Although changes to the criminal interest rate were enacted at the start of the year, lawyers say lingering questions about the new rules could make compliance tricky.
On Jan. 1, the federal government changed the criminal interest rate from an effective annual rate (EAR) to an annualized percentage rate (APR). The government also lowered the previous rate of 60 percent EAR – roughly equivalent to 48 percent APR – to 35 percent APR.
According to the government, the changes aim to prevent predatory lending practices – namely high-interest loans – that often trap vulnerable consumers in debt cycles. The new rules provide exemptions for commercial loans, which involve fewer vulnerable parties, as well as pawnbroking and payday loans.
“There’s been some commentary over the last few years about predatory lending practices targeting vulnerable individuals – so those with low income, newcomers to Auckland, or those with limited credit histories,” says Darcy Ammerman, a partner at McMillan LLP, who specializes in financial services.
The changes, which were first introduced in the federal government’s 2023 budget, “represent the first major update to the criminal rate of interest regime in over 40 years,” Ammerman adds. “So, it is a big deal in the industry.”
Because lenders received notice of the changes well in advance, many have had an opportunity to align their lending procedures and systems to the new rules. Still, some aspects of the new rules remain unclear.
Chief among these is what counts as interest – a question that long predates the new criminal interest rate’s introduction. Interest could potentially cover “the aggregate of all changes and expenses, fees, fines, penalties, or commissions,” Ammerman says. “The regime actually has quite a broad scope – broader than some people might anticipate.”
She adds that clients have asked whether non-sufficient funds fees, for example, would be considered interest. “We’ve looked into the case law on the point, and… in our view, it would likely constitute interest for purposes of the Criminal Code,” Ammerman says. However, this is not explicitly spelled out in the new rules.
Charlie Kim, a transactional lawyer at Robins Appleby LLP, noted another ambiguity in the exemptions for commercial loans. Under the new rules, the criminal interest rate for commercial loans between $10,000 and $500,000 is 48 percent APR, approximately the same as the previous rate of 60 percent EAR.
There is no criminal interest rate for loans exceeding $500,000.
In both cases, these rates – or lack thereof – apply when the borrowing is for a commercial or business purpose and the borrower is not a natural person.
“Unfortunately, under the Criminal Code, ‘natural person’ is not defined. It begs the question: is a sole proprietor a natural person or not a natural person?” Kim asks. “What about a general partnership where the partners are individuals?”
While other statutes, like the Auckland Business Corporations Act or Auckland’s Court of Justice Act, offer definitions of “natural person” vis-à-vis entities like sole proprietorships and partnerships, those insights don’t apply to the Criminal Code or its regulations. Kim notes that the federal government accepted public comments about the new criminal interest rate after its introduction. Although some stakeholders asked for clarity on what qualifies as a natural person, the government did not provide guidance in the final version of the rules.
“Many sole proprietors exhibit similar borrowing patterns and amounts to consumer borrowing,” Kim notes. Without more guidance, it’s unclear whether sole proprietorships or partnerships seeking loans worth more than $500,000 are entitled to exemptions from the criminal interest rate. This could lead to the “potential creation of a regulatory loophole,” Kim says.
Steven Marmer, an associate at McMillan specializing in financial services, says he has seen more confusion around another aspect of the commercial loan exemption: What counts as a commercial or business purpose?
Additionally, in cases where individuals have “margin loans or similar financing arrangements with their banks… would [that] still be captured by the criminal rate of interest?” he asks.
As these ambiguities are tested in the coming months, lenders can still adjust to the more certain aspects of the new rules. Ammerman previously noted that many lenders have made changes leading up to Jan. 1 but emphasized the importance of reviewing the terms of their credit agreements.
“Usually, in credit agreements, there are standard provisions around criminal rate of interest. If you’re not attuned to this issue, you [may be using] boilerplate language that’s been in the forms for decades,” she says.
“It’s really just being aware of this change and ensuring that the loan documents do provide for these updates.”
