Canada (Attorney General) v. McKinnon (C.A.) [2001] 2 F.C. 203
Date: 20001024
CORAM: STONE J.A.
ROTHSTEIN J.A.
EVANS J.A.
BETWEEN:
A-421-98
THE ATTORNEY GENERAL OF CANADA
Applicant
- and -
LYNDA MCKINNON
Respondent
- and -
A-422-98
HER MAJESTY THE QUEEN
Applicant
- and -
RONALD LAPOINTE
Respondent
- and -
A-423-98
HER MAJESTY THE QUEEN
Applicant
- and -
LYNDA MCKINNON
Respondent
- and -
A-424-98
THE ATTORNEY GENERAL OF CANADA
Applicant
- and -
BRAD WORRELL
Respondent
- and -
A-425-98
HER MAJESTY THE QUEEN
Applicant
- and -
BRAD WORRELL
Respondent
- and -
A-426-98
THE ATTORNEY GENERAL OF CANADA
Applicant
- and -
RONALD LAPOINTE
Respondent
Heard at Toronto, Ontario, on May 15, 2000.
Judgment delivered at Ottawa, Ontario, on October 24, 2000.
REASONS FOR JUDGMENT BY: EVANS J.A.
CONCURRED IN BY: STONE J.A.
CONCURRING REASONS BY: ROTHSTEIN J.A.
Date: 20001024
CORAM: STONE J.A.
ROTHSTEIN J.A.
EVANS J.A.
BETWEEN:
A-421-98
THE ATTORNEY GENERAL OF CANADA
Applicant
- and -
LYNDA MCKINNON
Respondent
- and -
A-422-98
HER MAJESTY THE QUEEN
Applicant
- and -
RONALD LAPOINTE
Respondent
- and -
A-423-98
HER MAJESTY THE QUEEN
Applicant
- and -
LYNDA MCKINNON
Respondent
- and -
A-424-98
THE ATTORNEY GENERAL OF CANADA
Applicant
- and -
BRAD WORRELL
Respondent
- and -
A-425-98
HER MAJESTY THE QUEEN
Applicant
- and -
BRAD WORRELL
Respondent
- and -
A-426-98
THE ATTORNEY GENERAL OF CANADA
Applicant
- and -
RONALD LAPOINTE
Respondent
REASONS FOR JUDGMENT
EVANS J.A.
A. INTRODUCTION
[1] Company directors are jointly and severally liable to Revenue Canada for employee source deductions and Goods and Services Tax ("G.S.T.") that their company has failed to remit and that cannot be recovered from it. However, it is a defence for a director to establish that he or she exercised the care, diligence and skill of a reasonably prudent person in comparable circumstances to prevent the failure.
[2] This case concerns the application of this defence of due diligence to a situation where, because the company had run into financial difficulties, its ability to make remittance payments was at the discretion of the bank to which it was indebted, but where it was also reasonable for the directors to believe that, by continuing to operate the business, they could restore the fortunes of the company.
[3] Whether the directors in this case satisfied the statutory standard of due diligence by exercising the degree of care, skill and diligence to prevent such failures as would be shown by a reasonably prudent person in comparable circumstances depends largely on the particular facts. However, some important legal issues about the scope of the due diligence defence are also raised.
[4] The proceeding argued before the Court is an appeal by the Crown against a decision of the Tax Court of Canada, dated June 4, 1998, in which McArthur J.T.C.C. allowed the taxpayer's appeal against a notice of assessment, both because the directors did not have de facto control of the company's finances and because they had exercised the requisite degree of care, skill and diligence to be exempted from liability for the company's failure to remit the employer portions of Canada Pension Plan ("C.P.P.") and Unemployment Insurance ("U.I.") deductions, and G.S.T.
[5] In addition, there are five other related proceedings. Each respondent is party to two proceedings: an appeal under the Income Tax Act in respect of the company's failure to remit C.P.P. and U.I., and an application for judicial review in respect of unremitted G.S.T. under the Excise Tax Act. The appeals are in files A-422-98, A-423-98 and A-425-98. The section 28 proceedings are in files A-421-98, A-424-98 and A-426-98.
[6] The proceedings were heard together on common evidence; Mr. Worrell testified on behalf of both himself and the other respondents, his co-directors, Ms. McKinnon and Mr. Lapointe, who, together, were the active directors and managers of the company, Abel Metal Limited ("Abel"). Accordingly, one set of reasons will suffice to dispose of all six cases. A copy of these reasons will be placed in each of the files and, when filed, shall become reasons for judgment in each of the matters.
| B. FACTUAL BACKGROUND |
[7] Abel had been in business in the Toronto area for the best part of thirty years, manufacturing and supplying non-structural metal components used in construction. During the recession that hit the construction industry in the late 1980s and early 1990s Abel suffered serious losses. It began to experience financial difficulties in the fall of 1992, which continued into the following year. Nonetheless, in 1993 it still employed seventy people.
