A mezzanine lender is routinely paid through more than a stated coupon — a closing fee, a prepayment premium, warrants, a payment-in-kind kicker. A federal statute over a century old sets a hard rule for what happens when the equivalent yearly rate of that whole package is never actually written down.
Key takeaways
SECTION 01 OF 03
The Interest Act sets a blunt default for exactly this situation: “Except as to mortgages on real property or hypothecs on immovables, whenever any interest is, by the terms of any written or printed contract, whether under seal or not, made payable at a rate or percentage per day, week, month, or at any rate or percentage for any period less than a year, no interest exceeding the rate or percentage of five per cent per annum shall be chargeable, payable or recoverable on any part of the principal money unless the contract contains an express statement of the yearly rate or percentage of interest to which the other rate or percentage is equivalent.” (Interest Act (R.S.C. 1985, c. I-15), s.4)
Notice the express carve-out at the start of the section: it does not apply to “mortgages on real property or hypothecs on immovables.” Most mezzanine and vendor financing on a business acquisition is secured by a general security agreement over personal property, shares, or an unsecured note — not a real-property mortgage — which is precisely the category s.4 was written for.
SECTION 02 OF 03
Mezzanine and vendor take-back notes are exactly the instruments most likely to price return through something other than a clean annual coupon: this hub's article on mezzanine capital in a mid-market deal already describes mezzanine pricing running roughly 8–12%, often with a payment-in-kind (PIK) component that accrues to the loan balance rather than requiring cash payment, plus in many structures a closing or exit fee and warrant coverage on top of the stated coupon. A prepayment bonus, an exit fee calculated as a percentage of the amount repaid, or a return calculated with reference to a period shorter than a year, all fall inside s.4's language of interest “payable at a rate or percentage… for any period less than a year.”
If the total economic return of that package, expressed as a true annual rate, is never written into the note as an express annual-rate statement, s.4's plain text caps what is chargeable, payable or recoverable on the shortfall at 5% per annum — not at whatever rate the parties actually intended.
SECTION 03 OF 03
The practical fix is on the page, not in litigation: the agreement should state the true annual equivalent rate expressly, in the document itself, capturing whatever the PIK, bonus, fee or warrant component is actually worth on an annualized basis. That is a drafting discipline for whoever is preparing the note, and it applies whether the lender is an institutional mezzanine fund or a selling shareholder taking back paper as part of the price. Where the parties dispute after the fact which claim gets paid first rather than what rate applies, that is the separate ranking question Treadstone Law's answer on whether a mezzanine lender's claim ranks before or after a bank loan addresses.
This is a different exposure from the ranking questions the mezzanine capital article and the vendor take-back priority article in this hub already cover — those address where a mezzanine or vendor claim sits against a senior lender's security. Section 4 is not about ranking at all; it is about whether the stated economics of the note as written are enforceable at their intended rate, independent of where the debt sits in the stack.
Interest Act s.4 caps what is chargeable, payable or recoverable on undisclosed interest calculated on a less-than-annual basis at 5% per annum, unless the contract expressly states the equivalent yearly rate — not whatever rate the parties actually intended.
Yes, in most cases. Section 4 excludes mortgages on real property and hypothecs on immovables, but most mezzanine and vendor acquisition paper is secured by a general security agreement, shares, or an unsecured note instead — exactly the category the exclusion does not reach.
A payment-in-kind component, a prepayment bonus, an exit fee calculated as a percentage of the amount repaid, or any return calculated for a period shorter than a year can all fall inside s.4’s language if the note never states the whole package’s true annual equivalent rate.
Sources
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