Legal Blog

Interest

The Courts of Justice Act refers to pre-judgment and post-judgment interest as simple interest but allows the possibility of altering simple interest to compound interest. When can it be altered? This question was answered by the Supreme Court of Canada in its 2002, as yet unreported, decision in Bank of America Canada v. Mutual Trust Co.

High Finance

In 1988 at the height of the boom, a developer was developing a project. It entered into a contract with Bank of America for initial construction financing and with Mutual Trust for takeout financing; all three entered into an agreement by which Bank of America’s interest would be assigned to Mutual Trust as part of the takeout financing.

After the economy and the real estate market tanked, Mutual Trust breached its agreement, in both 1991 and 1992, and refused the financing. Bank of America ultimately sold the project for a major loss.

The trial judge held that Mutual Trust breached its contract with Bank of America and awarded damages. He also awarded compound pre-judgment and post-judgment interest on those damages at the rate set out in the financing agreement. The Ontario Court of Appeal reduced the interest to simple interest. The difference between the two calculations of interest was $5 million.

Measure of Damages

The Supreme Court of Canada analysed the issue from first principles. There are two measures of damages for breach of contract. The first is expectation damages: place the plaintiff in the same position as if the contract had been performed. The second is restitutionary damages: give the plaintiff some or all of the advantage that the defendant gained from the breach of contract.

The Court noted that for a normal breach of contract, courts prefer not to use restitutionary damages because to do so would discourage an “efficient breach.” An efficient breach of contract occurs when the defendant is better off with the breach and the payment of expectation damages and the plaintiff is not worse off.

Compensation

The Court noted that times have changed and that compound interest is no longer thought of as usurious or unduly complicated in calculation. Accordingly, under common law, there was no longer any reason why compound interest could not be awarded. The Court then noted that under sections 128 – 130 of the Courts of Justice Act, courts had authority to award interest both in amount and in time in a manner that was different from the simple interest set out in the Act.

Application

With this analysis in mind, the Court considered the facts. It found that that all of the agreements contemplated compound interest at particular rates and that both parties were in the business of lending money at compound rates. The expectation of Bank of America was that it would be repaid all of its principal with compound interest. If Bank of America were not compensated at compound rates, then Mutual Trust would have a windfall. It would have used Bank of America’s money and loaned it to its customers with compound interest but would only have repaid it with simple interest. Using principles of restitutionary damages, this was no longer an “efficient breach.” Bank of America’s loss was Mutual Trust’s gain. Accordingly, under both measures of damages, the Court felt that compound interest should be awarded.

Floodgates

Does this decision mean that every plaintiff should specifically claim compound interest? Ask and ye shall receive? Probably not. There must be some facts that would necessitate compound interest. This case involved two financial institutions that lived and breathed compound interest as part of their business existence.

A simple run-of-the-mill contract breach would not necessarily attract compound interest unless more could be proven. For example, did the plaintiff have loans carrying compound interest that would otherwise have been paid down? If so, the plaintiff should claim compound interest; if not, where are the damages to the plaintiff that flow naturally from the breach?

We cannot say that the floodgates have been fully opened but this decision has certainly pushed them much further apart.