Canadian Mortgage Law and Prepayment Penalties

Western Journal of Legal Studies

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Canadian Mortgage Law and Prepayment Penalties

Abstract

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Keywords

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CANADIAN MORTGAGE LAW AND

PREPAYMENT PENALTIES

PETER SPIRO*

INTRODUCTION

Throughout their lives, people sell and purchase homes a number of times for a

variety of reasons. In Canada, approximately 500,000 homes are sold per year, most of

which have mortgages registered on their titles.

Many Canadians buy and sell rental

properties in the hope of realizing both rental income and capital gains. In these

transactions, either the purchaser of the property assumes the existing mortgage, or the

mortgage is discharged on closing and a prepayment charge of at least three months’

interest must be paid to the lender, as is almost universally provided for in the mortgage

contract. These prepayment charges are colloquially referred to as “penalties.” Lenders,

however, do not use this terminology, because penalties have a specific meaning in

contract law and are generally unenforceable. In residential mortgages, litigation often

costs more than the penalty payment.

Despite this, litigation has increased in recent

years, although it is still rare. For example, prepayment charges on residential mortgages

were the subject of a recently failed class action,

as discussed below.

In 2010, the federal government’s budget included a promise to bring clarity to

the subject of mortgage penalties. Here, the federal government specifically used the term

“penalty” and recommended “[s]tandardizing the calculation and disclosure of mortgage

pre-payment penalties”:

It is important that consumers have the information they need when making

financial decisions, including when to prepay a mortgage. As such, the

* Peter Spiro has combined interests in law and economics. He is an Executive Fellow of the Mowat Centre

for Policy Innovation at the University of Toronto's School of Public Policy and Governance, and a JD

graduate of Osgoode Hall Law School. He would like to thank Adjunct Professors Craig Carter, Mark

Hartman, and Justice Paul Perell for stimulating discussions related to the topic of this article. Part of the

research for this paper was done while the author was with the Law Commission of Ontario. The author

would like to thank the WJLS editorial team and Janet Ross for their comments.

The Canadian Real Estate Association “Canadian Home Sales Slip further in January” (17 February

2015), online: <http://creastats.crea.ca/natl/>.

In spite of that, in Pfeiffer v Pacific Coast Savings Credit Union, 2000 BCSC 1472, a mortgagor was

asked to pay a prepayment charge, but there was disagreement about the calculation of the charge. No

doubt the litigation costs were much higher than the amount in dispute, but some people will go to great

lengths to get justice.

Arabi v Toronto Dominion Bank, (2006), 30 CPC (6th) 164 (Ont Sup Ct) [Arabi].

Spiro: Mortgage Penalties

Published by Scholarship@Western, 2015

Government will bring forward regulations to bring greater clarity to the

calculation of mortgage pre-payment penalties.

Despite the promise, no regulations were made, resulting in a lack of meaningful

legislative control of the terms of prepayment charges in mortgages. While current low

interest rates have made the issue less prominent, prepayment charges will become more

significant if interest rates rise. Prepayment charges are not the only problematic clauses

found in mortgage contracts in Canada. Due-on-sale clauses permit the bank to require

payment of the full balance of the mortgage loan upon sale of the property. Thus, due-on-

sale clauses, if enforceable, may restrict purchase and sale of mortgaged properties.

This paper is divided into two parts. Part I discusses the relevant legislation

governing mortgages in Ontario and what protections, if any, exist for consumers. Part II

explores what the common law and the common practices of lenders have provided with

respect to consumer protection. In particular, penalty provisions and the due-on-sale

clause are examined. There is a lack of consumer protection for borrowers with respect to

mortgage interest penalties. This is especially true for individual borrowers, where the

inequality of bargaining power leads to potentially unconscionable outcomes. This

situation is not insurmountable. This paper concludes by suggesting some possible

reforms that could provide a reasonable balance between the interests of borrowers and

lenders.

I. THE STATUTORY APPROACH TO MORTGAGES IN ONTARIO

Under the Constitution Act, 1867,

the federal government has jurisdiction over

banking and finance, while the provincial government has jurisdiction over property.

Both levels of government therefore have the power to legislate in the field of mortgages.

Under Canadian constitutional law, the principle of federal paramountcy governs where

jurisdiction overlaps, so that the federal legislation prevails in the regulation of

mortgages. Three relevant pieces of legislation will be discussed: (1) the federal Interest

Act,

(2) the provincial Land Registration Reform Act

(LRRA) and (3) the provincial

Mortgages Act.

Interest Act

The statute governing interest rates on mortgages in Canada is the federal Interest

Act. Section 8 of the Act provides that, where mortgage payments fall into arrears, the

interest rate charged on the arrears cannot exceed the rate of interest that was payable on

House of Commons, Minister of Finance, Leading the Way on Jobs and Growth (March 2010) at 116

(Hon James M Flaherty).

30 & 31 Vict, c 3 ss 91 & 92.

RSC 1985, c I-15 [IA].

RSO 1990, c L4 [LRRA].

RSO 1990, c M40 [MA].

Western Journal of Legal Studies, Vol. 5, Iss. 4 [2015], Art. 4

https://ir.lib.uwo.ca/uwojls/vol5/iss4/4

the principal before the mortgagor fell into arrears.

As a result, a mortgagor who is

required to immediately repay the whole principal of the mortgage upon default could

argue that the mortgagee is not entitled to levy an extra charge for this involuntary

prepayment. The requirement for immediate repayment of the whole principal upon

default is known as acceleration.

In a number of early cases, such penalties were held to be unenforceable.

This

argument by the mortgagor was later rejected in Mastercraft Properties Ltd v El Ef

Investments Inc,

where the mortgage contract had been modified to provide for either

three months’ notice or interest in lieu of that notice. In Mastercraft Properties, the

Ontario Court of Appeal distinguished the earlier decisions and upheld the right of the

mortgagee to enforce what was effectively a disguised penalty. The Court stated, “The

obvious purpose of such a stipulation is to give the mortgagee the benefit, when the

mortgagor defaults, of a reasonable period during which to arrange for the alternate

investment of its funds.”

A later Ontario decision, O’Shanter Development Company

Ltd v Gentra Canada Investments Inc,

affirmed this point, noting that it would be an

anomaly if the prepayment charge was not enforceable upon default. If prepayment

charges were extremely vulnerable to litigation, a mortgagor could avoid the prepayment

charge in his or her mortgage “simply by allowing the mortgage to go into default and

forcing the mortgagee to take steps to realize on its security.”

The Interest Act does not

explicitly prohibit the clauses allowed in these cases, but section 10 has some effect.

