in the Port Capital Development (EV) Inc. (Re)The British Columbia Supreme Court recently declined to offer further consolation to a lender in possession (DIP) in a CCAA case, issuing a statement that the interest rate and fees charged under the loan exceeded the criminal code by charging an annualized interest rate of over 60%. DIP lenders in highly distressed situations, particularly for short-term loans, must be diligent in ensuring that interest and other charges payable by borrowers on their loans do not exceed this legal threshold to avoid the possible consequences of including, in extreme cases, any interest payable thereunder will be void.
Penalty interest: When “interest” is not the same as interest
It is a criminal offense according to § 347 para criminal code for a lender to enter into a contract that provides interest in excess of 60% per annum or to receive a payment of interest. In applying this section, interest includes not only the interest rate specified in the contract, but virtually all other elements of the cost of credit, regardless of how the parties have characterized them.
The costs that have been factored into the interest calculation include, but are not limited to, commitment fees, brokerage fees, loan advance fees, setup fees, renewal fees, financing fees, bonuses, legal fees and other lender costs, capitalized interest and compensation for lost interest money advanced in the short term.
Aside from being a criminal offence, courts generally refuse to enforce an agreement charging interest above the penalty rate, as it is contrary to public policy. The courts may, at their discretion, apply a variety of remedies in this situation. At one end of the spectrum, the court may rule that the contract as a whole is void from the beginning, which is only used in the most egregious and abusive cases. The court may void the payment of interest but still require payment of the principal. At the other end of the spectrum, the court can apply a notional settlement (the so-called “blue pencil” test) and strike out contract terms that cause interest to be charged below the criminal rate (e.g., fees and costs that set you a otherwise compliant interest rate above the criminal interest rate).
Bill C-274, a private member’s bill that went on first reading on May 11, 2021, would lower the criminal interest rate to 30% plus the Bank of Canada overnight rate on the date of inception or renewal of the deal (among others changes). to the criminal interest provisions). However, the bill has not made any progress since the first reading.
Port Capital: The “onerous” loan
Port Capital is the owner of a proposed real estate development in downtown Vancouver. Port Capital started in May 2020 Law on the regulation of company creditors (“CCAA‘) after his construction lender and first mortgagee (CMLS) stopped funding and demanded payment of his loan. A sale and investment solicitation process was completed and three liquidation offers were submitted along with a “refinancing” proposal from another company that had common ownership with Port Capital (“129”), which is a loan from Domain Mortgage Corp. (“domain‘) and other funding sources that would pay off the existing DIP loan and first secured CLMS loan and provide additional funds for Port Capital to stay afloat and continue to seek a replacement lender for construction.
In June 2021, the Honorable Madam Justice Fitzpatrick of the British Columbia Supreme Court denied a motion by 129 for approval and implementation of her proposal, and instead approved the best liquidation proposal. That decision was overturned by the British Columbia Court of Appeals in September 2021 and the refinancing proposal submitted by 129 was completed in October 2021. All amounts advanced by Domain were backed by a top priority DIP fee.
Port Capital filed a follow-up motion to increase the amount of its loan from Domain, which Judge Fitzpatrick approved despite the “onerous” financing terms, as it was the only option available to avoid liquidation.
Court refuses to declare DIP loan does not cross criminal threshold
Port Capital also requested the following declaratory judgment on the application:
The terms of the February letter of commitment do not violate Section 347 of the Criminal Code, RSC 1985, c. C‑46.
The domain loan had an annual interest rate of 24% and various other fees and charges. Domain submitted a spreadsheet showing that the “total annualized interest” under Domain’s additional loan would be 52.45% (perhaps too close to 60% to be comfortable).
Judge Fitzpatrick declined to grant the requested declaratory judgment on two grounds:
- First, because the additional funding was conditional and had not yet been brought forward, the declaratory judgment sought was “in relation to a potentially contentious matter or a scenario that is speculative.”
- Second, by authorizing the legal advice that Domain obtained and the calculations that it made, the court was unable to overrule “the legal opinions of corporate actors who intend to act in a certain manner in the business community.”
Takeaways: Calculate twice, lend once
The decision highlights that in highly distressed situations, where interest and costs under a DIP loan could approach the criminal 60% threshold, lenders should take special care to ensure that total interest does not exceed this threshold at any time Exceeding the point in time, especially in view of the hard relief, can be awarded by a court if the threshold is exceeded. This risk is particularly acute with short-term loans, where setup fees and other fees can quickly increase the overall interest rate given the shorter time horizon.
It appears that DIP lenders cannot rely on the CCAA or other bankruptcy court to provide more comfort by issuing a declaration that the threshold is in fact not exceeded. The attorney can help determine whether various fees and other provisions of a DIP loan constitute “interest” and need to be considered with a DIP lender making these crucial calculations.