[8] Abel's bank, the Canadian Imperial Bank of Commerce, expressed concern over the company's April 1993 financial statement. As a result, one of the directors, Mr. Lapointe, gave a personal guarantee to the bank of Abel's debt, which then stood at $1.6 million. Abel had reached the limit of its credit line by either the fall of 1992, or early in 1993. Although in the past Abel had always paid its bills, on September 30, 1993 the bank dishonoured a company remittance cheque to Revenue Canada for insufficient funds, without giving prior notice to its customer.
[9] Abel's already difficult financial situation had been made worse when its request for bonding in June 1993 was refused because there was insufficient equity in the company. The formal letter of refusal from the bonding company was dated August 30, 1993. Unless Abel could come up with new capital of some $350,000, or find another source of bonding, the refusal of bonding would severely limit its ability to obtain profitable new contracts and to contain its already serious cash flow problem.
[10] In an attempt to extricate itself from its financial troubles, on October 16, 1993 Abel engaged a Mr. Humphreys, a chartered accountant, who had had considerable success in assisting other companies in the construction industry that had fallen into financial difficulty. Together with two of Abel's directors, he met with bank officials to discuss the bank's concerns and to try to work out solutions.
[11] However, on October 18, only two days later, the bank dishonoured a cheque for $46,000 drawn by Abel in favour of the Receiver General of Canada in respect of September payroll source deductions. At about the same time, the bank started to reduce the company's line of credit. In a letter dated October 22, 1993 the bank informed Abel that it should be careful not to issue cheques that would take it beyond its credit limit with the bank. The bank also appointed BDO Dunwoody to "monitor" Abel's finances and to report to the bank on the company's prospects.
[12] The bank also required the directors of Abel to seek approval almost daily for permission to pay the company's creditors. After the October cheque was dishonoured for insufficient funds, it was clear both to the directors and Mr. Humphreys that the bank could not be counted on to honour any cheques issued by Abel in respect of G.S.T. or source deduction remittances. Nonetheless, Ms. McKinnon continued to prepare remittance cheques in the hope that the bank would honour them, which, on a few occasions, it did on a discretionary basis.
[13] Mr. Humphreys was satisfied that Abel was a viable company: it was well established in the construction business and had weathered previous cyclical downturns in the industry. His view was that, with an injection of new capital, the company could be turned around quickly and, even if none were forthcoming, Abel would be profitable within eighteen months.
[14] Despite strenuous efforts, Mr. Humphreys could produce only one potential investor, but he was not acceptable to the bank. At this point, on April 27, 1994, the bank decided to call in its loans and Abel filed for bankruptcy. The company probably had been insolvent for the previous twelve months, even though it had apparently paid all its bills before the bank first dishonoured the first remittance cheque in September 1993.
[15] Nearly all of the company's debt to Revenue Canada for unremitted payments, from which the respondents' personal liability derives, accrued after October 18, 1993 when the bank started to exercise control over the cheques issued by Abel. After Abel filed for bankruptcy, the trustee paid some of the money owing, namely, all the outstanding employee portions of the deductions. However, the employer portions of C.P.P. and U.I., and the G.S.T., were not paid. The unpaid remittances (including interest and late payment penalties) amounted to $133,747.00 and were the subject of the assessments with which this appeal is concerned.
| C. THE LEGISLATION |
Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.)
| 227.1 (1) Where a corporation has failed to deduct or withhold an amount as required by subsection 135(3) or section 153 or 215, has failed to remit such an amount or has failed to pay an amount of tax for a taxation year as required under Part VII or VIII, the directors of the corporation at the time the corporation was required to deduct, withhold, remit or pay the amount are jointly and severally liable, together with the corporation, to pay that amount and any interest or penalties relating thereto.
