Section 10 of the Canada Interest Act and closed mortgage loans exceeding five years: Anatomy of a legislative change

November 2011

Section 10 of the Canada Interest Act and closed mortgage loans exceeding five years: Anatomy of a legislative change

bouton-vers-francaisFredric L. Carsley
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The Interest Act1 (Canada) (Act) is federal legislation that applies across Canada. Until now, mortgage loans with maturity dates exceeding five years could be repaid with a penalty of three months' interest pursuant to Section 10(1), unless the grantor of the mortgage is a joint stock company or other corporation or the financing is structured by the issuance of a debenture by a joint stock company or other corporation.
For income tax, capital tax and other valid considerations, holders of Canadian commercial real estate frequently structure themselves as limited partnerships or trusts. Also, Real Estate Investment Trusts (REITS) represent a significant component of today's ownership segment. Yet, until now, neither limited partnerships nor trusts qualified for the exemption under Section 10(2).

Legislative history

The legislative history of these provisions is best explained by Mr. Justice Robins of the Ontario Court of Appeal, in the frequently cited Litowitz decision2, as follows:

The Section 10 right or prepayment was first enacted by Parliament in 1880. [...] Subsection 1, as the Parliamentary debates reveal (House of Commons Debates, March 31, 1880, p. 954), was intended to remedy the problem of farmers being locked into long term mortgages at high interest rates and being subjected to large bonuses or penalties when they sought prepayment. The exemption clause was enacted some ten years later in response to problems that s.-s. 1 had created for corporations, particularly railway companies, in obtaining long-term financing by way of loans secured by mortgages of real property. Lenders were understandably reluctant to provide long-term money when it was open to borrowers to repay the loan after five years even though the mortgage was closed on its terms. Subsection 2 was added to remedy this problem and facilitate long-term commercial borrowing by exempting any mortgage "given by a joint stock company or other corporation" from the operation of s.-s. 1. As a result, the application of s.-s. 1 is restricted to non-corporate mortgagors. [emphasis added in the judgement]

As mentioned above, structuring today is frequently effected through partnership or trust vehicles, neither of which are corporations. Prior to the 2008 worldwide economic recession, the capital markets provided an abundance of mortgage money for commercial property, often in the ten year closed category. To protect the lender's yield, these were either not prepayable under any circumstances prior to maturity, or prepayable with yield maintenance, to compensate the lender for economic loss it would not suffer if the principal and interest payments were made in full through to loan maturity.
The challenges Section 10 created for long term mortgage financing and the additional concerns for Quebec mortgage loans resulting from the differing treatment of nominees under Quebec civil Law from that applicable in the Common Law provinces were detailed by the writer in the Fall/Winter 2006 edition of Shopping Center Legal Update. To achieve stability, predictability and uniformity across Canada, in February 2006, on behalf of ICSC, the writer in collaboration with Mr. Steven Dover of The Capital Hill Group of Ottawa, launched a process to legislatively correct the problem. After over five years, this has now come to fruition.

The lobbying process

In 2006, we met with officials, from the Department of Finance, Canada (Finance), to explain the problem and propose a solution. What we requested was a simple amendment to Section 10(2) of the Act, adding trusts and limited partnerships to the exemption for corporations and debenture issuance. Finance appeared receptive, if we could obtain written support from some major institutional lenders. This was obtained.
As we discovered on numerous occasions throughout the process, politics trumps all. The Act would have to be amended by the parliamentary process, involving both the House of Commons (the House) and the Senate. Finance decided to package the amendment with the 2007 budget implementation legislation presentable in March 2007. In fall 2006, there was an uproar over the tax treatment of income trusts. We can never be sure, but our amendment fell out of the 2007 budget implementation legislation, possibly because trusts were involved.

