Stuart Mill call the Catholic laws against usury in middle-age Europe the cause of the 'industrial inferiority' of the Catholic regions of Europe compared to the Protestant areas where no such anti-interest laws prevailed (p.926).

Mill called this 'interference with contracts' which 'interfered with the spontaneous course of industrial transactions.' (p.926)

There is something valuable in the spontaneous course of industrial transactions.