The only section within the Interest Act that explicitly addresses prepayment

charges is section 10. Section 10(1) stipulates:

Whenever any principal money or interest secured by mortgage on real property

or hypothec on immovables is not, under the terms of the mortgage or hypothec,

payable until a time more than five years after the date of the mortgage or

hypothec, then, if at any time after the expiration of the five years, any person

liable to pay, or entitled to pay in order to redeem the mortgage, or to extinguish

the hypothec, tenders or pays, to the person entitled to receive the money, the

amount due for principal money and interest to the time of payment, as calculated

under sections 6 to 9, together with three months further interest in lieu of notice,

no further interest shall be chargeable, payable or recoverable at any time after the

payment on the principal money or interest due under the mortgage or hypothec.

IA, supra note 6, s 8.

See, e.g., 459745 Ontario Ltd and Wideview Holdings Ltd, (1987), 59 OR (2d) 361 (HC).

(1993), 14 OR (3d) 519 (CA), leave to appeal to SCC refused, (1994) 1 SCR ix [Mastercraft Properties].

Ibid at 523.

(1995), 25 OR (3d) 188 (Sup Ct) [O’Shanter].

Ibid at 194. This point was re-iterated in 259121 Ontario Inc v Canada Trust Co, [2007] OJ 1007 (Sup

Ct) at para 9.

IA, supra note 6, s 10(1).

Spiro: Mortgage Penalties

Published by Scholarship@Western, 2015

This provision provides for a flat three-month interest prepayment charge without regard

to the prevailing market interest rates, but it only applies to mortgages with terms of five

years or more on property not owned by a corporation. Significantly, over 95 per cent of

mortgages in Canada are contracted for a term of five years or less and, therefore, do not

fall under section 10.

It is likely that section 10 may contribute to why banks rarely

issue mortgages with a term greater than five years because the charges for shorter-term

mortgages are unregulated and remain at the discretion of the lender.

Section 10(2) goes on to stipulate that this provision does not apply if the

mortgagor is a corporation or a joint stock company.

Therefore, the right of prepayment

in section 10(1) will likely prevail when a large, unincorporated grouping such as a real

estate investment trust is the mortgagor. Provided the owners are not all corporations,

there is no restriction on the number of individuals who are owners.

The evasive actions taken by banks in response to section 10 have resulted in an

unregulated system that is problematic for consumers, particularly when the mortgage

market is relatively concentrated and oligopolistic. In a concentrated market, companies

compete by image and advertising but avoid genuine competition on substantive matters.

This is because these companies are aware that it would be a race to the bottom that

reduces profits. The banks, whose primary motivation is earning a profit, in effect set the

terms of the mortgages. In Canada, the current banking system is more concentrated than

in the past. While a number of smaller players remain in the market, most mortgages are

issued by the “Big Five” banks: Royal Bank of Canada (RBC), Toronto-Dominion Bank

(TD), Bank of Nova Scotia (Scotiabank), Bank of Montreal (BMO), and Canadian

Imperial Bank of Commerce (CIBC).

Therefore, section 10(1) does not protect most

Canadian borrowers from an unregulated and highly concentrated market. Furthermore, a

provision analogous to section 10 has existed since 1910 despite the fact that mortgages

with a fixed rate for 25-year terms were the norm for many decades following 1910.

Where mortgages are paid off early, a lender may suffer a loss if interest rates fall

and she has to re-lend the money at a lower rate. Thus, due to section 10, banks must

price mortgages with terms greater than five years at higher rates to reflect the risk

associated with early prepayment. This is evident in the yield curve of government bonds,

Allan Crawford, Césaire Meh, and Jie Zhou, “The Residential Mortgage Market in Canada: A Primer”

Financial System Review (December 2013) Bank of Canada, online: <http://www.bankofcanada.ca/wp-

content/uploads/2013/12/fsr-december13-crawford.pdf>.

IA, supra note 6, s 10(2).

See: Litowitz v Standard Life Assurance Co (Trustee of) (1996), 30 OR (3d) 579 (CA).

Canadian Banks, “The Big Five Banks in Canada” (2015), online:

<http://www.bankingcanada.net/big+five+banks+in+canada/>.

An Act respecting Mortgages of Real Estate SO 1910, c 51 at s 15, as amended by An Act respecting

Mortgages of Real Estate, RSO 1914, c 112 [ARMRE].

Western Journal of Legal Studies, Vol. 5, Iss. 4 [2015], Art. 4

https://ir.lib.uwo.ca/uwojls/vol5/iss4/4

where the cost of a 10-year mortgage does not greatly differ from that of a five-year one,

but the interest rate on it does.

In summary, while the Interest Act provides some protection for consumers with

regard to interest and prepayment charges, banks have taken advantage of loopholes and

gaps in the law to the detriment of consumers, which has resulted in an unregulated

system. Despite the promises made by the federal government in the 2010 budget,

progress has been made.

Land Registration Reform Act

The second statute relevant to mortgage law is the LRRA, which marks the advent

of electronic registration of titles and charges in Ontario. Historically, a mortgage was a

conveyance of the property by the borrower to the lender, with an equitable right of

redemption on repayment of the money owing. While this common law principle was

abolished by the LRRA, section 6(3) of the Act protects the rights of the lender as if the

principle had not been abolished.

Specifically, section 6(3) states that “a chargor and

chargee are entitled to all the legal and equitable rights and remedies that would be

available to them if the chargor had transferred the land to the chargee by way of

mortgage, subject to a proviso for redemption.”

This section is the vital link that allows

remedies in the Mortgages Act to apply to a charge. While the term “mortgage” continues

to be used colloquially, the LRRA has replaced it with the term “charge.”

Furthermore, section 8 of the LRRA delineates the filing of standard “charge

terms,” which is how the Act refers to the mortgage contract. Each standard contract has

a catalogue number that is used to refer to the contract when a charge is registered on the

title of a property.

Since section 8 does not impose any conditions on what the charge

terms may be, complete freedom of contract is preserved. If the parties to a contract are

of roughly equal bargaining power, then freedom of contract is a reasonable policy.

However, the lending relationship is highly unequal between banks and most borrowers,

whether they are individuals or large commercial borrowers.

As Ontario’s first new piece of legislation dealing with mortgages in nearly a

century, the LRRA does not amend any of the substantive rights of lenders and borrowers.

For example, on September 23, 2014, RBC offered a 5 year mortgage at 4.94%, and a 10 year mortgage

at 6.75%, a difference of 181 basis points. At the same time, the yield on 10 year Government of Canada

bonds was only 53 basis points higher than the 5 year bond yield. The 128 basis point (181 minus 53)

difference no doubt reflects a pricing in of the risk that, at the 5 year mark, the borrower will take

advantage of the Interest Act provision, and replace this mortgage with a new 5 year one, unless 5 year

rates at the time are over 6.75%.