(2) A director is not liable under subsection (1), unless (a) a certificate for the amount of the corporation's liability referred to in that subsection has been registered in the Federal Court under section 223 and execution for that amount has been returned unsatisfied in whole or in part; (b) the corporation has commenced liquidation or dissolution proceedings or has been dissolved and a claim for the amount of the corporation's liability referred to in that subsection has been proved within six months after the earlier of the date of commencement of the proceedings and the date of dissolution; or (c) the corporation has made an assignment or a receiving order has been made against it under the Bankruptcy and Insolvency Act and a claim for the amount of the corporation's liability referred to in that subsection has been proved within six months after the date of the assignment or receiving order. (3) A director is not liable for a failure under subsection (1) where the director exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances. |
227.1 (1) Responsabilité des administrateurs pour défaut d'effectuer les retenues -- Lorsqu'une société a omis de déduire ou de retenir une somme, tel que prévu au paragraphe 135(3) ou à l'article 153 ou 215, ou a omis de remettre cette somme ou a omis de payer un montant d'impôt en vertu de la partie VII ou VIII pour une année d'imposition, les administrateurs de la société, au moment où celle-ci était tenue de déduire, de retenir, de verser ou de payer la somme, sont solidairement responsables, avec la société, du paiement de cette somme, y compris les intérêts et les pénalités s'y rapportant. (2) Un administrateur n'encourt la responsabilité prévue au paragraphe (1) que dans l'un ou l'autre des cas suivants_: a) un certificat précisant la somme pour laquelle la société est responsable selon ce paragraphe a été enregistré à la Cour fédérale en application de l'article 223 et il y a eu défaut d'exécution totale ou partielle à l'égard de cette somme; b) la société a engagé des procédures de liquidation ou de dissolution ou elle a fait l'objet d'une dissolution et l'existence de la créance à l'égard de laquelle elle encourt la responsabilité en vertu de ce paragraphe a été établie dans les six mois suivant le premier en date du jour où les procédures ont été engagées et du jour de la dissolution; c) la société a fait une cession ou une ordonnance de séquestre a été rendue contre elle en vertu de la Loi sur la faillite et l'insolvabilité et l'existence de la créance à l'égard de laquelle elle encourt la responsabilité en vertu de ce paragraphe a été établie dans les six mois suivant la date de la cession ou de l'ordonnance de séquestre. (3) Un administrateur n'est pas responsable de l'omission visée au paragraphe (1) lorsqu'il a agi avec le degré de soin, de diligence et d'habileté pour prévenir le manquement qu'une personne raisonnablement prudente aurait exercé dans des circonstances comparables. |
Excise Tax Act, R.S.C. 1985, c. E-15
| 323(1) Where a corporation fails to remit an amount of net tax as required under subsection 228(2) or (2.3), the directors of the corporation at the time the corporation was required to remit the amount are jointly and severally liable, together with the corporation, to pay that amount and any interest thereon or penalties relating thereto. (2) A director of a corporation is not liable under subsection (1) unless (a) a certificate for the amount of the corporation's liability referred to in that subsection has been registered in the Federal Court under section 316 and execution for that amount has been returned unsatisfied in whole or in part; (b) the corporation has commenced liquidation or dissolution proceedings or has been dissolved and a claim for the amount of the corporation's liability referred to in subsection (1) has been proved within six months after the earlier of the date of commencement of the proceedings and the date of dissolution; or (c) the corporation has made an assignment or a receiving order has been made against it under the Bankruptcy and Insolvency Act and a claim for the amount of the corporation's liability referred to in subsection (1) has been proved within six months after the date of the assignment or receiving order. (3) A director of a corporation is not liable for a failure under subsection (1) where the director exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances. |
| 323(1) Les administrateurs de la personne morale au moment où elle était tenue de verser une taxe nette comme l'exigent les paragraphes 228(2) ou (2.3), sont, en cas de défaut par la personne morale, solidairement tenus, avec cette dernière, de payer cette taxe ainsi que les intérêts et pénalités y afférents. (2) L'administrateur n'encourt de responsabilité selon le paragraphe (1) que si_: a) un certificat précisant la somme pour laquelle la personne morale est responsable a été enregistré à la Cour fédérale en application de l'article 316 et il y a eu défaut d'exécution totale ou partielle à l'égard de cette somme; b) la personne morale a entrepris des procédures de liquidation ou de dissolution, ou elle a fait l'objet d'une dissolution, et une réclamation de la somme pour laquelle elle est responsable a été établie dans les six mois suivant le premier en date du début des procédures et de la dissolution; c) la personne morale a fait une cession, ou une ordonnance de séquestre a été rendue contre elle en application de la Loi sur la faillite et l'insolvabilité, et une réclamation de la somme pour laquelle elle est responsable a été établie dans les six mois suivant la cession ou l'ordonnance. (3) L'administrateur n'encourt pas de responsabilité s'il a agi avec autant de soin, de diligence et de compétence pour prévenir le manquement visé au paragraphe (1) que ne l'aurait fait une personne raisonnablement prudente dans les mêmes circonstances. |
[16] In addition, section 21.1 of the Canada Pension Plan, R.S.C. 1985, c. C-8 and subsection 54(1) of the Unemployment Insurance Act, R.S.C 1985, c. U-1 respectively incorporate section 227.1 of the Income Tax Act with regard to directors' liability for failing to remit C.P.P. and U.I. source deductions.
| D. THE TAX COURT'S DECISION |
[17] On the facts essentially as outlined above, McArthur J.T.C.C. held (at paragraph [16]) that, from October 18, 1993, when Abel's payroll remittance cheque was dishonoured, until the company filed for bankruptcy in April of the following year,
| [I]t was the bank, and not the directors, that controlled the finances of Abel. This restriction on the directors' freedom of choice is sufficient to relieve the [directors] of personal liability for both the payroll assessment and the GST assessment. The [directors] did not have the freedom of choice to govern the corporation and prevent the failures to remit.... |
[18] Hence, since the directors had no de facto control over the payment of the company's debts, they were not liable under subsection 227.1(1), since this provision assumes that the directors had freedom of choice in this regard. He relied on Robitaille v. Canada, [1990] 1 C.T.C. 121 (F.C.T.D.) as the leading authority for this proposition, although he also noted that directors who lose de facto financial control of the company to its banker have also been excused under subsection 227.1(3) on the ground that, if in fact it was not within their power to prevent the company's default in making payroll remittances to Revenue Canada, they had satisfied the due diligence defence.
