Decision #113

From: Financial Consumer Agency of Canada

Commissioner's reasons for decision

(Financial Consumer Agency of Canada Act subsection 23(2))

This decision concerns mortgage prepayment rights and the information provided to a consumer about those rights.

In June, 2011 the Deputy Commissioner of the Financial Consumer Agency of Canada (FCAC) issued a Notice of Violation to the company pursuant to subsection 22(2) of the Financial Consumers Agency of Canada Act (Act). The Notice stated:

I have reasonable grounds to believe that the company has committed two violations by contravening Paragraph 8(1)(l) and Subsection 6(4) of the Cost of Borrowing (Trust and Loan Companies) Regulations, in that:

  • The company did not disclose all the necessary components to calculate the actual mortgage prepayment penalty as required under Paragraph 8(1)(l)of the Cost of Borrowing (Trust and Loan Companies) Regulations in the initial mortgage disclosure provided to consumers for fixed-rate mortgages.
  • The company's disclosure of the terms and conditions related to prepayment privileges of the mortgage and the manner in which the prepayment penalty would be calculated were not presented in a manner that is clear, simple and not misleading for the consumer, as required by subsection 6(4) Cost of Borrowing (Trust and Loan Companies) Regulations.

The penalty proposed for these violations is in the amount of $50,000.00.

I have carefully reviewed the file, including the company's written representations [in which it states “We recognize the Deputy Commissioner's concerns {in the Notice of Violation} and are prepared, at this time, to accept same and pay fines in respect of the two violations”]. I confirm that the company has committed the two violations and I will impose an administrative monetary penalty of $50,000.00.

Applicable legislation

Section 438 of the Trust and Loan Companies Act states:

Where a company makes a loan in respect of which the disclosure requirements of section 436 are applicable and the loan is required to be repaid either on a fixed future date or by instalments, the company shall disclose to the borrower, in accordance with the regulations,

(a) whether the borrower has the right to repay the amount borrowed before the maturity of the loan and, if applicable,

(i) any terms and conditions relating to that right, including the particulars of the circumstances in which the borrower may exercise that right, and

(ii) whether, in the event that the borrower exercises the right, any portion of the cost of borrowing is to be rebated, the manner in which any such rebate is to be calculated or, if a charge or penalty will be imposed on the borrower, the manner in which the charge or penalty is to be calculated.

Paragraph 8(1)(l) of the Cost of Borrowing (Trust and Loan Companies) Regulations states:

A company that enters into a credit agreement for a loan for a fixed interest rate for a fixed amount, to be repaid on a fixed future date or by installment payments, must provide the borrower with an initial disclosure statement that includes the following information:

...

(l) the disclosure required by paragraph 438(1)(a) of the Act, including a description of any components that comprise a formula to calculate a rebate, charge or penalty in the event that the borrower exercises the right to repay the amount borrowed before the maturity of the loan and, if section 17 applies, the formula set out in subsection 17(4) ...

Subsection 6(4) of the Cost of Borrowing (Trust and Loan Companies) Regulations states:

Any disclosure that is required to be made by a company under these Regulations must be made in language, and presented in a manner, that is clear, simple and not misleading.

Facts

The company provides its borrowers with multiple mortgage disclosure documents.  Typically, the broker initially provides the borrower with a Commitment Letter and then at closing, the borrower is provided with Standard Charge Terms (SCT).

The Notice of Violation asserted two violations relating to the calculation of the mortgage prepayment penalty. The facts are based on two different complaints received by the FCAC.

First Complaint

In July, 2009, FCAC received a self-reported complaint from the company regarding a mortgage prepayment penalty charge. The customer had complained that she was not advised that the amount of the penalty would be determined by the term of the mortgage.

FCAC's review of this complaint suggested that the company did not disclose in the initial mortgage disclosure provided to consumers for fixed-rate mortgages all the necessary components to calculate the actual mortgage prepayment penalty as required under Paragraph 8(1)(l)of the Cost of Borrowing (Trust and Loan Companies) Regulations.

