Momentum towards lowering Canada’s criminal rate of interest?

On August 9, the Canadian government published a consultation paper seeking feedback on proposals to reduce the criminal rate of interest of 60 percent and make other changes in how high cost loans are provided in Canada.

Though a reduced rate has not yet been proposed, the initiation of the consultation does suggest that change may be coming. To the extent a reduction in the interest rate cap does result, it could have a significant impact for Canadian lending markets—particularly for highly distressed situations where risk profiles are high and time horizons are short.

Yet, while the stakes are high, it remains to be seen whether reforms will be broadly applied. Based on the consultation itself, the federal government appears to be concerned almost exclusively with the high-cost consumer loans, suggesting that any reforms are unlikely to affect the commercial loan market writ large.

The current regime

Under Section 347 of Criminal Code, it is an offence to enter into an agreement or arrangement to receive interest, or actually receive interest, at an effective rate exceeding 60% annually.

For this purpose, "interest" is defined broadly and includes all fines, fees, commissions, expenses and penalties charged or paid in connection with the underlying loan (e.g. arrangement, commitment, bonus or late fees, legal costs and expenses, etc.), subject to only limited exceptions. It also refers to the effective annual rate of interest and takes into account the actual timing of payments. Thus, for instance, where a loan is otherwise inoffensive but also charges substantial further fees and/or has a short term repayment term, it can breach Section 347.

Notably, the Code exempts consumer payday lenders from the 60 percent limit where certain conditions are met. To qualify, (a) the loan must be CAD$1,500 or less and for a maximum term of 62 days or less; (b) the lender must be provincially licensed as a payday lender; and (c) the province at issue must have certain further consumer protection rules in place and have been so designated by the federal government. 

Beyond the punishments that can attach to the criminal offence itself, courts have a variety of civil remedies at their discretion where Section 347 is breached. Most typically, they will "read down" or sever the offending provisions at issue such that the agreement can be brought into compliance or require only the repayment of the principal. In particularly egregious circumstances, a court may even decline to enforce the agreement in its entirety.

Prior efforts at reform

The consultation follows on the heels of a number of recent prior attempts at reform.

When the criminal rate of interest was set in 1980, the Bank of Canada's overnight rate was 21 percent. With the Bank of Canada having maintained a near zero overnight rate for over 10 years however (and a rate below 12 percent for over 30 years), calls for reform have been growing. Since 2013, five private members' bills have been introduced that would have reduced the rate substantially and in increasingly larger amounts. The most recent of these, Bill-S-239, reached second reading in the Senate in March 2022 and would have set the rate to just 20 percent above the Bank of Canada's overnight rate.

Though none of these bills have received sufficient support from the government to pass into law, they have nevertheless had an impact—particularly as cost of living issues have become more politically salient. The federal government announced in the 2021 Budget that it would seek to fight "predatory lending practices by payday lenders" and followed it with a similar instruction to the Minister of Finance in their December 2021 public mandate letter. Finally, last month, they launched the consultation on lowering the criminal interest rate.

The consultation

The consultation generally focuses on consumer and payday lending and solicits comment across four primary issues, as follows:

• Rates and Pricing Risk – Whether the interest rate pricing set by high-cost alternative lenders (who, per the consultation, typically lend to consumers at the maximum allowable rate under the law) is a reflection of the actual credit risk of a borrower or whether the interest rates on these loans are set simply to comply with the ceiling permitted under the criminal rate of interest.
• Access to Credit – What impact lowering the criminal interest rate (including if lowered substantially) would have on the availability of credit to financially vulnerable consumers.
• Other Loan Products – What impact lowering the criminal interest rate would have on credit products other than high-cost installment loans.
• Consumer Education – How the federal government, including the Financial Consumer Agency of Canada, could improve financial education and awareness with respect to high-cost installment loans.

The Department of Finance has asked for written feedback from the public and stakeholders by October 7, 2022.

Takeaways: Exclusions (likely to) apply

Given the broad manner in which the criminal rate of interest rule currently operates (including how "interest" covers nearly all loan costs and fees), any change in the capped rate has the potential to significantly affect Canadian lending markets. This will be particularly the case for lenders in distressed situations where short time horizons, cash sweeps and additional fees and expenses can often push effective interest rates especially high. 

So, should lenders anticipate a lowering of the maximum rate in the near term? It's hard to say.

The initiation of the consultation suggests that there is definite momentum towards reform. However, whether any such reform will affect a given lender is another question and is likely to depend on to whom they lend. Specifically, it appears likely that commercial lenders will be largely exempted from any reforms, while lenders to individual consumers, and above all those who are financially vulnerable, will be more directly affected.

The primary reasoning behind this opinion is based on the content of the consultation itself. The questions asked by the consultation are almost exclusively concerned with high-cost installment loans and payday lending-type products and their impact on individual consumers. The questions cover such vulnerable consumers' access to credit, the reasons for their seeking high-cost credit and how greater consumer education may help consumers avoid especially risky loan products. By contrast, the consultation almost completely ignores commercial loans to businesses, mentioning only bridge financings for real estate transactions as examples of the sort of high-interest, non-consumer loans that a reduced maximum interest rate might inadvertently affect.

Taken together, this suggests that the government's animating concern with the initiative is to protect financially vulnerable individuals rather than to interfere with lending arrangements between or to businesses.

Whether these apparent early priorities will bear out in any future amendments to Section 347 remains to be seen, but the stakes are high. Lenders would do well to monitor this issue closely going-forward.