Hav-A-Kar Leasing: Accelerated Payments in Canada ' Close But Not Quite Right

In Hav-A-Kar, a lease agreement for a motor vehicle provided for payment of all amounts unpaid upon default by the lessee. The lessee defaulted and the lessor sued for damages, including enforcement of the accelerated payment clause. The trial judge rejected the lessee's argument that the payment clause was a penalty, as opposed to a liquidated damages clause. The lessee appealed the decision on the basis that the trial judge erred in enforcing the accelerated payment clause. The appeal was dismissed. The Court of Appeal in making its determination relied on the well-established principle that damages for breach of contract should put the plaintiff in the same position as if the contract had been performed. It was found that the accelerated payment clause was not excessive; it simply put the lessor in the position it would have been in if the lessee performed its obligations under the lease agreement. It should be noted that this decision was focused on whether acceleration was an appropriate remedy and to a much lesser extent (or not at all) on how the payments should have been calculated.

The court relied on the Supreme Court's decision Keneric Tractor Sales Ltd. v. Langille, [1987] 2 S.C.R. 440 (“Keneric Tractor“), as precedent for the enforcement of payment acceleration clauses; however, this case acknowledges the need to discount future payments to properly reflect the time value of money. This case dealt with a breach of an equipment lease where the sum of all lease payments was equal to 120% of the equipment's purchase price. A portion of the damages was calculated by taking the original purchase price of the equipment, subtracting payments made by the lessor, then adding a margin to the remaining payments based on the 20% markup rate. This formula yields a lower amount than the sum of all remaining lease payments, effectively discounting the future payments presently received by the lessor. Further, the decision specifically states that the lessee is liable for “the unpaid rentals under the lease (discounted for early receipt) minus the proceeds of sale plus the expenses of repossession, repaid and resale.” (Keneric Tractor, at 30, (emphasis added)). Hav-A-Kar correctly relies on Keneric Tractor for the principle that contractual payment acceleration clauses are enforceable as damages owed to the lessor; however, it incorrectly applies this reasoning. By ignoring the need to present value the unpaid rent, the lessor receives more than he or she would have had the contract been fulfilled. The enforcement of the accelerated payment provision in Hav-A-Kar may be a penalty, and is certainly more advantageous than a properly drafted liquidated damages clause.

Hav-A-Kar

also relied on the reasoning in Peachtree II Associates ' Dallas LP v. 857486 Ontario Ltd. (2005) 76 O.R. (3d) 362 (C.A.) (“Peachtree“), in determining not all accelerated payment clauses are unenforceable penalty clauses; however, this case is helpful mainly for its discussion regarding the enforcement of penalty clauses. Peachtree involved a dispute between a corporation and investors whose obligations were secured by a promissory note; upon a breach of contract by the investors, the amounts due under the promissory note were deemed payable. The investors appealed an arbitrator's enforcement of the clause on the basis that it was a penalty and therefore void under contract law. The appeal was dismissed, as neither contract law nor equity has a black-letter rule against the enforcement of penalty clauses. The legal principles surrounding penalty clauses are complicated and nuanced; therefore, the penal effect of a clause does not automatically mean it will be unenforceable. Peachtree mainly discusses the principles of contract law and the court's willingness to interfere. If an accelerated payment clause is properly drafted to present value payments, then it cannot be considered a penalty clause; therefore, whether or not a proper accelerated payment clause is upheld has little to do with the discussion in Peachtree.

It may be that in Hav-A-Kar the court recognized the clause in the lease agreement could be considered a penalty clause because it did not allow for a discounting of payments, but then relied upon Peachtree for the ability to enforce a contract clause regardless of its potential penal effect. If this is in fact what the court based its decision on, then it recognizes the need to present value accelerated payments for a fair result, but allowed this clause to be enforceable using the legal principles of freedom of contract. Since the court did not discuss the present value of money in Hav-A-Kar, it is difficult to know whether the court acknowledged the need to discount payments and simply allowed this provision to be enforced based on reluctance to interfere with freedom of contract, or if that reluctance was the basis of the decision without considering the ability to properly adjust damages by adjusting the amount with some present value formula. The decision's emphasis on the lessee being in the same position had the contract been fulfilled suggests the latter.

Another potential factor that the court may have taken into account but did not specifically address in the decision is the possibility that the differential between the full value of the remaining payments and the discounted value of those payments was so minute that applying the discount would have little relevance; this is particularly likely given that it is a small-ticket lease and a low interest rate environment.

