Commitment fees, penalty clauses, and relief from forfeiture: the bargain prevails in the Court of Appeal for Ontario
There is sometimes something of a battle in contract cases between enforcement of the parties' bargain, even if the outcome has turned out to be harsh for one of the parties, and the use of equitable relief and contractual doctrines to soften a harsh outcome, but at the cost of undermining contractual certainty. This was the issue in 660 Sunningdale GP Inc. v. First Source Mortgage Corporation.1 A lower court had invalided a mortgage commitment fee by invoking the law relating to penalty clauses and relief from forfeiture. The Court of Appeal for Ontario reversed and enforced the parties' bargain – which was that the commitment fee was payable even if the loan did not ultimately proceed – even though the outcome was a harsh one according to the borrower.2
The background
660 Sunningdale GP Inc., a commercial real estate developer, signed a commitment letter with First Source Mortgage Corporation for a first mortgage refinancing loan on a development property in the amount of $15,500,000. The loan commitment contained a lender's fee of 2.75% or $426,500 as consideration for First Source committing to the loan. A portion of the fee, $100,000, was paid upfront, with the balance to be paid from the loan proceeds, upon funding, or directly by the borrower in the event the loan was not funded without a default by the lender.
The loan did not proceed, with no defaults by either borrower or lender. Sunningdale refused to pay the balance of the commitment fee ($326,500). Litigation ensued.
At first instance, the court found that the initial $100,000 payment was payable because it was a pre-estimate of damages and not a penalty clause, but that the balance of the commitment fee ($326,500) was an unenforceable penalty constituting a sum that was extravagant and unconscionable in comparison with the maximum loss that could have been sustained by First Source under the terms of the loan commitment. The court also invoked relief from forfeiture as a second ground for relieving Sunningdale of the obligation to pay the balance of the commitment fee.
The commitment fee was not a penalty clause
The Court of Appeal found the lower court's invalidation of the commitment fee as an unenforceable penalty clause to be wrong because, to put it bluntly, there was no penalty clause. For a contractual payment to be a penalty (and consequently a stipulated remedy clause that may not be enforceable according to its terms) it must first arise out of non-observance or breach of a contractual term. First Source's lender's fee for arranging a loan was not a stipulated remedy clause because it did not arise out of non-observance or breach of a contractual term. Instead, it formed consideration for obtaining the loan commitment.
The loan agreement was clear that the commitment fee was earned at the time of signing ("In consideration of First Source obtaining this Commitment, the Borrower agrees to pay a fee" ... "the Lender fee is deemed earned upon acceptance and execution of this Commitment"). Thus, the commitment fee was not compensation for breach of contract. It was a fee for services rendered.
Relief from forfeiture was not available
Furthermore, the Court of Appeal found the motions judge took an overly expansive view of her equitable powers granting relief from forfeiture in favour of the Sunningdale with regard to the balance of First Source's lender's fee. In overturning the motions judge, the Court of Appeal took a much narrower view and enforced the parties' bargain, which was to deny relief from forfeiture with regard to the lender's fee (the consideration for the contract).
The Court of Appeal also found the motions judge had incorrectly applied the doctrine of unconscionability in order to invalidate the parties' bargain. The doctrine of unconscionability requires proof of inequality between bargaining parties and a resulting improvident bargain. There was no evidence to suggest that Sunningdale was of inequal bargaining power with First Source and, to the contrary, Sunningdale was a commercial developer not a disadvantaged consumer.
Key takeaways
This decision has implications for transactions involving commitment fees. It reinforces the need for clarity and precision in drafting loan commitments to avoid ambiguities that could lead to protracted legal disputes. This decision stands for the proposition that non-observance or breach of a contractual term is required for contractual payment to be categorized as a penalty or stipulated remedy clause that may be unenforceable. With regard to relief from forfeiture, at least in respect of commitment fees, the courts are willing to enforce the parties' bargain and are not inclined to use aggressive equitable theories to change the deal after the fact when the outcome turns out to be a harsh one.
Footnotes
1 660 Sunningdale GP Inc. v. First Source Mortgage Corp., 2024 ONCA 252.
2 Of course harshness of outcome depends upon one's perspective. The lender would say – and the court agreed – that the commitment fee was payable for precisely what the lender had done by sourcing the loan.
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