About 200,000 canadians will be collectively reimbursed an estimated $100 million in mortgage penalties that allegedly were improperly charged if an Ottawa lawyer is successful in what could be described as a “David and Goliath” legal battle.

Three years ago, John Farah, of the two-man Ottawa firm Farah and Wilson, started 11 class-action lawsuits against major Canadian financial institutions. He hopes to recoup payments averaging $500 for every mortgage holder who, he alleges, overpaid on a not-yet-mature mortgage. Among the financial institutions involved are Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, CIBC Mortgages Inc. and National Bank of Canada.

The essence of the allegations is that in calculating the prepayment penalty for early payment of mortgages — usually three months interest on the remaining balance — the lenders ignored a clause in many mortgages that gives borrowers an annual, penalty-free prepayment privilege. Wording of prepayment clauses varies from lender to lender, but in most cases borrowers are entitled to prepay up to 10%, 15% or 20% of their original principal balance each year without notice or penalty. Most prepayments can be made at any time, but some mortgages specify that the payment must take place on a payment date or on an anniversary date.

For example: let’s assume a client has a $200,000 mortgage at 7%, with an annual 15% penalty-free prepayment privilege. He wins the lottery and wants to pay his mortgage off in full right away. Farah says the 15% prepayment privilege means $30,000 of the early payment would not be subject to the three-month interest penalty. That would reduce the interest penalty from $3,500 to $2,975 — a saving of $525.

The wording of a specific prepayment clause determines whether, in calculating an early payment figure, the lending institution failed to give the borrower an interest credit relating to the amount he or she would have been entitled to prepay in accordance with the prepayment privilege.

The statements of claim allege that the lenders overcharged certain borrowers who were making early repayments of their mortgages. The claims state: “The relationship between defendant and plaintiff and other class members involves a significant level of trust, in that the plaintiff and other class members rely entirely on the integrity of the defendant as chartered financial institutions to ensure that, among other things, payments are properly credited, interest is fairly charged … and savings and credits to which the plaintiff and other class members are entitled are in fact passed on to the plaintiff and other class members. The defendant has a vast and irrefutable advantage over the plaintiff and other class members in respect of financial, administrative and record-keeping matters.”

Actions involving Ottawa’s Civil Service Co-operative Credit Society Ltd., HSBC Bank Canada and Industrial Alliance Life Insurance Co. have settled without going to trial, and without the defendants admitting liability.

A certification hearing for the remaining class actions was heard in the Superior Court of Ontario last May, and Justice Anne Molloy has not yet released her decision. “It’s possible a decision will be released any time now,” Farah says.

The defendants in the eight lawsuits that have not been settled seem determined to see their actions through if the class actions are certified. For example, McCarthy Tetrault LLP’s Paul Steep, who represents National Bank of Canada, told Investment Executive: “We have no intention to settle.” Other lawyers contacted refused to comment until after Justice Molloy’s decision is released.

The statement of defence for TD is typical of the stance adopted by the remaining defendants. It states, for example, that the mortgage contract did not require the bank to credit the borrower “for any notional unused portion of the annual 10% prepayment privilege” upon prepayment of the entire outstanding balance. It also says that the borrower never requested credit for the unused portion of the prepayment privilege and failed to make such a payment “in advance of discharging the mortgage loan.” Third, it says that “by paying the amount required by the discharge statement, and by accepting a discharge of the mortgage, the plaintiff has waived his right to” claim that the amount should have been reduced.

The class actions purport to represent all persons in Canada who:

> had to pay a penalty for early payment of their mortgage;

@page_break@> had the right to prepay a specified portion of their mortgage each year without penalty;

> were charged the prepayment penalty by the lending institution without being given credit for the available prepayment privilege.

According to Farah, Royal Bank of Canada is the only major institution that automatically provided the prepayment credit to its mortgage borrowers.

Royal Bank has declined comment. “This is not an issue the bank will comment on because it’s before the court,” says Judi Levita, director of Royal Bank’s media and public relations office.

The lawsuits cover the maximum period of time permitted by provincial limitation laws (which prevent plaintiffs from starting lawsuits for causes of action that happened too long ago). At the time Farah’s claims were issued, all of the provinces except Alberta and British Columbia had six-year limitation periods for matters dealing with contracts, such as mortgages. Alberta and B.C. had two-year limitation periods.

Farah, a real estate lawyer, says he became involved in the legal battle because of clients who were discharging a mortgage, and whom he thought may be entitled to some savings by using their prepayment privilege. In this case, the lender refused to credit Farah’s clients with the interest savings arising from their prepayment privilege because the prepayment had not been made with a separate cheque.

“I thought it was unreasonable for them to demand two cheques, and it got me thinking that all the banks and lenders should allow credit for their prepayment privileges. So I looked at the language all the banks used in their mortgages. Most of them said prepayment can be made at any time without notice or bonus or penalty. There was no request for a separate tender. No notice was required that money was stipulated for that purpose.”

Three institutions have settled without going to trial and without admitting liability. In June 2004, Civil Service Co-operative Credit Society in Ottawa agreed to pay $147,300 to 778 customers for prepayments dating back to 1997. The co-op’s prepayment privilege allowed for a principal prepayment of up to 15% “at any one time during a calendar year without notice or penalty.” The co-op decided to settle because the cost of litigation was likely to be larger than the amount of its settlement.

The other two companies that settled without admitting liability had prepayment clauses that made their exposure much smaller than that of the other lenders.

HSBC, for example, allows the following prepayment: “On the anniversary date, an additional amount of the principal not in excess of 20% of the original principal money secured by the mortgage and an administration fee of $25.”

This means that borrowers could make a penalty-free payment only on the mortgage’s birthday. If they prepaid their mortgage on any other day of the year, they were not entitled to have their three-month prepayment penalty reduced by the amount of interest on the amount of their penalty-free prepayment privilege. Part of the HSBC settlement was paid to charity.

Similarly, Industrial Alliance Life Insurance Co. permits prepayments only on regular instalment dates in the amount not exceeding 15% of the original loan amount. IE