In its response to FCAC queries, when asked to locate the description of any components that comprise the formula to calculate the penalty for fixed rate mortgages, the company stated in December, 2010:

The SCT outlines and defines the four components included in calculating the Interest Rate Differential (IRD). The IRD represents an amount that is the difference between the i) customer's existing interest rate on their mortgage, and the ii) interest rate that the company currently offers on a similar mortgage, iii) for the term remaining on the mortgage, calculated against the iv) principal amount of the mortgage being repaid.

In January, 2011, the company was asked whether it believed it fulfilled the requirement of paragraph 438(1)(a) of the Trust and Loan Companies Act and Paragraph 8(1)(l) of the Cost of Borrowing (Trust and Loan Companies) Regulations. The company replied:

In accordance with section 438(1) of the TLCA, the company does disclose whether the borrower has the right to repay the amount borrowed before maturity together with the terms and conditions. The SCT provides that one may prepay if the Mortgage is not in default and certain prepayment costs are paid. Paragraph 8(1)(1) of the Cost of Borrowing Regulations requires a descriptive of the components that comprise the formula. The SCT provides that 3 months interest at existing Interest Rate is payable. The amount of interest is disclosed and implicitly is applied against the amount prepaid otherwise the prepayment charge would not be reflective of the amount being repaid. This is further supported by the fact that the Commitment Letter, the terms of which prevail over the SCT, specifically provides that the three months interest is calculated on the full principal amount being repaid. Similarly the IRD calculation implicitly requires that it applies to the term remaining on the mortgage which is explicitly provided for in the Commitment Letter.

Second Complaint

In November, 2009, FCAC received another complaint via email from a customer of the company who was unclear about how his mortgage prepayment penalty would be calculated. The client was concerned because the mortgage prepayment penalty terms disclosed initially in a Commitment Letter provided by his broker were inconsistent with the mortgage prepayment penalty terms subsequently disclosed in the company's SCT.

Prior to 2008, the company's SCT did not include prepayment terms; such terms were included as a schedule to each mortgage based on the terms negotiated with the customer. The SCT terms were amended in April 2008 to include, among other provisions, standard prepayment terms. The SCT disclosure reflects that the IRD calculation is based on the difference between the current mortgage interest rate and the customer's mortgage interest rate.

In late 2008, a business decision was made by the company to change the basis upon which the IRD calculation would be made. This method to calculate the IRD is reflected in the Commitment Letter; however, it is not reflected in the SCT.

In July, 2009, the consumer signed the Commitment Letter document with the company through its Broker Services Division. The Commitment Letter reflected the new basis upon which the IRD would be based. In July, 2009, the consumer received the company's SCT, April 2008 version through the solicitor. The SCT reflected that the IRD is calculated based on the difference between the current mortgage interest rate and the customer's mortgage interest rate.

The company was aware of the discrepancy in its documentation.  However, the company believed that the statement in the SCT which states that if there is any conflict between the terms of the mortgage and the terms of the commitment, the terms of the commitment will prevail reflected a common industry practice and was clear.

FCAC's review of the complaint indicated that, in some instances, the company's disclosure of the terms and conditions of mortgage prepayment privileges, and the manner in which the prepayment penalty would be calculated, were not presented in a manner that is clear, simple and not misleading for the consumer. This is required by subsection 6(4) Cost of Borrowing (Trust and Loan Companies) Regulations.

Position of the Company

In its written representations dated July, 2011, the company stated that “We recognize the Deputy Commissioner's concerns [in the Notice of Violation] and are prepared, at this time, to accept same and pay fines in respect of the two violations.”

The company submitted that the amount of the penalty ought to be reduced to $12,500 per violation, especially given its record of no previous violations. The company also referred to its submissions in its letter of June, 2011 in response to the compliance officer's report that are relevant, including:

  • Reliance on outside counsel to ensure compliance with the regulations and drafting of the SCT
  • Full cooperation with FCAC throughout the compliance process
  • The limited period of time (April 2008-October 2008) during which customers would have received the disclosure that is under review
  • Its willingness to proceed immediately and promptly to take the necessary steps to rectify matters.