If the factors discussed above were considered but dismissed, it would be helpful if the court indicated such. What is concerning about the decision and its lack of discussion of the aforementioned reasoning is that it may be relied upon in a different fact situation where the differential between the two amounts is large and the penal effect of a clause that does not present value payments is not recognized. The problem with Hav-A-Kar is that the decision as stated ignores the benefit to the lessor of receiving future lease payments today. At face value the math is simply wrong; however, it is possible the court was fully aware of the need to discount payments but did not discuss this for a variety of reasons.

Conclusion

Present value termination clauses have been rightly upheld by the courts where there is a recognition that the payments must be discounted for early receipt. These clauses serve as a genuine pre-estimate of damages incurred and put the lessor in the position he or she would have been in had the breach not occurred. Where these clauses demand the whole amount remaining under the lease to be paid, the lessor is in a better position than had the breach not occurred. This allows for the lessor to benefit from the breach, which is in conflict with the long-standing principle of damages for breach of contract. Hav-A-Kar demonstrates the importance of flushing out the reasons behind a decision, as this case may be relied upon for an accelerated payment clause where the benefit to the lessor is great and the court does not turn its mind to the ability to correct the clauses. Practically speaking, lessees should pay attention to termination clauses, as an accelerated payment clause may be upheld even where the agreement ends up putting the lessor in a better position than if the contract had been fulfilled.

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Jonathan Fleisher is chair of Cassels Brock & Blackwell LLP's Equipment and Asset Finance Group and is located in Toronto, Ontario. He has particular expertise assisting U.S. commercial finance companies, both public and private, with establishing operations in Canada, providing both legal and practical business advice. Keri Wallace is an associate in the firm's Financial Services Group. Her practice focuses on bankruptcy, corporate restructuring, banking and finance. The authors may be reached at [email protected] and [email protected], respectively.

The objective of awarding damages for a breach of contract is to put the injured party in the same position as if the contract had been properly performed. This principle is commonly included in contracts through termination provisions that allow the injured party to recover future payments upon an event of default. Where all remaining payments automatically become due, the agreement typically includes a mechanism to discounted payments to take into account the time value of money. These acceleration clauses, if properly drafted, can be considered a genuine pre-estimate of damages as the lessor is in the same position it would have been in had the contract been completed. The key to a fair acceleration clause is to allow for proper discounting as to reflect the value of receiving the remaining payments before they would otherwise become due. If the lessor were to collect full payments at the time of default, the lessor would be in a better position than had the default not occurred.

The use of acceleration clauses has been accepted by Canadian courts; however, there is at least one case where the courts allowed for an accelerated payment clause to be enforced without discounting payments. An Ontario Court of Appeal case, Hav-A-Kar Leasing Ltd. v. Vekselshtein , 2012 ONCA 826 (“ Hav-A-Kar “), enforced such a clause and did not discount payments for early receipt. As discussed below, the decision to enforce this type of clause is problematic as it gives the lessor more funds than it would have received had the agreement been fulfilled.

Hav-A-Kar Leasing

In Hav-A-Kar, a lease agreement for a motor vehicle provided for payment of all amounts unpaid upon default by the lessee. The lessee defaulted and the lessor sued for damages, including enforcement of the accelerated payment clause. The trial judge rejected the lessee's argument that the payment clause was a penalty, as opposed to a liquidated damages clause. The lessee appealed the decision on the basis that the trial judge erred in enforcing the accelerated payment clause. The appeal was dismissed. The Court of Appeal in making its determination relied on the well-established principle that damages for breach of contract should put the plaintiff in the same position as if the contract had been performed. It was found that the accelerated payment clause was not excessive; it simply put the lessor in the position it would have been in if the lessee performed its obligations under the lease agreement. It should be noted that this decision was focused on whether acceleration was an appropriate remedy and to a much lesser extent (or not at all) on how the payments should have been calculated.

The court relied on the Supreme Court's decision Keneric Tractor Sales Ltd. v. Langille, [1987] 2 S.C.R. 440 (“Keneric Tractor“), as precedent for the enforcement of payment acceleration clauses; however, this case acknowledges the need to discount future payments to properly reflect the time value of money. This case dealt with a breach of an equipment lease where the sum of all lease payments was equal to 120% of the equipment's purchase price. A portion of the damages was calculated by taking the original purchase price of the equipment, subtracting payments made by the lessor, then adding a margin to the remaining payments based on the 20% markup rate. This formula yields a lower amount than the sum of all remaining lease payments, effectively discounting the future payments presently received by the lessor. Further, the decision specifically states that the lessee is liable for “the unpaid rentals under the lease (discounted for early receipt) minus the proceeds of sale plus the expenses of repossession, repaid and resale.” (Keneric Tractor, at 30, (emphasis added)). Hav-A-Kar correctly relies on Keneric Tractor for the principle that contractual payment acceleration clauses are enforceable as damages owed to the lessor; however, it incorrectly applies this reasoning. By ignoring the need to present value the unpaid rent, the lessor receives more than he or she would have had the contract been fulfilled. The enforcement of the accelerated payment provision in Hav-A-Kar may be a penalty, and is certainly more advantageous than a properly drafted liquidated damages clause.

