It is In Your Best Interest! – How to Express Interest Rates in a Contract?

Whether you are drafting a contract or signing one, there are several areas in which you should be careful. One of these areas is the manner in which interest rates for late payments are expressed in the contract. This is common in credit cards, vehicle lease arrangements, or contract work such as renovations or landscaping. In the event of a signee failing to make a payment on time, interest is usually charged by the drafter to encourage payments as soon as possible.  For example, to encourage you to make your lease payments on time, your lease agreement might say the following:

“25. LATE CHARGE: Subject to applicable legislation, if any amount, including any termination liability owing under Section 16 or Section 24, remains unpaid after its due date, you will pay per diem interest on the unpaid amount at the interest rate of 12% per annum”.

This section is an actual copy of Honda’s standard lease contract, found on their website. These terms and interest penalties are quite common and considering that the interest rate is 12% per annum, it is quite a good rate.

This example provided by Honda is perfectly normal. It is also very clear: if you fail to make a payment by the due date, you are charged interest. What many drafters and signees fail to realize however is that in most contractual agreements, interest rates expressed as “per annum” are the only way you are allowed to express an interest rate. This has been the case since the Interest Act (Canada) came into force in 1985. Section 4 of the Interest Act (Canada) stipulates the following:

“Except as to mortgages on real property or hypothecs on immovable, whenever any interest is, by the terms of any written or printed contract, whether under seal or not, made payable at a rate or percentage per day, week, month, or at any rate or percentage for any period less than a year, no interest exceeding the rate or percentage of five percent per annum shall be chargeable, payable, or recoverable on any part of the principal money unless the contract contains an express statement of the yearly rate or percentage of interest to which the other rate or percentage is equivalent”^[1] (emphasis added).

The implications of this section are two-fold.  The first part of S.4 means that if an interest rate is expressed in any manner other than “per annum”, then no matter how high the interest rate may be, it defaults to a maximum of 5% per annum. The second part of S.4 contains an exception to this strict principle. The exception to this would be to include the additional monthly compounded amount expressed in per annum numbers as well. This would be called the “effective rate”. As an example, if an interest rate were to be expressed as, “18% per annum, compounded monthly”, then it might default back to a maximum of 5% per annum. On the other hand, if you were to express the interest rate as, “18% per annum, compounded monthly (effective rate of 19.56% per annum)”^[2], then it would likely be enforceable.

All across Canada, the provincial courts have struggled to find a consistent application of this law. In fact, in 2007, the Uniform Law Conference of Canada (ULCC) discussed the difficulties and inconsistent case results that have varied throughout the provinces^[3]. For example, in Elcano Acceptance Ltd. v Richmond, Richmond, Stambler and Mills, the Ontario Court of Appeal said that expressing 2% per month and equating it to 24% per annum would not truly demonstrate the actual interest rate per annum. In fact, the actual interest rate per annum would be 26.8% per annum^[4]. However, the original trial judge in that case had previously expressed that 2% per month was obviously implying a per annum rate of 24%.^[3].\ The judges cannot seem to agree!

Meanwhile, in Canadian Tire Acceptance Ltd. Card Holders v Canadian Tire Acceptance Corp. the courts said that finding out the exact per annum interest rate when compounded monthly is almost mathematically impossible and would vary from client to client, as many would be paying different amounts per month.^[6] This would undoubtedly affect the effective per annum rate.

The conclusion is that the most effective way to express contractually agreed interest rates are on a per annum basis; it is the safest way. If you insist on including a compounding monthly amount, it should be expressed with the effective rate as well (i.e. 18% per annum compounded monthly [an effective rate of 19.56% per annum]). Drafters, if you are not already drafting your contracts with per annum amounts, we highly recommend you do. Signees, if you are currently involved in a contractual dispute which happens to involve an interest rate that is expressed contrary to S.4 of the Interest Act (Canada) 1985, you should know your right to have that interest rate potentially reduced. As always, if you are unsure, consult a corporate lawyer or a business lawyer.

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