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Can a lender charge a mortgage pre-payment penalty under Power of Sale proceedings or once the mortgage term has matured, regardless if it is an Open or Closed Mortgage?

Under section 17 of the Mortgages Act, and pursuant to relevant case law the answer is “Yes” the lender can.  Subject to the wording in the original mortgage commitment/agreement, you will often find that lenders will charge 3 months interest pre-payment penalty if they have to enforce the mortgage via a power of sale proceeding or if you neglected to renew the mortgage once the term has expired and have failed to pay the lender out (within the time allotted pursuant to the lender’s notice).  Also, often enough, the original mortgage commitment/agreement will have qualified wording for “Open” mortgages stipulating that so long as the borrower is not in default, the borrower will be able to pre-pay the mortgage in whole or in part without a penalty or bonus.  However, once in default, a lender can demand the penalty payment of three months’ worth of interest calculated on the then outstanding principle balance, even if your mortgage is an Open one.

In relevant case law the courts have often ruled in favor of the lender on disputes over its right to charge penalties pursuant to section 17 of the Mortgages Act, where the borrower was found in default of payment of any principal or interest money.

In Ialongo vs. Serm Investments Ltd. 54 RPR (4th) 310 (2007), the borrower was found to be in default where it was undisputed that the borrower did not pay the lender the amount required to discharge the mortgage when it matured.  The borrower then suggested that the payment of a penalty would contravene subsection 8(1) of the Interest Act, which stipulates the following:

8. (1) No fine, penalty or rate of interest shall be stipulated for, taken, reserved or exacted on any arrears of principal or interest secured by mortgage on real property or hypothec on immovables that has the effect of increasing the charge on the arrears beyond the rate of interest payable on principal money not in arrears.

(2) Nothing in this section has the effect of prohibiting a contract for the payment of interest on arrears of interest or principal at any rate not greater than the rate payable on principal money not in arrears.

In this case the lender relied solely on subsection 17(1) of the Mortgages Act as the basis for requiring such a payment, and the same case sited two other cases:

Mastercraft Properties Ltd. vs. El EF Investments Inc. (1993), 14 O.R. (3d) 519 (C.A.) the court held that subsection 17(1) of the Mortgages Act and mortgage covenants reflecting its terms, operate in harmony with section 8 of the Interest Act.

For the court noted at paragraph 4, where a mortgagor (borrower) in default is given the choice between providing three months’ notice or paying the arrears before the three months expire, the required bonus of three months’ interest is not an amount pain in punishment for a breach of the mortgage contract, but a payment required for the privilege of paying arrears without the necessity of giving the three months’ notice contracted for. As a result, it held that section 17(1) of the Mortgages Act did not conflict with section 8(1) of the Interest Act.

Gullett vs. Income Trust Co., [1985] O.J. No. 200 (C.A.) at para. 21, the court repeated the rationale of section 17 of the Mortgages Act stating:

It protects the mortgagee (lender) by giving him a three-month period during which to arrange for reinvestment of his principal, or monies to compensate for lack of that notice.

Also that the lender does not waive its rights by negotiating a renewal that eventually fails, regardless if the lender accepted mortgage payments in the interim.  Had the borrower given notice at maturity and three months went by during the negotiations, the borrower would not have had to pay an additional three months’ interest.

This case remains authority for a lender to require payment of three months’ interest as a bonus upon a default occurring at the maturity of the mortgage.

Given the borrower’s request for early payment, the lender/mortgagee was entitled to include a payment of three months’ interest in its pay-out/discharge statement. The statement complied with section 17(1) of the Mortgages Act, and as a result no question of incompatibility with the Interest Act arose.

NOW, did the issuance of the Notice of Sale (initiating a Power of Sale proceeding) affect the lender’s entitlement to claim interest under section 17 of the Mortgages Act?

In O’Shanter Development Co. vs. Gentra Canada Investments (1995), 25 O.R. (3d) 188 (Div. Ct.), the borrower was in default on the mortgage and the lender commenced a power of sale proceeding.  In this case the mortgage contained a clause requiring prepayment of the lender’s costs, with a minimum of three months’ interest, if default occurred prior to the maturity date. The court noted that although section 17 of the Mortgages Act overrides a mortgage contract, and thus it was open in that case for the borrower, upon default, to have given notice OR make the three months’ interest payment provided for in section 17, that it was not contingent on the lender not yet realizing on its security (as argued by the borrower).