[19] In response to the argument that, in this situation, it was within the power of the directors of Abel to have prevented the company's foreseeable defaults by closing the business, McArthur J.T.C.C. relied on Fancy v. Minister of National Revenue, [1988] 2 C.T.C. 2256 (T.C.C.). In that case, where the circumstances were somewhat similar to those of the instant case, Couture C.J.T.C.C. had rejected this argument (at page 2261), on the ground that the liability created by subsection 227.1(1) was not absolute, but was conditional upon the directors'
| ... personal conduct in respect of the circumstances linked to the omission by their company to remit the deductions from its employees' salary. |
[20] McArthur J.T.C.C. inferred from this statement that if a reasonable person would, like the directors in this case, have continued to operate the company, subsection 227.1(3) provided a defence to the Crown's contention that they were personally liable for Abel's foreseeable failure to make remittances. The Judge found (at paragraph [19]) that, in not closing the company down prior to October 18, 1993, the "appellants took a common sense approach" in view of: the company's "obligation to its employees not to shut down without satisfactory evidence that the business was not viable"; its history of surviving previous recessions in the construction industry; Mr. Humphreys' advice, and his attempts to persuade the bank to honour its cheques to the Receiver General of Canada and to find investors acceptable to the bank; and Mr. Lapointe's guarantee.
[21] After doing what it reasonably could, the Judge concluded, the company lost effective control of its finances to the bank as from October 18, 1993, which relieved the directors of any personal liability for subsequent defaults.
| E. ISSUES |
| 1. Did the de facto control exercised by the bank over the company's ability to make remittances to Revenue Canada exclude the directors from the scope of subsection 227.1(1)? |
| 2. If the answer to Issue 1 is in the negative, did the directors exercise the care, diligence and skill of a reasonably prudent person in comparable circumstances to prevent the failures to remit so as to establish a defence under subsection 227.1(3)? |
| F. ANALYSIS |
(i) some general principles
[22] While there is no shortage of cases on the application of subsection 227.1(3), relatively few contain statements of principle on the approach to be taken to its interpretation and application. Rather, reasons for judgment tend to be framed in terms of the facts of the particular case: analysis often does not proceed much beyond the proposition that whether the "due diligence" defence has been established is to be determined by a consideration of all the circumstances of the case.
[23] In the absence of a developed analytical framework, cases are readily distinguishable on their facts, even when those facts, including the facts in the instant appeal, conform to a recurring general pattern. Inevitably, but without express advertence, some decisions exhibit a relatively strict approach to subsection 227.1(3), while others, including the decision under appeal here, adopt a view more favourable to the director.
[24] Nonetheless, amid this wilderness of single instances some general guidance on section 227.1 is available, most notably from this Court in Soper v. Canada, [1998] 1 F.C. 124 (F.C.A.). First, writing for the majority in Soper, supra, Robertson J.A. (at paragraph [11]) put subsection 227.1(3) into context by explaining its rationale:
| Non-remittance of taxes withheld on behalf of a third party was likewise not uncommon during the recession. Faced with a choice between remitting such amounts to the Crown or drawing such amounts to pay key creditors whose goods or services were necessary to the continued operation of the business, corporate directors often followed the latter course. Such patent abuse and mismanagement on the part of directors constituted the "mischief" at which section 227.1 was directed.... |
[25] Whether or not non-remittance of taxes in the circumstances described above can always properly be characterised as "patent abuse and mismanagement", the conduct of the directors in the present case does not, in any event, fall within the precise mischief identified by Robertson J.A. The allegation here is not that the directors chose to pay creditors other than the Crown, but that they continued to operate the business in circumstances where they knew, or ought reasonably to have known, that the bank, which controlled their financial life support, was likely to honour cheques to pay creditors essential to the ability of the company to remain in business, but not to permit the company to discharge its debts to the Crown, for as long, at least, as the bank believed that the company's continued operation would best protect its interest as a creditor of the company.
