How should I set the interest rate and term on a seller note?

A seller note, also called seller financing or a vendor take-back, is a loan the seller makes to the buyer for part of the price. BDC notes that a financing structure may combine the buyer’s own investment, a business loan and seller financing. The rate and term are for the two sides to negotiate. The law does set limits on how high the rate can go and how it is written, and if a lender is also in the deal, its terms matter too.

The ceiling the Criminal Code sets

Section 347 of the Criminal Code applies despite any other Act of Parliament. It makes it an offence to enter into, or offer to enter into, an agreement or arrangement to receive interest at a criminal rate, and to receive a payment of interest at that rate. A criminal rate is an annual percentage rate, calculated in accordance with generally accepted actuarial practices and principles, that exceeds the percentage the section sets on the credit advanced. The section is longer than this summary, so have a lawyer read it before you fix a rate.

What counts as interest

The section defines interest broadly. It covers all charges and expenses, whether a fee, fine, penalty, commission or similar charge, paid or payable for advancing the credit. It does not include any repayment of the credit advanced, or any insurance charge, official fee, overdraft charge or required deposit balance, each as the section defines it. A note that carries a stated rate plus a fee, a late-payment penalty or another charge for the credit should therefore be tested as a whole, not rate by rate. Ask the lawyer drafting the note to calculate the combined annual rate.

Writing the rate down

Separately, section 4 of the Interest Act applies when a written or printed contract makes interest payable at a rate for a period shorter than a year, such as per month. Except for mortgages on real property or hypothecs on immovables, interest above the rate the section sets is then not chargeable, payable or recoverable unless the contract contains an express statement of the equivalent yearly rate. When must a seller note state a yearly interest rate? covers that rule in full. Expressly stating the equivalent yearly rate in the note meets that condition.

Setting the term

None of these sources fixes a term for a seller note, so it is a point to negotiate and put in writing. Settle when the first payment is due, whether payments are interest-only for a period, what happens on early repayment, and what security the seller holds. If a bank or BDC loan is also in the deal, ask the lender whether it limits payments on the note or requires the seller to rank behind it. BDC says the buyer and seller must agree on a purchase price before the buyer applies for financing. When the note is paid, releasing the vendor take-back security is a separate step.