Criminal Interest 

Legal Notes

Criminal Interest

Do royalty payments made after a loan has been paid in full constitute interest on that loan?

FROM: MAY-JUN 2003 ISSUE | BY RICHARD W. POUND

Could a person's royalties be subject to the criminal interest provisions of the Criminal Code? If so, would all royalties paid be criminal, or only the amount exceeding the maximum permitted under the Criminal Code? The British Columbia Court of Appeal addressed both of these questions in the case of Boyd v. International Utility Structures Inc. [(August 1, 2002), 27 B.L.R. (3d) 1 (B.C.C.A.)].

In July 1991, Dr. Ronald Boyd loaned about $50,000 to the predecessor of International Utility Structures Inc., which used the loan to acquire technology to manufacture utility poles. The loan was to be repaid in 120 days with interest at a rate of 30 per cent per annum. In addition, a continuing royalty of $2 per pole manufactured and sold using the acquired technology was to be paid to Boyd. International Utility repaid the loan, with the 30 per cent interest, within 190 days. It did not sell any utility poles until 1994, and it did not begin paying Boyd any royalties for the poles sold until 1996. The company then stopped paying royalties at the end of January 1997.

Boyd sued International Utility for the royalties accrued since the beginning of 1997. International Utility asked the Court to dismiss Boyd's lawsuit, based on the argument that, when combined with the royalty payments, interest on Boyd's loan exceeded the maximum interest permissible under the Criminal Codeand that, as a result, the royalty agreement was unenforceable.

The B.C. Supreme Court did not agree. The Court not only decided that the royalties constituted "interest" for purposes of the Criminal Code, it also found that the royalty agreement would become unenforceable only if and when the total of the royalties Boyd received exceeded the criminal interest rate. Both Boyd and International Utility appealed to the B.C. Court of Appeal. Boyd appealed the finding that the royalties were interest, and International Utility appealed the finding that the royalty agreement was enforceable until the royalties received exceeded the criminal interest rate.

Enforceable Royalties

Under the Criminal Code, anyone who receives a payment or partial payment of interest at an annual rate of more than 60 per cent is guilty of an indictable offence. The case of Boyd and International Utility did not fall within this provision, since the stipulated interest rate was only 30 per cent. Boyd would have committed an indictable offence only if the royalties constituted interest for purposes of the Criminal Codeand only if that interest was at the criminal rate. The Criminal Codebroadly defines interest to include all charges for the advancing of credit, except for some exclusions not applicable in this case.

Up until it stopped paying royalties in 1997, International Utility had paid Boyd almost $35,000 in royalties. The actuarial calculations revealed that a royalty payment of approximately $80,000 on July 1, 2000, would have resulted in the receipt of interest at a criminal rate.

The B.C. Court of Appeal considered three issues: whether or not the royalties were interest for the purposes of the Criminal Code, whether or not the royalty payments were voluntary and therefore excluded from the application of the Criminal Codeand whether or not the royalty agreement was enforceable until such time as Boyd had received payments in excess of the criminal rate.

The Supreme Court of Canada has emphasized that the definition of interest in the Criminal Code is very broad and includes payments that are not interest in common law or under generally accepted accounting principles. Nevertheless, Boyd argued that the royalty agreement was not a debt since the return was contingent on the results of the business and was therefore more like an equity participation than interest on a loan. He indicated that he had originally wanted to invest in shares in addition to receiving the interest on the loan but was told that no shares were available. The royalty was suggested as an alternative.

The Court of Appeal concluded that Boyd's original intentions and wishes were irrelevant. The terms of the loan and royalty agreements had superseded all prior discussions and negotiations. While Boyd argued that the royalty agreement should be construed separately, it was clear that the loan and royalty agreements were linked and Boyd became entitled to the royalty only because he had made the loan. In fact, the royalty agreement explicitly indicated that it was additional consideration for the loan. The Court of Appeal concluded that Boyd was in fact a lender and not an equity investor since Boyd had made no investment beyond the funds advanced under the loan. The nature of the royalty was more like interest than a share of profits since the royalty was not contingent on profits. Like interest, it was payable out of gross revenue.

This reasoning is somewhat questionable since, in the absence of the loan circumstances, it would be difficult to imagine that a royalty based on gross revenues would be considered interest for purposes of the Criminal Code. The distinguishing feature of the royalty agreement here is that it was entered into strictly because of Boyd's advance of funds. Had Boyd provided something additional to International Utility in consideration for the royalty agreement, the Court's decision would likely have been different. For instance, had Boyd acquired the technology sought by International Utility and then transferred that technology to the company in exchange for a royalty, the royalties would arguably have been payable for something other than the advancing of credit. Boyd would likely have stayed out of trouble even if he made a loan to International Utility to buy the technology from him.

Boyd also argued that the receipt of royalties could not contravene the criminal interest rate provisions since the royalty payments were conditional upon the manufacture and sale of utility poles, something entirely within the control of International Utility. In his view, if International Utility voluntarily decided to manufacture and sell utility poles, it was effectively volunteering to pay royalties. The principle excluding voluntary payments from the application of the criminal interest rate provisions of the Criminal Code was established by the B.C. Court of Appeal in Nelson v.C.T.C. Mortgage Corp. [(1984), 16 D.L.R. (4th) 139]. However, the circumstances in that case were significantly different from those of Boyd and International Utility. In the Nelson case, the borrower had exercised a prepayment option, and the amounts payable upon the exercise of that prepayment option resulted in an interest rate of more than 60 per cent over the term of the loan. The decision to prepay was not a foregone conclusion and was a voluntary decision by the debtor. In Boyd's case, the Court concluded that International Utility did not voluntarily, within the meaning of the Nelson case, decide to pay the royalties. To refrain from manufacturing and selling utility poles would have been to abandon the business venture on which the entire agreement between Boyd and International Utility was based.

When considering the enforceability of the royalty agreement, the Court concluded that the agreement itself was not unlawful since it did not stipulate a criminal interest rate. There would be no violation of the Criminal Code unless or until Boyd received royalties in excess of the criminal rate. It would be unreasonable for a rule to permit International Utility to have Boyd indicted simply by paying $1 more than the maximum permissible under the Criminal Code.

Credit Lesson

This B.C. Appeal Court judgment raises the spectre of the application of the criminal interest rate provisions of the Criminal Codeto contracts that provide for participatory payments. It is a reminder that interest, as defined in the Criminal Code, includes a broader category of payments than what is understood as interest usually or under generally accepted accounting principles. Caution should be exercised in drafting royalty agreements or other participatory agreements that are conditional upon the advancing of credit.

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Richard W. Pound, QC, is a partner with Stikeman, Elliott, Barristers & Solicitors, in Montreal.