[26] Second, Soper, supra, clarified the "due diligence" test applicable under subsection 227.1(3). Robertson J.A. held that the test is hybrid "objective-subjective" in nature. Thus, in deciding whether a director has "exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have shown in comparable circumstances", the court must take into account the characteristics of the directors whose conduct is in question, including their levels of relevant skill, experience and knowledge. The court must then ask whether, if faced with similar circumstances, a reasonably prudent director, with comparable levels of skill, experience and qualifications would have acted in the same way as these directors: paragraph [25]. Applying this test, Robertson J.A. said (at paragraph [44]):
| ... inside directors, meaning those involved in the day-to-day management of the company and who influence the conduct of its business affairs, will have the most difficulty in establishing the due diligence defence. |
[27] To relate this to the facts of our case, it is clear that the "due diligence" owed by the respondents is at the high end of the spectrum. They were "inside" directors who managed the company, with which they had been associated from its early days, and were very experienced in and knowledgeable about the company's business.
[28] Third, "due diligence" normally requires that, when a director becomes aware, or ought to have become aware, that the company is falling behind with its remittances, he or she should take some positive steps to prevent the default, such as an attempt to increase the company's operating line of credit with its bank or to come to an arrangement with the bank that would enable it to make remittances. Directors have also alerted Revenue Canada to the problem and attempted to arrange to make payments by instalments.
[29] It is clear that the directors of Abel did take some positive steps to try to extricate the company from its financial difficulties. In particular, they engaged the services of Mr. Humphreys, who advised them that the company was viable, with or without an injection of new capital, and made efforts, with some success, to find interested investors.
[30] There were also discussions with the bank over the honouring of cheques drawn in favour of Abel's suppliers and employees. While it is unclear from the evidence whether either Mr. Humphreys or the directors discussed with the bank the remittance cheques to Revenue Canada, it was clear to them that the bank would honour such cheques only at its discretion, as indeed it occasionally did.
[31] It is equally clear that the directors were aware that, unless there was an early injection of capital by an investor approved by the bank, or the bank changed its position by regularly honouring the company's cheques to Revenue Canada, Abel was likely to be in default in its remittances for eighteen months, the time that Mr. Humphreys had estimated that it would take for Abel to regain its financial footing.
[32] However, whether the directors thereby did enough to exempt themselves from liability for the unremitted source deductions and G.S.T. will depend, in part at least, on the fourth principle to be found in the case law: the due diligence required of company directors by subsection 227.1(3) is to prevent the failure to remit. This has been held to mean that, if directors become liable prima facie for a company's failure to remit, they normally cannot claim the benefit of subsection 227.1(3) if their efforts were capable only of enabling them to remedy defaults after they had occurred. Accordingly, of the measures taken in an attempt to rescue Abel, those most relevant to this inquiry are limited to the ones that were logically capable of preventing failures to remit the source deductions and G.S.T. when they became due.
[33] This point was made inCorsano v. The Queen, [1999] 3 F.C. 173 (F.C.A), where the Court emphasised (at paragraph [35]) that a director's duty is to prevent default, not to condone it in the hope that matters can be rectified subsequently. And, in Soper, supra, Robertson J.A. said (at paragraph [48]) that the purpose of the subsection
| .... is to prevent failure to make remittances and not to cure default after the fact (though, as a practical matter, the provision should have the latter effect as well). |
Similarly, in Canales v. The Queen, 97 DTC 49 (T.C.C.) McArthur J.T.C.C. (at page 50) described it as a well established principle that
| ... the Appellant must demonstrate that a reasonable attempt was made to prevent the failure to deduct and remit and not just an attempt to remedy the situation after the failure. |
Most recently, writing for this Court in Ruffo v. Minister of National Revenue (F.C.A.: A-429-97; April 13, 2000), Létourneau J.A. said (at paragraph [6]):
| The appellant's duty as a director was to anticipate and prevent the failure to pay the sums owing and not to commit such failure or perpetuate it as he did from March 1992 in the hope that at the end of the day the firm would again become profitable or there would be enough money, even if it were wound up, to pay all the creditors. |
[34] In our case, the most important thing done by the directors to prevent Abel's failures to remit was to engage Mr. Humphreys to find new sources of investment for the company: his advice had been that, with the injection of approximately $350,000, the company could be turned around quickly and he expressed confidence that a suitable investor could be found. In addition, the fact that remittance cheques continued to be prepared by Ms. McKinnon in the hope that the bank would honour them can also be considered a potentially preventative measure. The directors did not continue simply to operate the business on the basis of an assurance that the company was sufficiently robust to enable them wait eighteen months to take advantage of an anticipated economic recovery.
[35] Fifth, directors incur no personal liability under subsection 227.1(1), and therefore do not need to invoke subsection 227.1(3), if at any time the company's debt to Revenue Canada, including interest and late payment penalties, is discharged. This is because subsection 227.1(2) qualifies subsection 227.1(1) by providing, in effect, that a director is liable to pay to the Crown the amounts not remitted by the company only after all efforts to collect have been exhausted.
[36] Thus, in this case, while Abel had failed to remit the employee portions of the payroll deductions, these amounts were subsequently paid to Revenue Canada by Abel's trustee in bankruptcy. Accordingly, the directors were never vicariously liable under subsection 227.1(1) to pay them.