Canada, Department of Finance, Archived – Minister of Finance Announces Review of Financial

Institutions Legislation (20 September 2010), online: <http://www.fin.gc.ca/n10/10-083-eng.asp>.

LLRA, supra note 7, s 6(3).

Ibid.

Ibid, s 1.

Ibid, s 8(6).

Spiro: Mortgage Penalties

Published by Scholarship@Western, 2015

Rather, these rights remain governed by the longstanding and essentially unchanged

Mortgages Act.

Mortgages Act

The third relevant statute is Ontario's Mortgages Act. The Act predominantly

addresses enforcement of mortgages and provides specific rights to both the lender and

the borrower. The Act also briefly addresses prepayment charges. For example, section

18 mirrors the terms of section 10 of the federal Interest Act and allows the prepayment

of any mortgage for a term of five years or more, with only three months' interest as a

prepayment charge.

While section 17(1) of the Mortgages Act addresses prepayment charges, it does

so in the context of default and, therefore, in considerably different terms:

Despite any agreement to the contrary, where default has been made in the

payment of any principal money secured by a mortgage of freehold or leasehold

property, the mortgagor or person entitled to make such payment may at any time,

upon payment of three months interest on the principal money so in arrear, pay

the same, or the mortgagor or person entitled to make such payment may give the

mortgagee at least three months’ notice, in writing, of the intention to make such

payment at a time named in the notice, and in the event of making such payment

on the day so named is entitled to make the same without any further payment of

interest except to the date of payment.

The above provision confers a right on the mortgagor to repay, but it does not permit the

mortgagee to demand a payment. Despite this, numerous modern judicial decisions have

interpreted this provision to impose a substantial penalty on a mortgagor who defaults on

repayment. As with most of the Act, it has been part of the statute since 1910 and the

language has remained essentially unchanged since then. In the original printed statutes,

the marginal note beside the section (section 15 at the time) suggests that the drafters of

the legislation intended the literal meaning of the section to apply: “[m]ortgagor in

default to be entitled to redeem on giving three months’ notice, or on paying three

months’ interest in lieu of notice.”

While marginal notes are not binding, they are often

accepted as an aid to statutory interpretation.

This marginal note specifically provides

the mortgagor with the right to provide notice or repay. The note provides nothing with

respect to the mortgagee’s right, which suggests that the provision does not permit the

mortgagee to demand payment, despite subsequent interpretations. Furthermore, this was

IA, supra note 6, s 18.

MA, supra note 8, s 17(1).

ARMRE, supra note 20. The only difference between Section 15 in the 1910 Act and the current Section

17 is that the 1910 version restricted this privilege to mortgages taken out after the 12

day of June, 1903.

See: R v McIntosh, [1995] 1 SCR 686 at para 70; see also: R v Wigglesworth, [1987] 2 SCR 541 at para

19.

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likely intended to be a benefit for the mortgagor due to the facts that it only provides for

the mortgagor and that the mortgagee has no recourse. Therefore, it appears that the

legislature intended to provide a benefit to the borrower in the form of the right to delay

repayment without penalty, as long as notice of late payment has been given.

In Ontario, defaulters have frequently pleaded in court that three months’ notice

can be given in lieu of three months’ interest. For example, in Parkhill et al v Moher et

al,

the principal of the mortgage was due, but the mortgagor could not raise the money

until approximately one month later. The mortgagee sought a penalty, but the court ruled

against it and invoked section 17:

[A prepayment charge] is applicable where the mortgagor attempts to force

payment upon the mortgagee, but where the mortgagee is enforcing payment by

action after maturity, the payment will not be unexpected and the mortgagee must

be contemplated to have need of it, or a better opportunity for reinvestment.

The court would not allow a prepayment charge where the mortgage had matured;

payment in full was thus expected by the mortgagee. In other words, the mortgagee could

not charge for a mortgage that was not prepaid.

More than 30 years later in 2009, in Mohtashami v Letichever

(Mohtashami),

the court came to a different conclusion despite similar facts. In this case, the mortgagor

sought a refund of a $15,000 penalty paid under protest to discharge a mortgage on which

he had defaulted. The mortgagor was unsuccessful in relying on section 17. In a terse

eleven paragraph decision, the court dismissed the borrower's application and allowed the

penalty charge, relying on the decision in Mastercraft Properties.

However,

Mastercraft Properties is distinguishable on its facts. In Mastercraft Properties the

borrower argued that the prepayment charge represented a violation of the Interest Act.

The borrower did not rely on the argument that there was notice, and the court

specifically allowed the charge as a payment in lieu of notice.

In Mintz v Mademont Yonge Inc,

Pepall J carefully considered how earlier cases

such as Mastercraft had interpreted section 17. She held that a mortgagor who knows

payment is going to be late and gives proper notice can use section 17 to avoid paying the

additional three months of interest. However, in the absence of such notice, the three-

month penalty must be paid if the principal repayment is late:

(1977), 17 OR (2d) 543 (Sup Ct).

Ibid at 546.

[2009] OJ 60 (Sup Ct).

O’Shanter, supra note 13.

Ibid at 523.

2010 ONSC 116.

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In the case before me, Mademont did not give three months' notice. Having failed

to do so, Mademont is required to pay an additional three months' interest . . . any

other result would do violence to section 17 of the Mortgages Act.

Justice Pepall’s approach appears to be the accepted interpretation of the statute.

The statutory provision is now often used as a means to impose penalties on borrowers,

despite the original intention to provide benefits. Furthermore, the inconsistent

interpretations of section 17 found in decisions such as Mohtashami, call for a legislative

amendment to clarify its intention and application.

II. THE COMMON LAW APPROACH TO MORTGAGES IN ONTARIO

This section considers mortgages in the context of the common law and the

standard terms used in practice. In particular, prepayment and due-on-sale provisions will

be examined. Surprisingly, the due-on-sale clause, a term found in almost all mortgages,

has rarely been litigated. However, the recent certification attempts of several class

actions related to penalty provisions indicate that litigation may be forthcoming.

Prepayment Charges

In contract law, penalty clauses incurred upon breach or default are generally

unenforceable.

When a buyer has defaulted, a seller can only keep a buyer’s deposit

when it is a reasonable estimate of liquidated damages. If there are no damages resulting

from the breach, a penalty amount cannot be kept. This was elucidated by Laskin CJC in

HF Clarke Limited v Thermidaire Corp Ltd:

The primary concern in breach of contract cases . . . is compensation, and judicial

interference with the enforcement of what the courts regard as penalty clauses is

simply a manifestation of a concern for fairness and reasonableness, rising above

contractual stipulation.

