The reason Clear Flow is important to anyone lending money is because there is a trap in the Interest Act s.4 which has the effect of reducing the interest rate on your credit instrument to 5%.
Your lending instruments had better be written with kindergarten clarity (as to annualized interest rate on all compensation for the use of money) if you don’t want to risk some judicial math reducing your overall return to 5%.
If the judge can’t figure out your ANNUAL interest rate, then he will reduce all of your credit instrument to 5%. That’s an issue because very few private credit instruments compound annually. Easy-going creditor compound semi-annually, and others compound monthly. It is not impossible to compound daily.
For example: at a daily compounding of 0.05% (1/2 of 1%), if you are owed $1000 on your defaulted credit instrument today, the debtor will have to pay you $6022 one year from now.
That is different from $1050 which the Interest Act s.4 imposes if the judge can’t figure out your annual interest rate.
I hope you see the game: The borrower in Clear flow pretended that he couldn’t translate the daily compounding of 0.003% into an annual rate. Therefore he didn’t pay, went to court and asserted the Interest Act s.4. The motion judge, uncomfortable with numbers and all that, made the mistake of saying that the Interest Act triggers the 5% rate whenever a judge can’t be certain as to the amount of the total interest owing (court of appeal para 22). Even though the annual interest rate, by itself,was ascertainable from the daily rate and the formula in the credit instrument (1.095%), (court of appeal para 46), what if the debtor paid off a few dollars sometime in the year? Then there was no way to predict the total amount of remaining principal + interest on an annual basis. Therefore the motion judge default to 5% for the whole credit instrument. Consumer protection etc.
This judicial mistake is merely a repetition of the more ridiculous judicial mistake the first time the Interest Act s.4 was ‘considered’ by the Ontario High Court (para 57). In that 1989 case the judge though a 2% monthly compounding meant a 24% annual rate. It doesn’t the annual rate is equivalent to 26.8% per annum.
The take-away for creditors worrying about how to be sure about their rate of return, is language with sufficient clarity that you don’t have to worry that some Ontario superior court judge will determine your words to be to hard to annualize. Ultimately the court of appeal fixed the Clear Flow uncertainty.
The problem remains: at least two Ontario superior court judges have been unable to properly interpret the Interest Act s.4. The macroeconomic consequences of a single judge’s mistake in this area would be greater than Judge Judy deciding that you have to pay child support.
