The Ontario Court of Appeal recently released its judgment in 660 Sunningdale GP Inc. v First Source Mortgage Corporation, 2024 ONCA 252 (“Sunningdale v First Source”), on appeal from 2023 ONSC 2129.
In this case, the Ontario Court of Appeal has set a precedent in the enforceability of contractual payments, distinguishing between penalty clauses and non-contingent contractual obligations.
In considering a $426,500 disputed lender fee for a loan that was never advanced, the Court reversed the decision of the trial judge in determining that the entire fee is enforceable and payable to the lender since it was not contingent on the advancement of loan monies. In doing so, the Court drew a line between (i) payments triggered by breach of the payor in an agreement, which can be considered penalty clauses and thus unenforceable at common law when excessive, and (ii) general contractual payments not contingent on default, which are not subject to the same scrutiny. This case has significant implications for lenders, borrowers and parties to commercial contracts generally in clarifying when contractual payments can be deemed unenforceable penalty clauses.
Key takeaways
- To be deemed an unenforceable “penalty clause,” a payment obligation must be triggered by or contingent on a breach of the payor. The Courts will not consider a contractual payment obligation that applies irrespective of whether there has been a breach of the agreement to be a penalty clause.
- In Sunningdale v First Source, this reasoning was applied by the Ontario Court of Appeal in denying relief to a developer that was required to pay a lender fee despite loan monies never being advanced as the obligation to pay did not arise from any non-compliance of the developer.
Case background
The plaintiff/respondent in Sunningdale v First Source, 660 Sunningdale GP Inc. (“Sunningdale”) entered a commitment letter (the “Commitment Letter”) with the defendant/appellant First Source Mortgage Corporation (“First Source”) wherein First Source agreed to refinance the first mortgage over a property located a 660 Sunningdale Road East in London, Ontario. Under the Commitment Letter, Sunningdale agreed to pay a lender fee (the “Lender Fee”) of 2.75% of the loan value ($426,500). Sunningdale was required to pay a combined initial fee/deposit of $100,000 on acceptance of the Commitment Letter (the “Deposit”).
The Commitment Letter included a term stipulating that if, through no fault of First Source, the Commitment Letter was terminated before the loan was advanced, Sunningdale would still be liable to pay the Lender Fee in its entirety on demand. On March 31, 2021, Sunningdale accepted the Commitment Letter and advanced $100,000, representing the Deposit, to First Source. On April 22, 2021 Sunningdale terminated the Commitment Letter before any funds were advanced by First Source. Sunningdale later paid the remaining balance of the Lender Fee, $326,500, into trust with its lawyer in exchange for First Source removing a PPSA registration it had filed on the property.
One – Trial Decision
Sunningdale then applied to the Court for summary judgment in the amount of $426,500, asserting that First Source made unreasonable demands after the Commitment Letter was signed resulting in a change to the fundamental terms of the agreement, and that the clause requiring payment of the Lender Fee where funds were never advanced is an unenforceable penalty clause. First Source responded claiming the unpaid remainder of the full fee, $326,500. By way of summary judgment at the trial level, Justice Pamela L. Hebner handed down a mixed decision, determining that the balance of the Lender Fee is a penalty and awarding Sunningdale the $326,500 in trust, while finding that the Deposit was a legitimate pre-estimate of damages, allowing First Source to retain the $100,000 already received.
Two – Appeal
On appeal, the Ontario Court of Appeal reversed the trial decision regarding the balance of the Lender Fee, ordering that the $365,500 also be paid to First Source along with a combined $70,000 in costs for the initial summary trial and appeal. The Court determined that the payment of the balance of the Lender Fee was not a penalty as the payment was not contingent on any default of Sunningdale – it was already considered earned at the time of the Commitment Letter’s execution and specified to be payable on demand even where mortgage funds were never advanced.
In making this determination, the Court drew a clear line between payments triggered by or otherwise requiring breach to become payable, which are considered penalty clauses and thus unenforceable if excessive beyond a genuine pre-estimate of damages and general contractual payments that become payable without any breach.
Implications
- Going forward, parties to commercial contracts and their counsel should continue to ensure that the quantum of any contractually imposed penalty is restricted to a genuine pre-estimate of damages.
- In addition, parties should be alive to the distinction drawn between contractual payments and penalty clauses. Parties wishing to impose payments in excess of a genuine pre-estimate of damages must take care that such payments are not triggered by, or contingent on, the payor breaching the agreement.
- Conversely, parties subject to payments should take note of the limitations of common law liability protections. A “penalty clause” is a narrow concept, and even payments that seem punitive in the context of a given agreement are unlikely to be treated as such at common law unless they are directly triggered by or dependent on breach of the payor.
Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation. There were multiple plaintiffs and defendants in this case, those identified in the background facts herein are used representatively as the key parties.