Furthermore, although the parties can “make the predetermination . . . it must yield to

judicial appraisal of its reasonableness in the circumstances.”

Thus, where a penalty is

not a reasonable estimate of damages, it is not reasonable and should not be enforced.

This principle is not easily applicable to situations where the mortgagor wants to

pay off the mortgage early. Essentially, the mortgagor is asking the mortgagee to grant

something that the mortgagor is not contractually entitled to—to accept payment and

discharge the mortgage early. There is no breach of contract per se, but rather a payment

Ibid at para 18.

See Centre d’Apprentissage et de Formation + de Cornwall (Re), 2013 ONSC 2749 where the reasoning

in Mintz v Mademont Yonge Inc, infra note 40, was cited with approval at paras 17-19.

See: John D McCamus, The Law of Contracts (Toronto: Irwin Law, 2012) at 964-965, 968-972.

[1976] 1 SCR 319 at 331.

Ibid.

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in lieu of notice. The mortgagor is not in breach of contract until it fails to make monthly

payments. The major Canadian banks use similar terms for calculating the prepayment

charge.

In all cases, the minimum prepayment charge is three months’ interest,

regardless of the duration remaining on the term of the mortgage. If interest rates fall

compared to the existing interest rate in the mortgage, the standard mortgage contract

calls for the prepayment charge to be even larger. If a prepayment charge was included in

the contract, the bank will then re-lend the money at a lower interest rate and will require

the mortgagor to fully compensate it for the “interest rate differential” over the remaining

term of the mortgage.

This prepayment scheme is justified under the general principle

of contract law: damages in breach of contract should compensate for loss of expectation

interest.

Conversely, the one-sided nature of the agreement detracts from the

reasonableness of this justification. For example, where the current market rate is higher

than the mortgage rate, it is beneficial to the bank to have its money repaid early. The

bank will likely re-lend the funds to a new customer at a higher rate, but the bank is not

required to discount the principal amount to be repaid by the borrower. Economically, the

repayment may be a windfall to the bank, even without a prepayment charge. Where the

rates are significantly higher, there may be less demand for mortgage loans. However, the

bank will likely be able to lend its money elsewhere at a higher rate. Such a one-sided

situation is unlikely to occur where both parties have equal bargaining power.

There is one mitigating feature of the standard mortgage contract: where the

borrower has sold one house and is buying another, he or she may be allowed to keep a

lower interest rate by transferring the current mortgage to the new property. This option

may not be helpful for some sellers, such as “empty-nesters” who are downsizing and do

not need a mortgage on the new property. If the property being purchased has an existing

mortgage, there may be at least one prepayment charge. Regardless, while the existence

of a prepayment charge in a mortgage contract complicates the sale and purchase of

homes, most homeowners would not be able to move without financing and without

paying the prepayment charge.

In 1259121 Ontario Inc v Canada Trust Co

, a mortgage went into default and

the mortgagor argued that the three months’ interest prepayment charge was a

contractually unenforceable penalty. The court held that it was a payment in lieu of

notice. The mortgagor was not completely unsuccessful. This particular mortgage

provided for an additional $15,000 administrative charge in the event of a default, which

the court held was not a reasonable estimate of liquidated damages. As a result, the court

See: RBC Royal Bank "Form 3997: Standard Charge Terms (Fixed)", Royal Bank of Canada online:

<http://www.rbcroyalbank.com/RBC:r1e3BKwYUAsBxAB@@v0AAADG/legalforms/download/3997(04

-2013).pdf>. The standard charge terms from BMO, CIBC and Scotiabank all have essentially identical

terms.

See: ibid, where the calculation is set out in the standard charge terms

(2007), 58 RPR (4th) 58 (Ont Sup Ct) [1259121 Ontario].

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did not allow this additional charge. In 1259121 Ontario, the mortgagor went into default

in February of 2006, only a few months after taking out a five-year mortgage the previous

November, during a time of rising interest rates. Given the rising interest rates, if a

mortgage was paid in full in June, the bank could re-lend it at a higher interest rate and

end up financially better off than if the mortgage had not gone into default. This

reasoning undermines the argument that the prepayment charge was a necessary

compensation in lieu of notice. As with the previously mentioned case, if the injured

party can immediately mitigate its damages and avoid all loss, no notice is required and

compensation is not necessary. There was no reported argument raised by the mortgagor

regarding this issue.

As a result of these financial realities, in a period of rising interest rates, any

prepayment charge may be unreasonable. Although housing sales and mortgage

borrowing may drop in periods of high interest rates, lenders still benefit from early

repayment because they will likely re-lend the funds at higher interest rates in the

government bond market.

In such a situation, borrowers could argue that the contract is

unconscionable. As La Forest J stated, “[a]n unconscionable transaction arises in contract

law where there is an overwhelming imbalance in the power relationship between the

parties.”

Given the high costs of litigating against a bank compared to the amount of

money involved for the typical mortgagor, mortgagors would hesitate to pursue

individual remedies. However, unfairness in mortgage contracts is the type of claim that

could conceivably become the subject matter of class actions.

The Due-on-Sale Clause

Prepayment charges are a standard feature of mortgage contracts and apply

regardless of the motivations of the mortgagor. In the majority of situations, prepayment

is required because the property is being sold. When a property is sold, the parties to the

transaction may be able to avoid the prepayment charge if the purchaser assumes the

existing mortgage. Where market interest rates have risen, this option is particularly

attractive for both the mortgagor and the purchaser of the property. However, this

mutually beneficial arrangement is often prevented by the due-on-sale clause, which

purports to allow the lender to refuse permission for the buyer to assume the mortgage. In

their book Real Estate Law, Reiter, McLellan, and Perrell view such clauses suspiciously:

[S]ome fear that “approval of purchasers” clauses may violate the doctrine of

"clogging the equity of redemption" and use due-on-sale clauses instead. Some

people claim that mortgagees have been inserting and relying on due-on-sale

clauses for the purpose of terminating the loan if current interest rates are above

See: Paul Cardinal “Factors that Determine Mortgage Rates in Canada” FCIQ (February 2011),

Fédération des chambres immobilières du Québec online:

<http://www.fciq.ca/pdf/mot_economiste/en/me_022011_a.pdf> for a discussion of the close correlation

between mortgage rates and government bond rates [Cardinal].

Norberg v Wynrib, [1992] 2 SCR 226 at para 30.

