When Is a Late Payment Penalties Illegal?
A Payment Penalty or Late Fee Is Often Viewed As a Disguised Interest Charge and Is Often Deemed Unlawful or Unenforceable.
Understanding When a Late Payment Fee Is An Illegal Penalty and Unenforceable Without Binding Effect
A business will sometimes use the threat of additional fees as a financial motivator to encourage customers to make timely payments; however, a contract may become unlawful and unenforceable if a contract contains an illegal late fee. A late fee is illegal, if the amount violates the Criminal Code, R.S.C. 1985, c. C-46, section 347, wherein it is prescribed that charging interest rate beyond a rate of sixty (60%) percent per annum is a criminal act. 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.
Although a business may try to disguise interest by labeling an interest charge as a late fee, courts will carefully review whether the late fee is indeed an interest charge as additional monies due from the providing of credit on the balance overdue. 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 a business that imposes a ten 00/00 ($10.00) dollar late fee when a monthly payment of one hundred 00/00 ($100.00) is overdue 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.