Hare v. Hare (218 O.A.C. 164), a December 2006 decision of the Ontario Court of Appeal, has important ramifications for the use of demand promissory notes in tax planning. Legal and tax planners should be aware that standard drafting language used in promissory notes may bring about unintended consequences.
In Hare, the taxpayer loaned a sum of money to her son and secured the loan with a promissory note. Although some interest payments were made under the note, the son did not respond to a demand for payment of the loan and the taxpayer brought an action for recovery.
At trial and on appeal, the defendant claimed the action was barred because it was made after the statutory limitation period had expired. The issue was whether the two-year limitation period under the Limitations Act, 2002 (the “Act”) had started to run at the time the note was issued, or on the demand for payment under the note. If the former, the action was statute-barred, if the latter, the action could proceed.
The Act provides that the two-year limitation period begins to run on the “discovery” of the claim. The Court of Appeal emphasized that the law that a creditor has the right to immediate repayment of a demand loan is well-settled. As the creditor under a demand note has the right to immediate payment, there is nothing to be “discovered” by the creditor before he or she becomes aware of their claim, which is established immediately on receipt of the demand promissory note. The Court of Appeal, therefore, found that the discovery of the claim occurred at the time the note was issued, as the creditor was in a position to enforce the note as of that date. The action was, therefore, statute-barred because it was commenced more than two years after discovery of the claim.
The practical outcome of the decision is that the limitation period for ordinary demand promissory notes will start to run on the execution and delivery of the promissory note by the debtor. Under the Act, each payment of interest or principal, if made within two years of the later of: a) the date the note is made; and b) the last such payment, will restart the limitation period. If the said two-year limitation period expires before demand is made and a statement of claim issued by the holder, the holder is prevented by law from enforcing a claim against the debtor by court proceedings. Although this may not necessarily invalidate the promissory note as an obligation per se, for all practical purposes the note then has no value. It is commonplace to use demand promissory notes in many situations, and the expiration of collection rights under such notes two years after the later of the date the note is made and the date of the last payment would have grave consequences.
However, the Act also provides that, in the case of business agreements, taxpayers may elect to vary or exclude any limitation period provided for in the Act, except for a 15-year limitation period that sets an ultimate limit on claims even where other limitation periods in the Act have not expired. A “business agreement” is one in which neither party is a “consumer” as defined in the Consumer Protection Act. Therefore, as a result of this decision, it would be prudent to add language to demand promissory notes used for business purposes to the effect that:
You can avoid the complete, and often unexpected, loss of the loan principal and accrued and unpaid interest and costs, but you have to change the form of demand note you may have used in the past. Clearly this is a case of “lender beware”.