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the loan rate when mortgaged property is sold, thus requiring new financing to be

procured at higher rates.

Due-on-sale clauses also once again illustrate the uneven bargaining power of the

mortgage contract. The standard form of charge provides that the lender has discretion to

refuse the purchaser’s consent to assume the mortgage. The putative reason for

withholding consent is that the lender does not approve of the purchaser’s credit. These

evaluations are not only subjective but they also provide the potential for a conflict of

interest for the lender. For example, even if the purchaser’s credit is sufficient, it may be

economically beneficial for the lender to refuse the transfer and receive its remaining

balance. In this scenario, the mortgagee receives the extra three months of interest from

the prepayment charge imposed on the seller, and, in a situation of rising rates, the

mortgagee may be able to re-lend the money at a premium, albeit with fewer borrowers

due to the higher rates.

The discretionary nature of the lenders’ decisions in these loan agreements is

concerning. A more equitable contract would ideally state some objective criteria.

Professor Joseph Roach suggests that due-on-sale clauses ought to be more important for

lenders in the western provinces, where the mortgagee’s statutory right to sue on the

covenant is more limited.

He notes, however, that “there are relatively few reported

cases in Canada,” having found only eleven dealing with the question of enforceability.

Given their ubiquity, it is remarkable how infrequently due-on-sale clauses have been

subject to litigation in Canada.

a) Ontario Statutes and Common Law Rules

As the contract is framed, if the due-on-sale clause is violated, acceleration may

be imposed, wherein the borrower is required to pay off the entire mortgage. Following

this conveyance, the question arises as to whether or not a bank could require the

purchaser to immediately pay off the whole principal or face foreclosure. The Mortgages

Act provides no clarity on this issue.

Specifically, section 20(2) of the Ontario Mortgages Act provides that “the

mortgagee has the right to recover from the grantee the amount of the mortgage debt in

respect of which the grantee is obligated to indemnify the mortgagor.”

In this context,

indemnification can be characterized as adjusting for any deficiency after a property has

been sold under power of sale. The statute remains ambiguous with respect to the breadth

of this obligation and whether this requirement to indemnify would allow the mortgagee

to enforce an acceleration of the mortgage against the grantee. Under the Mortgages Act,

Barry Reiter, Bradley H McLellan & Paul M Perell, Real Estate Law, 4th ed (Toronto: Emond

Montgomery, 1982) at 897.

Joseph E. Roach, The Canadian Law of Mortgages, 2nd ed (LexisNexis Canada, 2010) at 441.

Ibid at 443.

MA, supra note 8, s 20(2).

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a mortgage is a conveyance of the land where all that the mortgagor possesses is the

equity of redemption.

The Act does not address a situation where the mortgagor has

transferred the equity of redemption. Further, there are no provisions in the Act that

require notification to the lender that the owner of the equity has changed. The Act

neither explicitly authorizes nor forbids the lender from setting conditions on this issue.

The Mortgages Act places clear limits on the lender's entitlement to acceleration.

For example, sections 22 and 23 suspend any contractual provisions regarding

acceleration, even after the borrower has gone into default. Section 22(1) provides that a

mortgagee cannot enforce acceleration of the mortgage despite any agreement to the

contrary, if the mortgagor pays arrears and costs to come back into good standing.

Moreover, even after an action for possession has commenced, section 23(1) gives the

mortgagor a chance to make outstanding payments and, again, despite any agreement to

the contrary, acceleration of the mortgage is barred.

The Mortgages Act also strictly regulates the remedies available to the mortgagee

in the event of a default.

For example, there are requirements as to the time period of

notice provided and the form of the notice.

The aim of the Act appears to be to avoid

acceleration as much as possible. For example, section 22(1) provides that, in order to

avoid acceleration, “the mortgagor may perform such covenant or pay the amount due

under the mortgage.”

In this case, the amount due is the whole amount of the principal,

thus creating a scenario of acceleration in order to avoid acceleration. Arguably, an

acceleration clause that offers the mortgagor no corrective mechanism is contrary to the

intent of the Act. This issue does not seem to have been addressed in Ontario courts, but

the courts have paid some attention to other issues associated with mortgage contracts.

Historically, equity has treated mortgage contracts as distinct from ordinary

contracts:

The principle that a man who enters into a contract should be held to his bond has

been frequently said with varying degrees of eloquence in many arguments and

many cases. This principle does not override certain principles developed by the

Courts of equity . . . provisions in an agreement prohibiting the alienation of land

are void and the rigidity of this principle is not tempered by the willingness of the

alienee to be so restricted even though such restriction may be reasonable.

Ibid, s 10.

Ibid, s 20.

See: ibid, ss 31-34 & 39. See also: ss 22-23 for relief from default before and after action.

Ibid, s 22(1).

Laurin v Iron Ore Company of Canada, [1977] 19 Nfld & PEIR 111 (Nfld Sup Ct) at paras 96-98

[Laurin]; quoted with approval in Canada Mortgage and Housing Corporation v Hong Kong Bank of

Canada (1990), [1991] 75 DLR (4th) 307 (Alta CA) at 316.

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In Tiernan v Bird's Eye Cove Farm Ltd,

the British Columbia Court of Appeal

declined to enforce acceleration of a mortgage following breach of a due-on-sale clause

on equitable grounds. The court concluded that “the covenant that was breached does not

appear to be one of great moment.”

Specifically, the court referred to the fact that the

property was worth substantially more than the mortgage debt, and it found that the

lender was not prejudiced by the sale. This decision was made under the auspices of

British Columbia's Law and Equity Act. The Act provided that, notwithstanding any

written terms in a contract, “the court may impose any terms as to costs, expenses,

damages, compensations and all other matters it considers appropriate.”

In Ontario, the law is not quite as explicit, but the Ontario Courts of Justice Act

notes “where a rule of equity conflicts with a rule of the common law, the rule of equity

prevails.”

Ontario courts regularly apply equitable principles in deciding how contracts

are enforced.

A number of state courts in the United States have likewise rejected due-

on-sale clauses on equitable grounds.

In Briar Holdings Ltd v Bow West Holdings Ltd,

the Alberta Court of Queen’s Bench observed that, “American authorities dealing with a

‘due-on-sale’ clause . . . appear to be based on the equities of a particular situation and

the power of a court in equity to relieve against forfeiture.”

In response to the findings

of several state courts that due-on-sale clauses were unenforceable and subsequent

lobbying by lenders in opposition to these findings, a federal statute was enacted to

uphold due-on-sale clauses.

Under the Supremacy Clause of the United States

Constitution, Congress may deliberately pass legislation to pre-empt state laws.

