On September 4, 2018, Ontario’s Court of Appeal released its much anticipated decision in the case of Solar Power Network Inc. v. ClearFlow Energy Finance Corp. In the original decision, an application judge found that the use of an annualizing formula (a widely accepted mechanism in commercial agreements) failed to satisfy section 4 of the Interest Act, RSC 1985, c I-15 (the “Act”), sending shockwaves through the Canadian commercial lending world. 
Section 4 applies to any written agreement (except mortgages on real property or hypothecs on immovables) for the payment of interest for a duration of less than one year (for example, per day, week, or month). The provision stipulates that these agreements must contain an express statement of the yearly rate or percentage of interest to which the other rate or percentage is equivalent. Where such an agreement fails to comply with section 4, the Act states that the interest rate may not exceed five per cent per annum.
Despite the loan documents between Solar Power and ClearFlow providing for a far greater return, and including a statement for annualizing the interest rate, the application judge found that section 4 of the Act was not satisfied and that the lender was precluded from charging more than 5% interest. This interpretation of such a common element in commercial loan documentation created stress and uncertainty throughout the lending community when the application decision was released. Therefore, the Ontario Court of Appeal’s decision to largely overturn the application judge comes as a relief.
Solar Power Network Inc. and its affiliates (together, “Solar Power”) obtained project financing by way of a series of loans from ClearFlow Energy Finance Corp. (“ClearFlow”) to finance the development and construction of renewable energy projects. Solar Power later encountered financial difficulties and defaulted on its loans. Most of the loans that Solar Power would go on to dispute had three factors in common. The loans:
- had a base rate of interest (typically 12% per annum or 24% per annum in the event of a default), compounded and calculated monthly;
- included an administrative fee of either 1.81% or 3.55%, charged when the loan was advanced and, if not paid off, each time the loan was renewed; and
- contained a discount fee of 0.003% of the principal amount of the loan, payable on the due date of the loan and every day thereafter until the loan was repaid.
As the administrative fee and discount fee were not calculated on an annual basis, an annualizing formula was included in the loan documents in an effort to satisfy section 4 of the Act. The annualizing formula provided that:
1.2 Interest and Fee Calculations, Maximum Interest Rate
a. Unless otherwise stated, in this Agreement if reference is made to a rate of interest, discount rate, fee or other amount “per annum” or a similar expression is used, such interest, fee or other amount shall be calculated on the basis of a year of 365 or 366 days, as the case may be. If the amount of any interest, fee or other amount is determined or expressed on the basis of a period of less than one year of 365 or 366 days, as the case may be, the equivalent yearly rate is equal to the rate so determined or expressed, divided by the number of days in the said period, and multiplied by the actual number of days in that calendar year.
The Application Decision
On the application, Solar Power successfully argued that the discount fee was actually interest and not simply a fee as described in the loan documents. The application judge agreed with Solar Power that the “fee” was actually interest as it was: (i) compensation for the use or retention of money, (ii) related to a principal amount owing, and (iii) accrued over time. Once it had been properly characterized as interest, Solar Power successfully argued that the discount fee failed to comply with section 4 of the Act.
The application judge accepted Solar Power’s arguments, finding that the formula provided in the loan documents did not produce a “sufficient and equivalent rate for the purposes of satisfying s.4 of the Act”. In particular, the application judge found that the formula failed to take into account the effect of compounding on the actual rate that might be paid by the borrowers if loans were rolled over after a year. As a result, the application judge felt that further explanation ought to have been used by ClearFlow in order to provide for the equivalent effective annual rate of interest.
One particularly noteworthy aspect of the application decision was that the judge held that all interest under the loan documents, and not simply the impugned discount fees, were to be capped at 5% per annum as per a strict literal interpretation of section 4.
ClearFlow appealed the application judge’s decisions on numerous grounds and, while it was unsuccessful in arguing that the discount fee was not interest, the Court of Appeal agreed with its position that the annualizing formula contained in the loan documents satisfied section 4.