[37] Sixth, a director who has lost legal control over the company, on the appointment of a receiver-manager for instance, is not liable to Revenue Canada for company debts that are incurred subsequently. Some cases have extended this principle to situations where directors have lost de facto control over the company's finances to another, typically its bank. Non-liability in these situations has been explained both on the ground that the charging provision, subsection 227.1(1), assumes that the directors were able freely to choose whether the company remitted its payroll deductions, and because directors who lacked the necessary control over the company's finances could not be said to have failed to show "due diligence".
(ii) the case law
[38] A number of cases have been decided on the basis of facts that fall broadly within the pattern presented by the instant case. While the facts of no two cases are ever identical, the decisions can be divided into two categories: those that favour the Crown, and those that favour the directors. I first examine those relied on by the appellant, the Crown.
[39] In Deschênes v. Canada (Minister of National Revenue) (T.C.C.; No. 87-1364 (IT); September 1, 1989) the taxpayer wished to keep the business going despite its financial problems and negotiated an agreement with the bank that enabled it to pay the employees' wages, but did not also ask it to honour cheques drawn for source deductions. The company was in default in making its remittances and went into bankruptcy.
[40] In response to the taxpayer's argument that, in the circumstances, there was nothing else that he could reasonably have done to prevent the failures to remit, Lamarre-Proulx J.T.C.C. said:
| ... the testimony of the appellant himself, cited above, indicates that it was he who deliberately chose not to pay the income tax and unemployment insurance deductions. That was a risk the appellant took. It was a risk taken in difficult circumstances, certainly; but it was still a deliberate choice which remained unchanged for a period of several weeks, and was contrary to the duty of the director of a corporation to act with care, diligence and skill in remitting source deductions from employee salaries. |
[41] I should note that, unlike in our case, there was apparently no evidence in Deschênes, supra, that the bank had indicated that it would not necessarily honour cheques drawn in favour of Revenue Canada by M. Deschênes' company. In addition, the Judge seems to have been influenced by the fact that, as an endorsee of two bank loans, the taxpayer hoped that, by keeping the business going, he would avoid being called upon to honour the endorsements. Finally, there was no finding of the reasonableness, or otherwise, from a business standpoint of the taxpayer's continuing to operate the company in the hope of turning its fortunes around.
[42] The Crown also relies on Hamel v. Minister of National Revenue, 92 DTC 1288 (T.C.C.), where the facts are closer to those of our case and the cases relied on in the Tax Court were expressly considered. The Judge in Hamel, supra, concluded that, having made a conscious decision to continue in business, rather than to cease operating, the directors had not demonstrated "due diligence" and consequently remained vicariously liable for the company's failures to remit, even though there was nothing else that they could have done to prevent them.
[43] The evidence was that, as the company got into financial difficulty, the bank closely supervised its operations and from February to June, when the company ceased operating, the bank increased its credit to enable the company to pay its employees and essential suppliers. However, the bank refused to honour cheques for the source deductions; the directors had discussed this topic with the bank, although no arrangement was ever made with respect to the remittances. Nor, the Judge found, did the directors speak with Revenue Canada about their problem.
[44] The Judge concluded (at page 1291) as follows:
| If one agrees to continue operating a business despite the financial difficulties it is experiencing, and if one accepts to pay employees and suppliers, one must also discharge one's income tax obligations. One must be able to show, if not positive steps, at least concrete facts which may explain one's inaction during such a long period of time. The decision made jointly with the bank to continue operating for several months when the animals could have been sold earlier implies that the parties had some hope of deriving some benefit from it eventually, if only by limiting their losses. Such a decision, however, implies a responsibility to ensure that the business was not being financed out of what was owed to the government. |
I should note that no finding was made about the business prudence of the directors' decision, made jointly with the bank, to continue to operate the company.
[45] I turn now to the principal cases relied on by the directors, starting with the earliest, Fancy v. Minister of National Revenue, 88 DTC 1641 (T.C.C.), which concerned the liability of husband and wife directors of an excavating company that had failed to remit source deductions. When the company ran into financial difficulties its banker monitored all its cheques and refused to authorize a deduction remittance cheque, a fact of which Ms. Fancy notified Revenue Canada as soon as she became aware of it.
[46] From the company's beginning, the bank had financed its operation, securing its loans by a general assignment of the company's accounts receivable. Hence, Couture C.J.T.C.C. held (at page 1643), the bank had always been "in effective control of the company's cash flow" and "in a position to dominate the finances of the company and to dictate its fate." The Judge concluded that the taxpayers had shown the degree of care and skill required to bring them within subsection 227.1(3) in view of: the encumbrance that the directors had placed on the company's receivables; their attempts to raise additional capital to see the company through its difficulties; and their hope that the bank would allow the company to meet its obligations to Revenue Canada. They were, he said (at page 1644), "victims of circumstances over which they had no effective control."