Despite

the enactment of that pre-emptive federal law, Richard Hayden has suggested that “[s]tate

courts must be free to determine that the enforcement of an otherwise valid due-on-sale

(1982), 41 BCLR 14 (CA). Unlike in Ontario's Mortgages Act, the BC statute contains an explicit

obligation to indemnify for "covenants express or implied": Property Law Act, RSBC 1979, s 20.

Ibid at para 21.

RSBC 1996, c 253, s 25(2).

Courts of Justice Act, RSO 1990, c C-43, s 96(2).

See: 306793 Ontario Ltd in Trust v Rimes (1990), 25 OR (2d) 79 (CA) which cited Lord Wilberforce in

Johnson et al v Agnew, [1979] 2 WLR 487 (HL) at 496: “It is an appropriate case for a court of equity to

say: ‘As a matter of discretion, this contract should not now be enforced specifically, but, in lieu of the

decree for specific performance, the court will award the plaintiff such damages as have been suffered by

her in consequence of the defendant's breach’” at 82, citing McKenna v Richey, [1950] VLR 360 (HL) at

376.

See: David A. Gauntlett, “Wellenkamp v Bank of America: Invalidation of Automatically Enforceable

Due-on-Sale Clauses” (1979) 67(4) Cal L Rev 886; See also W. Wade Berryhill, “The Due-On-Sale

Clause: A Marriage Gone Sour – A Checklist for the Practitioner” (1981-1982) 16 U Rich L Rev 35.

[1981] 16 Alta LR (2d) 42 (QB).

Ibid at para 17.

Preemption of Due-on-Sale Prohibitions, USC tit 12 §1701j–3 (2012); see also: D. Barlow Burke, Real

Estate Transactions: Examples and Explanations, 4th ed (Portland, Aspen Publishers, 2006) at 261 for a

discussion of this statute.

See US Const art VI cl 2.

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clause is unconscionable as a matter of state contract law, when, for example, it is used

solely to collect interest.”

Broadly, the aim of contract law is that “where a party sustains a loss by reason of

a breach of contract, he is, so far as money can do it, to be placed in the same situation,

with respect to damages, as if the contract had been performed.”

The Supreme Court of

Canada modernized this long-standing rule in Bank of American Canada v Mutual Trust

Co,

stating that there is no longer a moral stigma to a deliberate breach of contract as

long as the appropriate payment is made for the actual damages suffered:

Efficient breach is what economists describe as a Pareto optimal outcome where

one party may be better off but no one is worse off, or expressed differently,

nobody loses. Efficient breach should not be discouraged by the courts. This lack

of disapproval emphasizes that a court will usually award money damages for

breach of contract equal to the value of the bargain to the plaintiff.

Provided the new purchaser maintains the regular payments, there may be no damage that

the bank can claim, particularly without evidence of damage. It must be noted, however,

that the bank has a process for approving loans and borrowers: where the mortgage has

been transferred to the purchaser without permission, the bank has not approved the

purchaser and the purchaser has not entered into a covenant to repay the debt. This lack

of apparent damage was highlighted in the recent case Huttonville Acres Ltd (cob Forest

Homes) v Archer,

in which the purchaser of a building lot in an exclusive community

breached her contract by re-selling the land for a profit. The defendant admitted to breach

of contract, but the plaintiff could not show that it had suffered any damages, and,

consequently, the “innocent party” was required to pay costs.

In contract law, the rules of damages indicate that the wronged party must be

compensated so that it is as if the contract had been performed. The wronged party,

however, cannot enforce the specific terms of the contract unless a court grants specific

performance. If the bank insisted on immediate repayment of the mortgage, rather than

only claiming for the damages it actually suffered, the bank would be making a claim for

specific performance. This is notable because in Semelhago v Paramadevan,

the

Supreme Court of Canada changed the rules of equity. In this case, the Court announced that

for real property, specific performance should not “be granted as a matter of course absent

Richard J Hayden, “The ‘Due-On-Sale’ Clause in Washington After De La Cuesta and Garn: Has

Washington Been Left A Loan?” (1984-1985) 20 Gonz L Rev 511 at 542.

Bank of America Canada v Mutual Trust Co, [2002] 2 SCR 601 at para 27, citing Haack v Martin, [1927]

SCR 413 at 416 [Bank of America].

Ibid.

Ibid at para 31.

[2009] OJ No 4139 (Sup Ct); aff'd 2011 ONCA 115.

[1996] 2 SCR 415.

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evidence that the property is unique [emphasis added].”

As a result, specific performance

is now restricted to where the plaintiff can prove that monetary damages are inadequate

because of the unique characteristics of the property in question.

Where a bank holds several thousands of mortgages, it is difficult to argue that the

bank is uniquely interested in the characteristics of any particular mortgagor’s property.

Provided the monthly mortgage payments are forthcoming, the identity of the party

issuing the payment, be it the original mortgagor or a third party, should be irrelevant. It

should be noted, however, that the purchaser has not entered into a covenant with the

bank to repay the debt. It is inequitable to mandate specific performance and require the

mortgagor to pay the balance remaining on the mortgage before maturity (and pay a

prepayment charge for doing so) simply as a result of selling their property.

It can be argued that the bank does suffer some inconvenience due to an

unauthorized transfer. The bank had vetted the original mortgagor's creditworthiness but

does not have this opportunity with the purchaser, who may be less creditworthy.

However, while there is no privity of contract between the bank and the purchaser, this is

offset by the bank’s ability to sue the original mortgagor for any future deficiency

because the bank retains privity of contract with the mortgagor. Under section 20 of the

Mortgages Act, if there is a deficiency where the value of the property drops below the

amount of the mortgage, the bank can choose to sue either the purchaser or the original

mortgagor, whichever party is most solvent.

The sale of a small percentage of the

mortgaged properties would not be likely to significantly increase the bank’s risk in its

portfolio.

The inconvenience suffered by a bank may be less than that suffered by the

borrower if a due-on-sale clause is enforceable, which is significant in regards to the

principle of efficient breach discussed above.

For most mortgagors, the subject matter

of the mortgage is their only real property. Thus, they could suffer major disadvantages

from being forced to pay a prepayment charge, including not being allowed to keep the

lower interest rate (in a rising interest rate environment) and possibly encountering more

difficulty in selling the property. Given the imbalance of inconvenience, it is unlikely that

a due-on-sale clause would exist in mortgages if these contracts were negotiated between

parties with equal bargaining power. A court of equity ought to take such factors into

account. This argument does not apply to an individual mortgagee because, in such a

scenario, a transfer of the property might create a significant increase in risk for the

mortgagee. For example, in Griffiths v Zambosco et al,

the sellers provided a vendor

take-back mortgage. The property was subsequently re-sold, and the new purchaser

Ibid at para 22.