There were follow-up meetings between the company and FCAC, and further letters from the company between August and October 2011. I have fully considered each of these communications.

Discussion

I have carefully reviewed the compliance officer's report and the company's written representations and subsequent communications.  I am not persuaded that the company met its disclosure obligations and I believe the full administrative monetary penalty proposed in the Notice of Violation is in order.

First Violation: Disclosure of any Component of a Formula to Calculate a Penalty

According to Subparagraph 438(1)(a)(i) and (ii)of the Trust and Loan Companies Act, companies are required to disclose whether the borrowerhas the right to repay the amount borrowed and to provide any terms and conditions relating to that right, including the manner in which a charge or penalty, if any, is to be calculated, in the event of prepayment

Under Paragraph 8(1)(l) of the Cost of Borrowing (Trust and Loan Companies) Regulations, companies are required to provide a description of any components that comprise a formula to calculate a penalty in the event that the borrower exercises the right to repay the amount borrowed before the maturity of the loan.

The compliance officer's review determined that the consumer was charged a penalty to prepay her fixed-rate mortgage in full prior to maturity. The company stated that the prepayment cost was based on the interest rate differential (IRD) provided for in the Commitment Letter.

However, the mortgage prepayment penalty disclosures in the Commitment Letter and in the SCT did not describe all the components that comprise the formula to calculate the penalty in the event that the borrower repays the mortgage. The review of the company's prepayment penalty disclosure highlights that “multiplied by the remaining term” was a missing component in the Commitment Letter.

In its disclosure documents, the company failed to indicate that the IRD charge is calculated for the remaining term. Without knowing this component, the consumer would not know that the calculation required them to multiply by the remaining term, which is an essential component of the calculation. Regardless of the impact on individual customers, without the remaining term component, the consumer could not estimate the penalty. Any calculation would necessarily be based on an unstated assumption, which would defeat the very purpose of the regulatory disclosure requirement. The company believed that the IRD calculation implicitly requires that it apply to the term remaining on the mortgage; however, it is important to recognize that this component may not be and may not have been evident to all customers.

Second Violation: Discrepancy between Mortgage Prepayment Disclosure Documents

Subsection 6(4) of the Cost of Borrowing (Trust and Loan Companies) Regulations stipulates that a disclosure statement must be made in language, and presented in a manner, that is clear, simple and not misleading.

In an email to FCAC, the customer complained about the mortgage prepayment penalty. The client was concerned because the terms disclosed initially in the Commitment Letter provided by the broker were inconsistent with the terms disclosed later in the SCT. The compliance officer's review revealed that the company's prepayment penalty charge is based on the greater of a three-month interest calculation or IRD calculation.

The SCT terms were amended in April 2008 to include, among other provisions, standard prepayment terms. The SCT disclosure reflected that the IRD calculation is based on the difference between the current mortgage interest rate and the customer's mortgage interest rate. In late 2008, a business decision was made by the company to base the IRD calculation for new fixed rate mortgages, on a different basis. This method to calculate the IRD is reflected in the Commitment Letter; however, it is not reflected in the SCT.

In fact, the mortgage prepayment information provided in the Commitment Letter and SCT were inconsistent. The mortgage prepayment calculations were very specific in both documents and would result in different penalties depending on which IRD formula was used by the borrower to calculate the prepayment penalty. Even if there is a provision in one document that addresses possible differences between two or more documents, a financial consumer should not be confronted with inconsistent documents in the first place. Especially with respect to a term and condition of their mortgages with such direct monetary impact. Doing so is a failure to meet the requirements of subsection 6(4) of the Regulations.

Harm Done to Customers

Since April 2008, consumers entering into fixed interest mortgage agreements with the company have not received the benefit of complete disclosure with respect to the manner in which a charge or penalty, if any, is to be calculated, in the event of prepayment.

Consumers are entitled to the information required by the Regulations to make informed choices regarding different products and services. Borrowers who receive incomplete mortgage disclosure documents are not in a position to make informed decisions regarding this significant financial commitment. Inaccurate and incomplete information impairs consumers' ability to compare mortgage products and may result in consumers purchasing products that do not suit their needs.