Having dispensed with the question of whether or not the discount fee constituted interest pursuant to the Act, the Court of Appeal set out to determine two questions: (1) whether the Loan Agreements complied with the Act, and (2) if not, the appropriate remedy for non-compliance.
1. Did the loan documents comply with the Interest Act?
The Court of Appeal viewed this as a question of statutory interpretation. As such, a standard of correctness was appropriate and little deference was afforded to the application judge’s decision. In determining compliance, the Court of Appeal focused on the language used by Parliament when it drafted the statute.
Section 4 of the Act states:
Except as to mortgages on real property or hypothecs on immovables, 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 per cent 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.
The Court of Appeal stressed that section 4 required an equivalent “rate or percentage”. While Parliament could have simply limited the section to the word “percentage”, it instead indicated that the effective annual interest could also be expressed as a “rate” and need not necessarily be expressed as a numerical percentage. Therefore, the Court of Appeal found that the annualizing formula provided in the Loan Agreement satisfied the requirement for a “rate” for the purpose of section 4.
The Court of Appeal also addressed the application judge’s issue with the formula’s inability to convey the effects of compounding thereby not providing an “effective” equivalent rate of yearly interest. Here the Court of Appeal was clear that since, in this instance, neither party could know if, or for how long, any of the loans would be rolled over; it was sufficient for the purposes of section 4 to provide for a formula to calculate the equivalent nominal rate. Furthermore, the Court of Appeal added that the use of formulas to satisfy section 4 was consistent with the use of formulas, upheld by the courts, to address other similar provisions of the Act. Finally, in allowing the appeal, the Court placed a strong emphasis on the argument made by ClearFlow and supported by the intervener, the Canadian Bankers Association, that weight had to be given to the “modern commercial reality” that formulas of this nature are regularly used in complex commercial loan agreements.
2. What was the appropriate remedy for non-compliance?
While most of the loan documents contained the annualizing formula, several promissory notes did not. Therefore, the promissory notes were found to breach section 4 of the Act. Rather than cap all interest arising under the documents at 5% (as the application judge had done), the Court of Appeal limited the remedy so that only interest components not in compliance with section 4 would be capped at 5%.
On this point, the Court of Appeal focused on the context of the situation: a commercial transaction, between sophisticated parties of equal bargaining power. It noted no bad faith or any attempt to subvert the law was involved and stressed that the discount fee represented a small portion of the amounts owing under the loans. To the Court of Appeal, the application judge’s decision to limit all interest payable to 5% was flawed and represented “a substantial windfall to Solar Power”. In finding that there was no evidence of an attempt to circumvent the protection of section 4, the court interpreted the phrase “any interest” in section 4 to refer only to interest that is not stated as a “yearly rate or percentage”.
This decision is a welcome and comprehensive analysis of the Act. In particular, lenders will be pleased by its clear statement on the legitimacy of using annualizing formulas in commercial financing arrangements. In that regard, we are happy to report that reason has prevailed.
That said, the decision also highlights the difficulties that can arise when courts determine that payments lenders have labeled as “fees” are, instead, actually interest and subject to the provisions of the Act. This case should serve as a reminder that courts will look to the characteristics of a charge, and not simply its name in an agreement, when making determinations on important factors such as the application of the Act.
 Stefan Mirkovic and Allen Fowlis, “The Solar Power Decision: A Matter of Interest” (27 February 2018), online (blog): Miller Thomson Financial Services & Insolvency Communiqué: <https://www.millerthomson.com/en/publications/communiques-and-updates/financial-services-insolvency-communique/february-27-2018-fsi/solar-power-decision-matter-interest/>
 In making this determination the court did imply that where it is possible to provide an “effective” equivalent rate of yearly interest by taking compounding into account, it is necessary to do so in order to comply with section 4.
 Ibid, at para. 78.
 Ibid, at para. 80.