See: Southcott Estates Inc v Toronto Catholic District School Board, 2012 SCC 51 at paras 38-40.

MA, supra note 8, s 20.

Bank of America, supra note 67.

(2001), 54 OR (3d) 397 (CA).

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defaulted, resulting in a loss for the mortgagees. They successfully sued their solicitor for

negligence for omitting to insert a due-on-sale clause. Whether a due-on-sale clause was

enforceable does not affect this outcome, as most mortgagors would not think of trying to

contest it.

b) Case Law Dealing with Due-on-sale Clauses

While due-on-sale clauses are likely rampant in Ontario, there is limited

jurisprudence on the matter. The only direct Ontario authority is from 1960—Bahnsen v

Hazelwood,

where the mortgage contained a term stating that “[i]n the event of sale

before the herein mortgage has been discharged the said mortgagor must pay an amount

agreeable to both parties of the existing mortgage and the new purchaser must be

approved by the mortgagee herein.”

The Court of Appeal ruled that this term

constituted an improper restraint on alienation and was therefore void.

Moreover, the

Court ruled that the provision “cannot affect either the right of the vendor in this

application to convey good title to the purchaser or the right of the purchaser to receive

such title unaffected by the stipulation to which I have referred.”

Two later cases in Ontario have been cited as examples of judicial acceptance of

due-on-sale clauses, although neither is a case of a mortgagee trying to force a mortgagor

to pay off the principal before selling a property. First, in Valley Vu Realty (Ottawa) Ltd

et al v Victoria & Grey Trust Co (Valley Vu),

the mortgagor wanted to get relief from a

high interest mortgage without paying a penalty. Rather than defaulting, the mortgagor

assigned the property to a related party without authorization from the mortgagee in the

hopes of triggering the due-on-sale clause to permit him to pay off the principal on the

mortgage. The mortgagee argued that the due-on-sale clause would only be triggered if it

had been asked for approval to transfer the property and had refused, but in this case, the

mortgagee had never been asked for its approval. The question of the general

enforceability of a due-on-sale clause was not argued.

Second, in Weeks v Rosocha, the Ontario Court of Appeal ruled that the seller

could only force a due-on-sale clause on the purchaser when there was prior disclosure.

Weeks can hardly stand as a precedent to validate a due-on-sale clause; the lender, RBC,

was not a party to the action, and the defendant purchaser admitted that she had no

intention of applying to have the transfer approved.

The Court of Appeal did not make

[1960] OJ No 21 (CA) [Weeks].

Ibid at para 1.

Ibid at paras 4-5.

Ibid at para 5. The latter part of the statement appears to suggest that the mortgagee could not require the

purchaser to pay off any portion of the principal, since he is "unaffected by the stipulation." The court also

stated at para 6 that the order by the lower court went beyond what is required but little analysis was

provided on this point.

(1984), 44 OR (2d) 526 (HC), aff'd (1984), 47 OR (2d) 544 (CA).

(1983), 41 OR (2d) 787 (CA) at 791-792.

Ibid.

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any direct comment on the validity of a due-on-sale clause. The due-on-sale clause in a

mortgage can be a disadvantage because of the uncertainty it can cause for the purchaser.

Both Valley Vu and Weeks illustrate that due-on-sale clauses have yet to be firmly

addressed by the Courts. This reality underlines the need for legislative clarification.

c) Due-on-sale Clause: a Restraint on Alienation?

The common law embodies various public policy principles that can render

contract terms void if they are to the contrary. One such public policy goal is to allow real

property to be “alienated” (sold) when there is a willing buyer and seller. Consistent with

this, a long-standing principle of mortgage law finds a term that constitutes a restraint on

alienation is void and unenforceable.

A restraint on alienation occurs “where there is a

condition annexed to a grant or devise of land in fee simple . . . it will be void as being

repugnant to that estate.”

Moreover, case law illustrates that a sale in violation of a due-

on-sale clause is a valid conveyance, meaning that the buyer still receives good title.

is unclear if this principle can be extended to further weaken the enforceability of such a

clause and, in particular, the acceleration and due-on-sale provisions.

If an acceleration clause is enforceable, a due-on-sale clause means the property

cannot be sold unless the potential purchaser has access to alternative financing.

Therefore, the due-on-sale clause is tantamount to a restraint on alienation because the

sale of the property is obstructed by it. This is, however, how commerce works: if a buyer

cannot get financing, then, the buyer cannot afford it. The due-on-sale clause’s potential

to constitute a restraint on alienation warrants greater attention, given the regular

fluctuations in Canada’s financial system. In the years since the financial crisis of 2008,

the North American financial system has had abundant financing available. This has not

been the case in the past, and it is unlikely to continue in the future.

In summary, a clause that prohibits sale of a mortgaged property should not be

upheld, as it would be a restraint on alienation. The sale of the property must be permitted

even if subject to a mortgage with a due-on-sale clause. The issue then becomes the

recourse available to a lender if the clause is breached. If a lender can impose arbitrarily

large penalties, including acceleration, then the lender has the power to impose its will

and, in effect, enforce the due-on-sale clause. Such a situation is contrary to equitable

principles of contract law.

Laurin, supra note 55.

Stevens v Gulf Oil Canada Ltd et al (1976), 11 OR (2d) 129 at 155.

Hongkong Bank of Canada v Wheeler Holdings Ltd., [1993] 1 SCR 167. Canada Mortgage and Housing

Corporation (CMHC) wanted to preserve the low income character of the property and sought,

unsuccessfully, to block the sale. Acceleration was not an issue, as CMHC did not seek it.

See: Peter Spiro, “Was Your Mortgage Made in Bangladesh?” Huffington Post (30 April 2013) Huffpost

Business online: <http://www.huffingtonpost.ca/peter-spiro/bangladesh-factory-collapse_b_3174852.html>

for a discussion of the global financial forces affecting mortgage rates.

Spiro: Mortgage Penalties

Published by Scholarship@Western, 2015

Class Action Litigation Related to Mortgage Penalties

Class actions for financial service claims in Canada are a relatively new and a

growing phenomenon. Although they provide an avenue of redress for individual

mortgagors, class actions are a risky route because they are costly and time-consuming

for the plaintiff lawyers, as well as subject to strict procedural requirements that plaintiffs

may struggle to meet.

In 2006, a class action was filed against several lenders in Ontario: Arabi v

Toronto-Dominion Bank.