The court’s view was that a borrower ought not to be able to avoid the covenant to pay three months’ interest by purposefully defaulting and forcing the lender to enforce the charge.

“If the submission of O’Shanter were to be accepted, a borrower with the same terms could avoid the prepayment amount simply by allowing the mortgage to go into default and forcing the lender to take steps to realize on the security. Equity will on occasion relieve a borrower of the rigorous terms of a mortgage document, but that, in my opinion, is not the case here. A borrower should fulfill his proper contractual obligation as a condition of redemption.”

By applying section 17 of the Mortgages Act to the mortgage, the court in O’Shanter, supra, ultimately held that the lender was entitled to the three month interest payment on default.  The Court decided that equity would not relieve a borrower of its obligations to pay the interest bonus. To do so would allow the borrower to purposefully go into default and force a lender to take steps to realize on its redemption (power of sale), thus allowing the borrower to avoid the prepayment clause.

In Irwin Mintz, In Trust vs. Mademont Yonge Inc., [2010] O.J. No. 660, if there is a default in payment; to obtain a discharge, a borrower may either pay three months’ interest on the principal in arrears or may give three months’ notice of its intention to pay. Provided payment is made, no further interest need be paid.  Here the court relied on the following case:

Gullett vs. Income Trust Co. [1985] O.J. No. 200 (C.A.), (the same case cited above), again reiterating that section 17 of the Mortgages Act applies to a mature mortgage.  Furthermore, In this case the mortgage matured on November 15, 1983, no notice was given by the borrower but the lender continued to accept interest payments while the borrower and lender negotiated a renewal of the mortgage.  The court noted that had the lender done nothing on the date of maturity, the covenant would have taken effect and three months’ interest in lieu of notice would be payable.  The court then found that the lender had not waived its rights to three months’ interest simply by accepting interest payments after maturity.  The court therefore ordered that the borrower pay three months’ interest as compensation.

In a more recent case, 2088300 Ontario Limited vs. 2184592 Ontario Limited, 2011 ONSC 2986 (CanLII), the court considered the decision of the Divisional Court in O’Shanter Development (cited earlier/above), which specifically says that “section 17 of the Mortgages Act overrides the mortgage contract.  The court also accepted the reasoning of the court in 1259121 Ontario Inc. vs. Canada Trust Company, 2007 CanLII 8628 (ON SC) and that in in Piesok vs. Johnson, 2010 ONSC 1284 (CanLII) (which reaffirmed the ruling/law in Ialongo vs. Serm Investments Ltd. ), that it would be inequitable for the borrower, who would be required to pay the three months of interest in order to cure its default, to benefit from a failure to remedy its default to the extent of those three months of interest.  And thus found that the lender was entitled to claim the three months of interest as part of the amount required to redeem the mortgage after Notice of Sale was issued. [THIS IS THE CURRENT CASE LAW]

Finally, in Lister Property Corp., LIUNA Local 837 vs. 810322 Ontario Ltd., [2006] O.J. No. 3260 (S.C.J.), the borrower sought a declaration that it is not required to pay an additional three months’ interest, and for return of the three months’ interest payment the lender holds in trust.  The borrower did not pay on maturity/demanded as required. Hence the lender issued a notice of sale under mortgage, claiming principal and interest to that date, together with the additional three months’ interest.  The lender took the position that the failure to pay on that date was a default, entitling the lender to three months’ interest under section 17 of the Mortgages Act.  The borrower suggested that this remedy is only available in circumstances where the borrower wishes to prepay a mortgage, or prior to the maturity of a mortgage.  The borrower said that section 17 does not apply once the borrower has the right to redeem under a power of sale proceeding.  The court held that the borrower’s reasoning was inconsistent with the that in Gullett vs. Income Trust Co. [1985] O.J. No. 200 (C.A.) [cited earlier/above] and SK Properties and Development Inc. vs. Equitable Trust Co. [2003] O.J. No. 2234, as well as the plain wording of section 17 of the Mortgages Act.  The court reaffirmed that section 17 provides that the three months’ interest becomes payable on default. Failure to pay the mortgage in full on its due date was a default that triggered section 17 requiring the payment of three months interest, just as it did in SK Properties.  The lender is entitled to the three months’ interest regardless of taking steps to realize on its security (i.e. Power of Sale).