It is paramount that consumers be informed about the cost of obtaining the credit as well as the consequences of paying off their mortgages prior to maturity. Furthermore, the requirements to do so are clearly written in the legislation.

Degree of Intention

In 2004, FCAC initiated an industry review of prepayment penalty disclosure in mortgage documents. A letter was subsequently sent to the industry detailing the expectations that federally regulated financial institutions were to undertake a detailed review of mortgage prepayment clauses contained in the disclosure documents provided to consumers.  The company received this notification.

In 2009, FCAC's Annual Examination Questionnaire covering the period April 2008 to March 31, 2009 posed the following question: “Does your initial mortgage disclosure statement include a description of any components that comprise a formula to calculate a rebate, charge or penalty in the event the borrower exercises the right to repay the amount borrowed before maturity?” In July, 2009, the company submitted its questionnaire and responded Yes to this question.

The company had sufficient opportunities to review its mortgage disclosure documentation and should have implemented all of the necessary steps to comply with the requirements as set out in the Trust and Loan Companies Act and the Cost of Borrowing (Trust and Loan Companies) Regulations.

Compliance History

The company has no previous violations.

Due Diligence

The company has not explicitly pleaded due diligence in its written representations and other communications, although it is implicit in citing reliance on outside counsel (as set out in its June and August letters)… On the information provided to me by the company, I do not see how this particular reliance on outside counsel, or any other steps the company took, were sufficient to now be an effective defence to the clear violations the company committed.

Conclusion

On a balance of probabilities, I find that the information provided in the disclosures did not meet the requirements of paragraph 8(1)(l) of the Cost of Borrowing (Trust and Loan Companies) Regulations. Nor did it meet the clear, simple and not misleading requirement as set out in Subsection 6(4) of the Cost of Borrowing (Trust and Loan Companies) Regulations.

I have found that not every component of the calculation of the mortgage prepayment penalty was adequately disclosed, as required by paragraph 8(1)(l) of the Regulations. The impact on the calculation of including or not the missing component could be substantial. This made it impossible for a customer to understand with certainty the monetary consequences of early mortgage discharge.

Subsection 6(4) of the Regulations states that a disclosure statement must be made in language, and presented in a manner, that is clear, simple and not misleading. The mortgage prepayment terms disclosed initially in the Commitment Letter provided by the broker were inconsistent with the SCT disclosed later. I do not accept that the provision in a legal document such as the SCT dealing with possible conflicts between it and the Commitment Letter was sufficient to address the apparent inconsistency. While the SCT reflects the company's policy in that if there is any conflict between the terms of the Mortgage (SCT) and the terms of the Commitment Letter, the terms of the Commitment Letter will prevail, I am concerned that inconsistent document created uncertainty for consumers when it came to understanding their prepayment terms and the manner in which a penalty would be calculated in the case of a prepayment.

In this situation, there was harm to a significant number of consumers. Due to confusing and incomplete information, consumers did not benefit from complete disclosure with respect to the prepayment rights of their mortgage. The company had an obligation to provide all the necessary information to consumers in an initial disclosure statement which would allow them to estimate the mortgage prepayment penalty amount. Moreover it missed opportunities to prevent these problems or deal with them prior to complaints being made.

I acknowledge that the company has communicated in detail with the FCAC's Compliance and Enforcement Branch throughout this process (but the number of follow-up meetings and communications required after the initial written representations should not have been needed). I also acknowledge that the company has also begun to update some of its disclosure documentation. I note the company's lack of prior violations. But this is what I would expect of any federally-regulated financial institution. These facts do not explain or excuse the two violations.

I impose an administrative monetary penalty of $50,000 for the combination of the two violations.

As indicated in the cover letter to the Notice of Violation, there will be a formal Compliance Agreement to ensure the company is completely successful in its efforts to fully comply with the legal requirements.

Ottawa, October 21, 2011

Ursula Menke

Commissioner

Financial Consumer Agency of Canada

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