January 14, 2019
Interest rates and contractingBY ROBERT KENNALEY AND JOSH WINTER
You have completed your contract, you’ve sent your invoice but no payment appears to be forthcoming. Upon reflection, you remember that your invoice references a healthy rate of interest, which you think can work in your favour. Stating a rate of interest on an invoice, however, might not be effective. Further, recovering a contractual rate of interest in the event of continued non-payment, or a dispute, can help offset collection costs. Accordingly, it is important to understand how interest rates will, and will not, apply in particular circumstances.
According to Section 2 of the federal Interest Act, any person may stipulate any rate of interest or discount that is agreed on. It should be noted, however, that Section 347 of the Criminal Code of Canada establishes a ‘criminal rate of interest,’ currently at 60 per cent per annum. You are therefore prohibited by law from charging a rate of interest in Canada which exceeds this amount.
It is not sufficient to simply insert an interest rate on an invoice. Rather, in order to receive a specified rate of interest, the interest rate should be expressly provided for in the contract. Further, Section 4 of the federal Interest Act states the rate of interest must be expressed on a per annum basis in a contract. If it is not, the applicable interest may generally not exceed five per cent per annum, or year. Accordingly, simply stating in a contract that interest will be charged at even a low rate of one per cent per month will not be effective, as this would equate to over five per cent per annum, and a “per annum” rate must be specified.
The Interest Act recognizes that interest might be payable ‘by law,’ even if the contract is silent on the issue. It recognizes, for example, that the Courts of Justice Act in Ontario specifies a pre-judgment interest rate to be paid on Judgments obtained by parties through litigation in the Ontario Courts. These rates, however, are nominal in comparison to what you might otherwise be entitled to charge under your contract. Since January of 2008, for example, the rates in Ontario have varied between 0.5 per cent and 4.8 per cent. Also, there is post-judgement interest, where interest begins to accrue from the date of the judgement, until payment is received.
The Courts will generally recognize a contractual rate of interest, so long as it is applied on a ‘per annum’ basis and is not at, or above, the criminal rate. In other words, if the Courts of Justice Act would only give you 0.5 per cent per annum, but your contract states you are to be paid 12 per cent per annum, the Courts will generally allow the contractual rate of 12 per cent to apply. The difference, of course, can be very significant.
The Courts might also award compound interest, but only if it can be shown the parties agreed that, the debt would bear compound interest as damages for default of payment. Interest is compounded, of course, as the applicable rate is applied not only to the principal amount owing, but also to the interest that has built up over time. The easiest way to show that the parties agreed to the compounded rate is to expressly provide for it in the contract. The Courts, in fact, will rarely apply compound interest where the contract does not expressly provide for it.
Further, in exercising its judicial discretion, the court should not interfere with the plaintiff’s right to receive pre-judgement interest on damages by reducing the amount due to inflation. It must be noted the court retains the ultimate decision to fix the rate of interest, regardless of a contractually agreed upon rate of interest for unpaid amounts. This was made clear in the Supreme Court of Canada case, Bank of America Canada v. Mutual Trust Co.  SCC 43.
Providing for interest at a rate which exceeds the relatively nominal rates established by the courts can better protect your position in the event of a dispute. Further, if you state the interest will be compounded (for example, monthly), your position will be even further strengthened should litigation be necessary. Given the amount of time it can take to bring litigation through our Court systems, the interest can add up quickly and put significant pressure on the other side during the process.
In summary, we suggest you always include a provision in the contract which specifies the interest rate to be applied on a per annum basis. Also, if you wish the interest to be compounded, you should make sure to include a provision in the contract which expressly provides this. Of course, whether or not you want to charge compound (or any) interest will be a business decision, based on how you believe your clients will react to the requirement.
Robert Kennaley and Josh Winter practice construction law in Toronto and Simcoe, Ont. They speak and write on construction law issues and can be reached for comment at 416-700-4142 or at firstname.lastname@example.org and email@example.com. This material is for information purposes and is not intended to provide legal advice. Readers who have concerns about any particular circumstance are encouraged to seek independent legal advice in that regard.