Loan Sharks: Criminal Interest Rate Provisions Fail to Curtail Practice

Back in 1980, unanimously, and without much debate at all, Parliament enacted Section 347 of the Criminal Code with the objective of combating “loan sharks”.

More than thirty years later however, it can fairly be said that “loan sharking” has not been curtailed as a result, and many honest Canadians have no idea that the provision even exists or how it may affect them.

Section 347 makes it a criminal offence to enter into an agreement to receive payments for advancing credit exceeding 60% of the total value of the amount advanced. The section states:

(1) Notwithstanding any Act of Parliament, everyone who

                (a) enters into an agreement or arrangement to receive interest at a criminal
                     rate, or

                (b) receives a payment or partial payment of interest at a criminal rate is guilty of

                (c) an indictable offence and is liable to imprisonment for a term not exceeding five years, or

                (d) an offence punishable on summary conviction and is liable to a fine not exceeding twenty-five thousand dollars or
                     to imprisonment for a term not exceeding six months or to both.

The section has been widely criticized since its introduction and has even faced constitutional challenges. The Supreme Court of Canada (“SCC”) has confirmed that s. 347 is a legitimate use of the federal government’s power under s. 92(13) of the Constitution Act 1867. Canadian courts have also held that the section does not violate the Charter of Rights and Freedoms in any way.

Overall, however, the provision has been regarded as a legislative failure because it has not achieved its stated objective and has invalidated transactions that many people would regard as commercially reasonable arrangements—sometimes with drastic consequences.

When considering whether a particular agreement falls foul of s. 347, the courts look to substance, not form or intention. Perhaps the major reason that s. 347 has not been successful in battling loan sharking is because loan sharks do not generally keep detailed record books; their agreements are more informal, and their collection methods crude and unusual. It boils down to evidence, which is scarce in loan sharking arrangements.

As the sub-sections state, it is a criminal offence to enter an agreement that calls for payment of a rate of interest above 60%, or if interest is in fact received at 60% or higher. The SCC has confirmed that for the latter to be triggered, a “wait and see” approach is appropriate. Therefore, an agreement that appears perfectly legal may still be caught under subsection (b) if a debtor is merely allowed to make a payment at any point within a period of time, and in doing so, effectively pays a rate of interest above 60%.

Payday loan companies operated illegally for many years because the substance of their agreements with their customers effectively called for interest at a rate above 60%; notwithstanding that part of the interest is stated to be something other than interest, such as “broker fees”, it is the substance of the transaction that invalidates it.

The courts have begun to enforce s. 347 on payday loan companies more often in the last decade or so it appears. In CAPS International v Kotello, a 2002 case from the Manitoba Court of Queen’s Bench, the court held that a loan in violation of s.347 need not be repaid at all—that is the criminal rate of interest and the principal sum! The court stated that:

“A clear message that courts will not assist lenders in the business of loaning short-term money at criminal interest rates to unsophisticated customers far outweighs the public policy concern of unjustly enriching a person by not granting judgment for repayment of principal.”

That is at the far end of the spectrum of remedies or punishments that the court will invoke for a prohibited arrangement under s. 347. In some instances courts have “read down” the interest provision in the agreement in order to bring it in line with Canadian law. Although courts are generally reluctant to re-write contracts, it appears that more discretion is being used to remedy certain contracts depending on the sophistication of the parties involved.

Consumer contracts that are not negotiated (i.e. so-called “boiler plate contracts”) tend to be scrutinized more so than when the court is faced with negotiated commercial contracts between two relatively sophisticated parties. In the latter case, courts have shown more willingness to find a solution that preserves interest for lenders who may, nonetheless, be in breach of the Criminal Code.

Very rarely is a prison term imposed under s. 347, and it seems that the trend is for courts to simply void the entire contract, or sever the interest aspect from the rest of the otherwise valid agreement.

Section 347 has, therefore, been criticized for not attaining its objective, for potentially imposing harsh penalties on unsuspecting citizens or corporations, and for its seemingly inconsistent application by Canadian courts; these criticisms are fair, but if more Canadians were aware of the provision in the first place, many of these problems could be avoided. The section has the potential to protect many unsophisticated consumers who enter into short-term payday loan agreements at egregious interest rates. It all leaves one asking:

Should we be free to contract however we like with whomever we like, or should there be some safeguards for our less educated citizens regarding unscrupulous financial services? What is the best way to deliver them? Or is the problem a different one entirely? Weigh in on this important issue in this month’s poll.

Greer Jacks is updating jurisprudence in EverGreen Explanatory Notes, an online research library of assistance to tax and financial professionals in working with their clients.