Initially, the Ontario Courts in the Transport North American Express case (the “Transport Case”) held that where a credit agreement obligated the borrower to pay a rate of interest which was determined to be in excess of sixty percent per annum, contrary to Section 347 of The Canadian Criminal Code, a judge should be entitled to effect a “notional” severance of the interest payment provision in the agreement by “reading down” the rate to sixty percent per annum.
This initial decision (made in May of 2001) was a departure from previous decisions concerning illegal interest under Section 347 in that where a Court determined that the illegal interest payment portion of a contract should be severed from it, keeping the “legal” principal payment portion of the contract intact, the Courts would simply eliminate the obligation to pay any interest at all, allowing the creditor to obtain repayment of its principal monies (but only the principal monies) advanced.
In the Ontario Court of Appeal decision for the Transport Case (released in June of 2002), it was held that this flexible - and creditors would certainly argue reasonable - approach should not be taken because the statute (the Criminal Code) and the case law pertaining to same didn’t really justify same. This holding makes it all the more critical for lenders to include properly drawn severance clauses in their loan agreements so that the Courts will have a basis on which to permit a creditor to charge and collect a lesser (and “legal”) amount of interest (something equal to or less than sixty percent per annum), while disallowing the creditor’s claim to anything in excess of sixty percent per annum. However, it must be kept in mind that even with a properly drawn severance clause, the Courts may not necessarily uphold that clause where the Court is of the opinion that to do so would be to subvert the policy behind Section 347. A Court would likely believe that such policy would be subverted where it viewed the creditor’s conduct as an outrageous attempt to extract unreasonable consideration such as, where the arrangement really was one which could be viewed as “loan sharking”. Indeed in the Transport Case, the Court noted that the transaction under challenge was a commercial one rather than loan sharking, the parties’ intention was not to contravene or evade Section 347 and they had bargained from relatively equal positions, and, each party had separate and informed legal advice.
The Transport Case is now being considered by the Supreme Court of Canada. Thus in the near future, we should find out if the trial Court’s flexible approach to dealing with “criminal” rates of interest will be upheld.