When Are Payment Penalties Illegal?
A Payment Penalty or Late Fee Is Often Viewed As a Disguised Interest Charge and Is Often Deemed Unlawful or Unenforceable.
Determining When a Payment Penalty Is Enforceable or Without Binding Effect
Business owners often attempt to encourage prompt payment by imposing delayed payment penalties (late fees) upon those who fail to pay on time. Unfortunately, contracts may be deemed unlawful and therefore null & void or otherwise unenforceable when the contract is written in such a way as to impose, or appear to impose, an improper late fee. Commonly, the late fee calculates to an amount that violates the Criminal Code, R.S.C. 1985, c. C-46, section 347, whereas charging an interest rate beyond sixty (60%) percent per annum is deemed a criminal offence. Any contract that prescribes an interest rate in excess of the maximum allowable sixty (60%) percent is therefore an illegal contract; Garland v. Consumers' Gas Co.,  3 S.C.R. 112. Do note that a severability clause may save the entire contract from becoming void.
While a business may attempt to disguise interest as a late fee, courts will view a late fee for what a late fee is - an interest charged as an additional amount of money due, and arising from, the extension of credit for an outstanding balance of monies owed. An exception applies if it is shown that the late fee genuinely correlates to the recovery of a disbursement cost incurred in the collection of the debt rather than as an additional fee correlated to the further advancement of the debt; De Wolf v. Bell ExpressVu Inc., 2009 ONCA 644; Garland, supra.
As an example, consider the business that charges a ten 00/00 ($10.00) dollar late fee when a monthly payment of one hundred 00/00 ($100.00) is over due by seven (7) days. This late fee actually calculates as a ten (10%) percent additional charge upon the actual amount due. This ten (10%) percent late fee imposed upon a one week overdue account produces an exorbitant, and unlawful, five hundred twenty (520%) percent annual interest rate. Note that the fact that this interest appears lower, and actually does calculate lower, over a greater period of time, it is the trigger date that causes the unlawfulness. While the $10.00 late fee charged on the 7th day is unlawful, it might appear that if six months later the same $10.00 is still outstanding that the amount, by then, is a lawful twenty (20%) percent interest; however, the very fact that the amount was unlawful when originally imposed continues to make the amount unlawful. What was at first unlawful fails to become lawful.
When an agreement contains a clause for late fees or other form of delayed payment penalty, such is viewed as an attempt to charge interest on monies due. Where the late fees, as a disguised interest, calculate to an interest rate beyond the legally allowable interest rate, the late fees are viewed as unlawful. Furthermore, even if the interest rate may be legal, late fees or a payment penalty that goes beyond the costs of recovering the genuine amount due are, generally, deemed unenforceable.Learn More About
Delayed Payment Penalty