DIP loans and the criminal interest rate | Bennett Jones LLP
[co-author: Amy Yun – Summer Student]
In Port Capital (EV) Inc. (Re), 2022 BCSC 370,1 the British Columbia Supreme Court recently refused to grant a declaration that the interest rate and fees charged under a debtor-in-possession (DIP) loan did not violate section 347 of the criminal code. The decision emphasizes that DIP lenders, particularly those involved in short-term loan transactions, should exercise due diligence to ensure that interest and other fees payable associated with a loan do not raise the criminal threshold, as a court will not preemptively provide comfort in this regard.
The criminal interest rate
Section 347 of the criminal code makes it an offense for a lender to enter into an agreement or receive an interest payment with an effective annual interest rate greater than 60%. Interest, for the purposes of criminal codeunderstand Every expense payable by the debtor to receive the loan, regardless of how the parties have characterized such charges. Although initially intended to deter loan sharks, the breadth of this provision provided a basis for borrowers to attack payments due under commercial loan agreements. Note that some payday lenders are exempt under section 347.1 of the criminal code provisions and regulated at the provincial level.
Application to DIP Loans
DIP financing describes a situation where an insolvent company (i.e. the debtor) remains in possession of its affairs in a restructuring process and receives additional financing from an existing creditor or a third party. The risk of lending to an insolvent business often allows DIP lenders to charge higher fees and interest rates. Therefore, incidental fees and other borrowing costs borne by debtors may, in theory, inadvertently push the ultimate interest rate, charged or paid, past the threshold of criminal interest.
The decision in Port Capital
The fear of such a risk is confirmed by the motion for declaratory judgment in Port capital. Port Capital, the owner of a real estate development project, commenced insolvency proceedings under the CCAA in May 2020. It then filed for an increase in the amount of its DIP loan with its lender, Domain Mortgage Corp. The additional funding was approved by Judge Fitzpatrick, despite its “onerous” conditions. As part of this application, Port Capital also sought a declaratory judgment that the terms of the additional loan did not violate the criminal rate of interest under section 347 of the criminal code. The loan bore an interest rate of 24% and required the payment of various loan servicing fees, mortgage brokerage fees and fundraising fees. The lender provided a spreadsheet showing that the “total annualized interest” was 52.45%. The amount advanced and the ultimate term of the loan may affect the calculation of the effective interest rate received.
However, Justice Fitzpatrick declined to grant declaratory relief on two grounds:
- First, given that the loan had not yet been executed and that the question of the interest rate that would arise was largely speculative, the declaratory judgment sought related to “what is potentially a theoretical question or a scenario that is speculative” .
- Second, the Court recognized that the parties would have obtained extensive legal advice on this issue and turned their attention to the question of whether the financing exceeds the criminal rate of interest. While this is an expected and prudent course of action, “it is not the role of this Court to uphold the legal opinions of corporate actors who intend to act in a certain way in the business world”.
Implications for commercial lenders
port capital stresses the importance for corporate lenders to exercise due diligence when interest and other charges on a loan could approach the 60% criminal interest threshold. Although CCAA proceedings are supervised by the courts and therefore often provide some inherent comfort to the parties involved as transactions are approved by the courts, this decision underscores that DIP lenders will not be able to rely on this comfort regarding the issue of billing or receiving a criminal interest rate. By its own calculations, the numerous charges on Port Capital’s DIP loan ultimately generated an annualized interest rate of 52.45%, an increase of 28.45% from the specified rate of 24%. In order to prevent DIP loans from inadvertently exceeding the criminal interest threshold, it is important that parties consider including costs and fees outside of the stated interest rate in the calculation of interest for purposes of section 347 of the criminal code.
1 Bennett Jones LLP acted as counsel for the plaintiffs, Port Capital Development (EV) Inc. and Evergreen House Development Limited Partnership.