[47] Couture C.J.T.C.C. rejected the argument that, when they became aware of the seriousness of the company's financial difficulties, the taxpayers should have ceased its operations, on the ground that such a proposition "[d]oes not reflect the true intent of the legislation." His reason for so concluding was that the liability created by subsection 227.1(1) was not absolute and if, through their personal conduct in connection with the company's failure to remit, the directors had exercised the degree of care, diligence and skill required to satisfy subsection 227.1(3), they were exempted from liability.
[48] Couture C.J.T.C.C. appears to have approached subsection 227.1(3) by asking whether the taxpayers had, in a broad sense, acted honestly and responsibly when faced with a difficult situation, and when the assignment to the bank of their accounts receivable had further restricted their ability to remit source deductions. On the facts, his conclusion that they were not liable is hardly surprising. However, in my opinion the Judge's analysis is open to question in that there was little evidence of any concrete steps taken by the directors to prevent the defaults that were clearly foreseeable if the business were continued.
[49] Robitaille v. The Queen, 90 DTC 6059 (F.C.T.D.) is the other case that is regularly cited in support of a broad approach to the exemption from liability under subsection 227.1(1) when taxpayers' ability to remit source deductions has been curtailed by the de facto control exercised over the company's finances by its banker. However, the facts of that case were so out of the ordinary that, in my opinion, the decision sheds little light on the application of the statutory exemption of directors from liability in more familiar commercial contexts, such as that of the case under appeal.
[50] Mme Robitaille was the wife of one of the principals of the company and had been made a director only to comply with a statutory requirement that a federally incorporated company had to have at least three directors. She had played no active role in the company, and learned of its financial difficulties, including its failure to remit source deductions to Revenue Canada, only after the bank had assumed de facto control of its affairs. In any event, Addy J. concluded (at page 6063), even if she had been informed of the situation earlier, "she could not have done anything about it." Further, such was the control exercised by the bank over the affairs of the company, partly as a result of the assignment of its inventory to the bank, that Revenue Canada dealt with the bank, not with the company directors, over the remittances and the continuation of the business.
[51] In these circumstances, it is hardly surprising that the Court exempted the taxpayer from personal liability for the company's failures to remit. However, despite some broad statements by Addy J., in my opinion this case cannot be regarded as authority for the general proposition that once a bank exercises control over the cheques written by a company, the directors are not vicariously liable for source deductions not remitted to Revenue Canada.
[52] Robitaille, supra, was followed in Champeval v. Minister of National Revenue, 90 DTC 1291 (T.C.C.), affirmed 99 DTC 5115 (F.C.T.D.), where the company had also made a general assignment of its receivables to the bank, which thus had absolute control over incoming funds and decided which of the cheques drawn by the company it would honour. In concluding that the appellant was not liable because the bank's total control over the company prevented liability from arising under subsection 227.1(1), the Judge also took into account the efforts that the taxpayer had made to come to an arrangement with Revenue Canada on the remittances.
[53] Finally, it remains to consider the recent decision of MacKay J. in Clarke v. The Queen, 2000 DTC 6230 (F.C.T.D). In that case, the directors were held not liable for remittances due after the appointment of a receiver-manager, who assumed the legal powers of the directors, or for those that had become due during earlier when the bank had put the company into "soft receivership". In contrast, the directors were found liable for source deductions that should have been remitted during the month when, concerned about the financial state of the company and its ability to recover its loan, the bank had appointed a firm of accountants to monitor the company and to report to the bank on the company's financial status and prospects. In the same month, a cheque written by the company to the Receiver General of Canada was dishonoured by the bank for insufficient funds.
[54] MacKay J. found (at paragraph [7]) that, while the company was in "soft receivership", the firm of chartered accountants appointed by the bank for this purpose
| ...was to have the final say in all operations, including accounts receivable, sale of inventory and of equipment, contracts, purchases, payables and payments, personnel, changes in and forecasting of operations. |
In addition, the company's chequebook was taken into the custody of the "soft receiver" and the bank exercised ultimate authority over the cheques that it would honour.
[55] MacKay J. held that, since the directors had no control in fact over the company, liability under subsection 227.1(1) was accordingly never engaged. He quoted with approval the following words of Addy J. in Robitaille, supra (at page 6063):
| The exercise of freedom of choice on the part of the director is essential in order to establish personal liability. |
(iii) conclusions
| 1. Subsection 227.1(1): a requirement of control? |
[56] With all respect to those who have taken a different view, in my opinion it is inappropriate to import into subsection 227.1(1) a requirement that it is only engaged if the directors have de facto control over the financial operation of the company, particularly the payment of its bills.
[57] First, these words are not contained in the statute, and courts should normally not add words to those in the statutory text approved by Parliament.