In this case, the plaintiffs challenged the calculation of the

prepayment charge on the grounds that the banks were not giving the mortgagors credit

for the annual prepayment allowance that was included in their mortgage contracts. This

class action was not certified, because it did not meet the test for certification in Ontario’s

Class Proceedings Act.

The plaintiffs were unable to meet the requirements to ascertain

an identifiable class and to identify common issues. The judge accepted that banks

sometimes use discretion to waive or reduce penalties and determined that it could not be

assumed that all potential class members had suffered sufficiently similar damages. As a

result, the judge ruled that the claims of different individuals were too diverse for a class

action to be the preferable procedure because “class members could not be identified

without individual examinations of each person's circumstances.”

This ruling was followed by Sherry v CIBC Mortgage Inc (Sherry), which was

certified recently in British Columbia for a claim regarding mortgage penalties.

The

CIBC mortgages contained a term that allowed a prepayment charge based on the

difference between the interest rate in the mortgage and the current interest rate. The

relevant contracts stated that the determination of the applicable comparison rate and the

calculation of the prepayment charge would be done “using a method determined by [the

bank] from time to time at our discretion.”

Moreover, the prepayment charge was based

on the rate currently posted by the lender, rather than some objective third party, and was,

therefore, subject to manipulation. The statement of claim alleges that, because of these

terms, the prepayment charge term is void for uncertainty. A similar claim has been filed

in Ontario.

While initially this cause of action does not appear viable, evidence about

mortgage rate fluctuations increases the plausibility of the claim. For example, the

underlying cost of funds for the lender depends on rates in the bond market, so one can

See: Ontario’s Class Proceedings Act, 1992, SO 1992, c 6 s 5(1) [CPA].

Arabi, supra note 3.

CPA, supra note 89, s 5(1).

Arabi, supra note 3 at para 48.

2014 BCSC 1199.

Ibid at para 18.

Jordan and Danao v CIBC Mortgages Inc (7 Oct 2011), London 5303/11 CP (Ont Sup Ct) (Statement of

Claim) Siskinds LLP, online: <http://www.classaction.ca/CMSFiles/PDF/Consumer/CIBC/2011_10_07_-

_Issued_Statement_of_Claim.PDF>.

Western Journal of Legal Studies, Vol. 5, Iss. 4 [2015], Art. 4

https://ir.lib.uwo.ca/uwojls/vol5/iss4/4

compare the five-year mortgage rate with the five-year government bond yield.

Monthly data reveal that the difference of the mortgage rate over the bond yield since

2000 has averaged about 3 percentage points.

However, occasionally, there can be large

deviations, as seen in Sherry where it varied from a low of about 2 percentage points to a

high of about 5 percentage points. Therefore, if an individual took out a mortgage near

the low point of this cycle and subsequently needed to redeem it when the spread was

high, he or she could pay a very large prepayment charge, even if there has been little or

no increase in general interest rates. Thus, the claim that the contract is void for

uncertainty is reasonable.

Class actions rarely proceed to trial; “[i]n Ontario, out of hundreds of class actions

that have been commenced, only 17 have led to common issues trials.”

Once the

appeals related to certification itself have been exhausted, settlement is the typical

method of resolution. Class actions can be expensive for plaintiff law firms to manage

over time, particularly when they face a deep-pocketed adversary such as a bank. It

remains to be seen whether the plaintiffs in this action can manage to prevail.

III. CONCLUSION

New legislation is necessary to regulate prepayment charges in mortgages. While

prepayment charges may be reasonable in some circumstances, there are many situations

where they are arbitrary, unfair, and possibly unconscionable. A prepayment charge is

appropriate where a borrower has agreed to pay a high rate of interest for a fixed number

of years and wants to alter the deal when market interest rates have fallen. In this case, it

would be unfair to the lender to discharge the mortgage without compensation for the loss

in income. The mortgagee may well be indebted to investors who hold fixed interest rates

such as Guaranteed Investment Certificates (GICs) that match the mortgage term.

Prepayment fees can also be unfair to the borrower. For example, a borrower who

wishes to prepay a mortgage is usually required to pay a charge of three months’ interest

without reference to whether that is an accurate measure of the cost to the lender. Indeed,

this charge remains even when prepaying the mortgage is beneficial to the lender because

market interest rates are rising. In such a case, there is no provision for the lender to

compensate the borrower. There is, however, some element of choice in this situation

with regards to the negotiated terms of the mortgage and the sale of the mortgaged

property. The borrower is choosing to sell rather than wait until the mortgage matures.

Furthermore, the borrower could make the sale conditional on the purchaser being

Cardinal, supra note 45.

Statistics Canada, Table 176-0043 - Financial market statistics, (Ottawa: StatCan) (CANSIM).

Law Commission of Ontario, "Review of Class Actions in Ontario: Issues to be Considered by the Law

Commission of Ontario" (November 2013) at 12, online: <http://www.lco-cdo.org/class-actions-issues-to-

be-considered.pdf>.

Spiro: Mortgage Penalties

Published by Scholarship@Western, 2015

approved to assume the mortgage. Despite this element of choice, legislation would still

play an important role in consumer protection.

Due-on-sale clauses also need to be addressed in Canadian mortgage law. In the

standard mortgage contract, prepayment charges and due-on-sale clauses appear as two

separate terms. In practice, however, they are closely connected because a sale of a

property is the most common reason for paying off a mortgage before the end of its term.

Frequently, this prepayment is forced on the borrower under the belief that the due-on-

sale clause is binding. In addition, banks may decide not to approve a new purchaser for

its own pecuniary benefit, where it has more to gain by a refusal if interest rates have

risen. This manipulation is not unexpected or even unreasonable on the bank’s part, as the

bank is acting in its best interest for its business, but it is problematic for mortgagors and

purchasers.

The ubiquity of this highly unequal clause indicates an imbalance in bargaining

power between lenders and borrowers. If Ontario courts were to hold that due-on-sale

clauses are enforceable, this would likely be problematic as these clauses place a

significant burden on borrowers. As such, Ontario courts and the legislature must seek to

find a balance between consumer protection to limit unreasonable burdens on borrowers

and the protection of banks’ finances in recognition of the fact that banks are businesses.

If legislation were enacted to address this, a reasonable compromise would be to base the

transferability of mortgages on objective criteria such as the size of the down-payment

provided by the buyer, rather than leaving it purely to the discretion of the lender. In so

doing, the imbalance in bargaining power between lenders and borrowers may be

reduced.

Western Journal of Legal Studies, Vol. 5, Iss. 4 [2015], Art. 4

https://ir.lib.uwo.ca/uwojls/vol5/iss4/4