We went back to the drawing board with a new group from Finance, this time headed by a former member of the tax policy group. He assured us that the proposal had been cleared by tax policy. There would be a consultative process with the provincial finance ministries, and an effort would be made to include our amendment with the 2008 budget implementation.
Finance did so, but in a rather curious manner. Section 10 of the Act was amended by making some minor wording changes to Subsection 10(1), by replacing Subsection (2) and by adding a new Subsection (3). Subsections (2) and (3) now read as follows:


(2) Subsection (1) of the Act does not apply
(a) to any mortgage on real property or hypothec on immovables given by a joint stock company or any other corporation, nor to any debenture issued by them, for the payment of which security has been given by way of mortgage on real property or hypothec on immovables; or
(b) to any prescribed mortgage on real property or prescribed hypothec on immovables given by a prescribed entity, nor to any prescribed debenture issued by it, for the payment of which security has been given by way of mortgage on real property or hypothec on immovables.


(3) For the purposes of paragraph (2)(b), the Governor in Council may, by regulation,
(a) prescribe entities; and
(b) prescribe classes of mortgages and hypothecs given by those entities and classes of debentures issued by them.

So much for a simple four word amendment! Without the "prescribed entities" and the "prescribed mortgages", nothing substantive changed. We were apprised of this when the bill had already passed second reading in the House. We met with Finance to try to convince them
simply to amend Section 10(2). Finance wanted the time to consult and examine before deciding what new exemptions would apply. The writer testified before the House finance committee, composed of representatives of the four major political parties. Everyone agreed with our proposition, but for political reasons, no changes were made to the 2008 budget implementation bill. So Section 10 of the Act as amended is in force, but without the regulations prescribing the entities and classes of mortgages. Finance promised draft regulations by fall 2008.

The new exemptions

Unfortunately, worldwide economic calamity struck in fall 2008, and this was no longer a priority. Finally, after months of prodding, in August 2010, we received an open invitation to comment upon draft regulations. On behalf of ICSC, we organized a submission, which included comments from pre-eminent real estate attorneys from various parts of Canada.
On July 2, 2011, Finance published draft regulations in the Canada Gazette, which, once approved by the Federal Cabinet, would become law and on October 20, 2011, they were promulgated. The text published in the Canada Gazette of November 9, 2011 reads as follows:
Precribed entities and classes of mortgages and hypothecs regulations

1. For the purposes of paragraph 1 0(2)(b) of the Interest Act,
a) the following entities are prescribed
(i) partnerships
(ii) trusts settled for business or commercial purposes
(iii) unlimited liability corporations as defined in the Business Corporations Act, R.S.A. 2000, c. B-9
(iv) unlimited liability companies as defined in the Business Corporations Act, S.B.C. 2002 c.57
(v) unlimited liability companies as defined in the Companies Act, R.S.N.S. 1989, c. 81

b) the prescribed class of mortgages and hypothecs consists of those issued after January 1, 2012

2. These Regulations come into force on January 1, 2012.
These will apply uniformly across Canada to mortgages and hypothecs (the Civil Law equivalent of a mortgage) granted after January 2, 2012. They will allow all exempt entities to negociate pre-payment rights and limitations with their Lenders.
Objectively, although it was a lengthy, arduous and at times frustrating process, on balance, we actually achieved more than we originally requested. The regulations apply to all partnerships, be they general or limited.
Unlimited liability companies, which are available in British Columbia, Alberta and Nova Scotia, will also be covered. The rationale here is that some ULCs are considered to be like partnerships, and therefore would be treated in the same manner.
Trusts do have a wrinkle. To qualify, they must be "settled for business or commercial purposes". REITS owning shopping centres and other commercial asset classes will be fine. Will non-profit trusts seeking long term mortgage financing benefit? The government's rationale is to apply these new rules to commercial interests. As stated in the explanatory notes to the new regulations:
Trusts can be settled to carry out a wide range of purposes including personal, charitable and education affairs, as well as for business or commercial purposes. In line with the policy objective, only trusts that are settled for business and commercial purposes, would be prescribed.
So when the mortgagor is a trust, it's objects and purposes must be scrutinized.


The process embarked upon in 2006 will provide a lasting benefit, not only to ICSC members, but to the entire commercial real estate industry in Canada engaged in the commercial mortgage loan process. The changes modernize legislation that simply did not respond to present day commercial realities and will provide both ease and flexibility to the financing process.

This bulletin provides general comments on recent developments in the law. It does not constitute and should not be viewed as legal advice. No legal action should be taken on the basis of the information contained herein.



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