DIP Loans and the Criminal Rate of Interest

May 26, 2022

Written By Denise D. Bright, David E. Gruber, Preet K. Gill and Amy Yun

In Port Capital (EV) Inc. (Re), 2022 BCSC 370,¹ the Supreme Court of British Columbia recently declined 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 highlights that DIP lenders, especially those involved in transacting short-term loans, should exercise diligence to ensure that interest and other charges payable associated with a loan do not trigger the criminal threshold, as a Court will not pre-emptively provide comfort in this respect.

The Criminal Rate of Interest

Section 347 of the Criminal Code makes it an offence for a lender to enter into an agreement, or to receive a payment of interest, with an effective annual interest rate in excess of 60 percent. Interest, for purposes of the Criminal Code, includes all charges payable by the debtor in order to receive the loan, regardless of how parties have characterized those charges. While originally intended to deter loan sharks, the breadth of this provision has provided a basis for borrowers to attack payments owing as part of commercial loan agreements. It should be noted that certain payday lenders are exempted under section 347.1 of the Criminal Code provisions and regulated provincially.

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 either a current creditor or a third party. The risk of lending to an insolvent company often allows DIP lenders to charge higher fees and rates of interest. Therefore, ancillary charges and other costs of borrowing payable by debtors may, in theory, cause the ultimate interest rate, charged or paid, to inadvertently cross the criminal interest threshold.

The Decision in Port Capital

The concern for such a risk is borne out in the request for declaratory relief in Port Capital. Port Capital, the owner of a proposed real estate development, commenced CCAA insolvency proceedings in May 2020. It subsequently brought an application to increase the amount of its DIP loan from its lender, Domain Mortgage Corp. The additional financing was approved by Justice Fitzpatrick, despite its "onerous" terms. On this application, Port Capital also sought declaratory relief that the terms of the additional loan did not violate the criminal rate of interest in section 347 of the Criminal Code. The loan bore an interest rate of 24 percent, and required payment of various loan serving fees, mortgage broker fees, and fund raising fees. The lender provided a spreadsheet demonstrating the "total annualized interest" to be 52.45 percent. Both the amount advanced and the ultimate term of the loan may impact the calculation of the effective rate of interest received.

However, Justice Fitzpatrick declined to grant the declaratory relief on two grounds:

1. First, since the loan had not yet been acted upon, and the issue of what interest rate will arise was largely speculative, the declaratory relief sought was "in respect of what is potentially a moot matter or a scenario that is speculative."
2. Second, the Court recognized that the parties would have obtained substantial legal advice on this issue, and directed their minds to the issue 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 backstop the legal opinions of corporate actors who intend to act in a certain fashion in the business world."

Implications for Commercial Lenders

Port Capital underscores the importance of corporate lenders exercising diligence where interest and other charges under a loan could approach the 60 percent criminal interest threshold. While CCAA proceedings are court-supervised, and therefore often contain some inherent comfort for the parties involved as the transactions are court-approved, this decision highlights that DIP lenders will not be able to rely on that comfort with respect to the issue of charging or receiving a criminal rate of interest. On its own calculations, the numerous charges on Port Capital's DIP loan ultimately accrued an annualized interest rate of 52.45 percent—a 28.45 percent increase from the specified rate of 24 percent. In order to prevent DIP loans from inadvertently exceeding the criminal interest threshold, it is important for parties to consider the inclusion of costs and fees outside the stated interest rate in calculating interest for purposes of section 347 of the Criminal Code.

¹ Bennett Jones LLP acted as counsel for the petitioners, Port Capital Development (EV) Inc. and Evergreen House Development Limited Partnership.

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