Hav-A-Kar

also relied on the reasoning in Peachtree II Associates ' Dallas LP v. 857486 Ontario Ltd. (2005) 76 O.R. (3d) 362 (C.A.) (“Peachtree“), in determining not all accelerated payment clauses are unenforceable penalty clauses; however, this case is helpful mainly for its discussion regarding the enforcement of penalty clauses. Peachtree involved a dispute between a corporation and investors whose obligations were secured by a promissory note; upon a breach of contract by the investors, the amounts due under the promissory note were deemed payable. The investors appealed an arbitrator's enforcement of the clause on the basis that it was a penalty and therefore void under contract law. The appeal was dismissed, as neither contract law nor equity has a black-letter rule against the enforcement of penalty clauses. The legal principles surrounding penalty clauses are complicated and nuanced; therefore, the penal effect of a clause does not automatically mean it will be unenforceable. Peachtree mainly discusses the principles of contract law and the court's willingness to interfere. If an accelerated payment clause is properly drafted to present value payments, then it cannot be considered a penalty clause; therefore, whether or not a proper accelerated payment clause is upheld has little to do with the discussion in Peachtree.

It may be that in Hav-A-Kar the court recognized the clause in the lease agreement could be considered a penalty clause because it did not allow for a discounting of payments, but then relied upon Peachtree for the ability to enforce a contract clause regardless of its potential penal effect. If this is in fact what the court based its decision on, then it recognizes the need to present value accelerated payments for a fair result, but allowed this clause to be enforceable using the legal principles of freedom of contract. Since the court did not discuss the present value of money in Hav-A-Kar, it is difficult to know whether the court acknowledged the need to discount payments and simply allowed this provision to be enforced based on reluctance to interfere with freedom of contract, or if that reluctance was the basis of the decision without considering the ability to properly adjust damages by adjusting the amount with some present value formula. The decision's emphasis on the lessee being in the same position had the contract been fulfilled suggests the latter.

Another potential factor that the court may have taken into account but did not specifically address in the decision is the possibility that the differential between the full value of the remaining payments and the discounted value of those payments was so minute that applying the discount would have little relevance; this is particularly likely given that it is a small-ticket lease and a low interest rate environment.

If the factors discussed above were considered but dismissed, it would be helpful if the court indicated such. What is concerning about the decision and its lack of discussion of the aforementioned reasoning is that it may be relied upon in a different fact situation where the differential between the two amounts is large and the penal effect of a clause that does not present value payments is not recognized. The problem with Hav-A-Kar is that the decision as stated ignores the benefit to the lessor of receiving future lease payments today. At face value the math is simply wrong; however, it is possible the court was fully aware of the need to discount payments but did not discuss this for a variety of reasons.

Conclusion

Present value termination clauses have been rightly upheld by the courts where there is a recognition that the payments must be discounted for early receipt. These clauses serve as a genuine pre-estimate of damages incurred and put the lessor in the position he or she would have been in had the breach not occurred. Where these clauses demand the whole amount remaining under the lease to be paid, the lessor is in a better position than had the breach not occurred. This allows for the lessor to benefit from the breach, which is in conflict with the long-standing principle of damages for breach of contract. Hav-A-Kar demonstrates the importance of flushing out the reasons behind a decision, as this case may be relied upon for an accelerated payment clause where the benefit to the lessor is great and the court does not turn its mind to the ability to correct the clauses. Practically speaking, lessees should pay attention to termination clauses, as an accelerated payment clause may be upheld even where the agreement ends up putting the lessor in a better position than if the contract had been fulfilled.

'

Jonathan Fleisher is chair of Cassels Brock & Blackwell LLP's Equipment and Asset Finance Group and is located in Toronto, Ontario. He has particular expertise assisting U.S. commercial finance companies, both public and private, with establishing operations in Canada, providing both legal and practical business advice. Keri Wallace is an associate in the firm's Financial Services Group. Her practice focuses on bankruptcy, corporate restructuring, banking and finance. The authors may be reached at [email protected] and [email protected], respectively.