Anonymised, illustrative composite. Split opco/propco structures are built for tax and liability reasons. They also split the borrower into two units for a federal statute most deal teams assume does not apply to companies at all.
At a glance
A buyer acquired a light-manufacturing business making formed steel components, together with the 34,000 square foot building it operated from, for $4,600,000 — $2,900,000 for the real property and $1,700,000 for the business.
The structure was the standard one: a property company took title to the building, an operating company took the business, and the operating company paid rent to the property company. See separating the property into a distinct holding company for why buyers do this.
One lender funded both. One credit agreement, two borrowers, cross-guarantees, and a single events-of-default schedule. The propco facility was $2,175,000 secured by a first mortgage on the building; the opco facility was $1,190,000 secured by a general security agreement over the business assets.
In year three the business lost an anchor customer representing 38% of revenue. Rent stopped, then the propco payments stopped, then the opco payments stopped. Nine months of arrears accumulated on both facilities before a refinancing was arranged with another lender.
The lender’s discharge statement applied the default-rate clause across both: the contract rate plus 5% on all amounts in arrears. On the propco side that produced $17,400 of uplift; on the opco side, $9,600.
The buyer’s counsel struck out the propco figure and paid the rest. The lender’s first response was that the borrowers were corporations, and corporations are outside the Interest Act. That is true of one section of it and not of the one that mattered.
Propco: $2,175,000 at 7.35%, monthly principal and interest of $16,300. Nine months of arrears building to about $146,700, on which the 5% uplift produced $17,400 over the period.
Opco: $1,190,000 at 8.10%, monthly payments of $14,900, arrears of about $131,200 and $9,600 of uplift.
Total default-rate charge on the payout statement: $27,000, of which $17,400 was attributable to arrears secured by the mortgage and $9,600 to arrears secured by the general security agreement.
Section 8(1) of the Interest Act, marginal note No fine, etc., allowed on payments in arrears, reads in full: “No fine, penalty or rate of interest shall be stipulated for, taken, reserved or exacted on any arrears of principal or interest secured by mortgage on real property or hypothec on immovables that has the effect of increasing the charge on the arrears beyond the rate of interest payable on principal money not in arrears.”
Three units are doing the work. First, arrears: the section is about what may be charged on amounts already overdue, not about the rate on the performing balance. Second, secured by mortgage on real property or hypothec on immovables: that is what confines it to the propco leg. A general security agreement over equipment, inventory and receivables is not a mortgage on real property, so the identical clause in the identical agreement is untouched on the opco side. Third, the comparator is “the rate of interest payable on principal money not in arrears” — the contract rate itself.
Section 8(2) is the corrective that keeps this from being a ban on default interest: “Nothing in this section has the effect of prohibiting a contract for the payment of interest on arrears of interest or principal at any rate not greater than the rate payable on principal money not in arrears.” The lender may charge 7.35% on the propco arrears. It may not charge 12.35%.
The lender’s corporate argument came from the wrong section. Section 10(1) gives a right, after five years, to pay out a mortgage on principal plus three months’ interest in lieu of notice — and s.10(2)(a) disapplies that right “to any mortgage on real property or hypothec on immovables given by a joint stock company or any other corporation”. Section 8 carries no equivalent exclusion. Knowing that corporations sit outside s.10 and inferring that they sit outside s.8 is the error, and it is a common one because both sections live in the same part of the same Act.
The remedy is in the section next door. Section 9: “If any sum is paid on account of any interest, fine or penalty not chargeable, payable or recoverable under section 6, 7 or 8, the sum may be recovered back or deducted from any other interest, fine or penalty chargeable, payable or recoverable on the principal.” A borrower who has already paid a void uplift is not left arguing about restitution at large.
The propco uplift was removed from the payout statement in full. Arrears interest on the propco mortgage was recalculated at the contract 7.35%, which s.8(2) expressly permits, and the refinancing closed on the corrected figure.
The opco uplift of $9,600 was paid. Counsel did not argue it, because there was nothing to argue: the security was personal property and s.8 does not reach it.
One drafting change came out of the file. On the next acquisition the same buyer’s counsel asked for the default-rate clause to be split by facility rather than written once across both borrowers, so that the propco rate was stated at the contract rate on arrears and the opco rate carried the uplift. The lender agreed without discussion, because the clause it had been using was unenforceable on one side anyway.
$17,400 on this payout. The number is modest; the pattern is not. A default-rate clause written once across an opco and a propco is a clause that is partly void on every deal it is used on, and neither side usually notices until a payout statement is produced under time pressure at a refinancing.
The wider cost is the one that does not show on a statement: a borrower who pays an unenforceable charge because the payout is needed today, and never recovers it because s.9 was not raised while the money was still moving.
The tell is one clause covering two borrowers with two kinds of security. Any acquisition split into an operating company and a property company has two security packages, and s.8 sorts them by asset class rather than by borrower name.
The second tell is the argument the lender made. It is a corporate borrower is an answer to a s.10 prepayment question, not a s.8 arrears question, and hearing it should send you to the section numbers rather than to the negotiation.
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