[58] Second, the due diligence exemption in subsection 227.1(3) will prove broad enough to provide a defence to directors who have acted with propriety in attempting to prevent defaults by their company. It is therefore unnecessary to read the notion of control into subsection (1) in order to ensure that directors are not saddled with liability when their conduct to prevent the company's failure to remit satisfied the standard of the care that a reasonable person would have exercised in comparable circumstances to prevent the defaults.
[59] Moreover, "control" is not a monolithic concept and it will inevitably be difficult to determine whether, in a given case, the directors retained sufficient "control" to trigger subsection (1). The situation is different on the appointment of a receiver whose legal powers supercede those of the directors who, in a functional sense, cease to be directors and thus fall outside the ambit of subsection 227.1(1): see, for example, Drover v. Canada (1998), 161 D.L.R. (4th) 518 (F.C.A), at paragraph [4].
[60] Third, if the concept of "control" extends to a de facto inability to take measures to ensure that remittances are paid when they fall due because the company's bank will not honour cheques in favour of Revenue Canada, then a director would not become liable under subsection 227.1(1), regardless of whether it was reasonable to keep the business going, and of the length of time that it was operated without making remittances when legally due. The reasonableness of a director's conduct is only relevant as a defence under subsection 227.1(3) once liability under subsection (1) has been engaged.
[61] Therefore, in my respectful view, the decision of McArthur J.T.C.C. that the directors of Abel were not liable for the unremitted source deductions and G.S.T. cannot be supported on the ground that subsection 227.1(1) was not triggered because the bank's insistence that it approve any cheques written by the company deprived the taxpayers of control of the company's finances.
| 2. Subsection 227.1(3): the due diligence defence |
[62] McArthur J.T.C.C. acknowledged that, prior to October 18, 1993, when the bank dishonoured a cheque payable to Revenue Canada, the directors could have closed the business. However, he concluded that, in following Mr. Humphreys' advice to keep the business going, the directors acted with "due diligence". I should also note that on October 25, 1993 BDO Dunwoody had submitted a report to the bank, with a copy to Abel, in which it recommended that the business not be closed down because closure would probably result in a loss of between 80-90% of the value of Abel's $2 million worth of receivables arising from its construction contracts.
[63] In my view, the question is whether, throughout the whole period of the defaults, starting from September 1993 and ending in April 1994, the directors exercised the degree of care, diligence and skill of the reasonably prudent person in comparable circumstances to prevent the company's failures to remit the source deductions and G.S.T.
[64] I accept that the directors of Abel are not personally liable for the amounts due prior to the dishonouring of the remittance cheque on October 18, 1993. Admittedly, the directors were well aware of the financial difficulties of the company, especially as a result of the refusal of bonding in the summer of 1993. They also knew that the bank had expressed its concerns after seeing the financial statement for April 1993, had moved Abel's account from the local branch to a department that handled troubled accounts and had dishonoured a remittance cheque at the end of September.
[65] However, a few days before the second cheque was dishonoured on October 18, there had been a meeting of the bank officers handling the Abel file, Mr. Humphreys and two of the directors of the company. As a result of the discussions at this meeting, the directors believed that the bank was satisfied with the way in which the company was dealing with its problems. Nonetheless, the bank did not warn Abel that it proposed to dishonour its cheques and, prior to the dishonouring of the cheque in October, it had not started to reduce the line of credit. It is also significant in this context that in the past Abel had always paid its bills.
[66] Consequently, the focus of this appeal should be on the conduct of the directors after October 18, 1993 when the bank dishonoured the second remittance cheque, and whether they exercised the requisite care, diligence and skill to prevent the company's subsequent failures to remit which they knew were likely to occur.
[67] Because he based his decision principally on the ground that the bank so controlled Abel's finances that subsection 227.1(1) was never engaged, the Tax Court Judge dealt relatively briefly with the due diligence defence. However, he did say that, in light of the advice that they had received from Mr. Humphreys and the efforts that he was making to find a new investor, the support that they apparently received from the bank, the cyclical nature of the construction industry, the history of the company and their duty to the employees, the taxpayers "took a common sense approach" in deciding not to close the business. However, it is not altogether clear from the reasons for judgment whether the Judge considered the possibility that the directors should have closed the business after October 18, 1993.
[68] In my opinion, it is essential to keep in mind the relevant question in this appeal: did the directors exercise due diligence to prevent the company's failure to remit? This is not necessarily the same as asking whether it was reasonable from a business point of view for the directors to continue to operate the business. In order to avail themselves of the defence provided by subsection 227.1(3) directors must normally have taken positive steps which, if successful, could have prevented the company's failure to remit from occurring. The question then is whether what the directors did to prevent the failure meets the standard of the care, diligence and skill that would have been exercised by a reasonably prudent person in comparable circumstances.
[69] It will normally not be sufficient for the directors simply to have carried on the business, knowing that a failure to remit was likely but hoping that the company's fortunes would revive with an upturn in the economy or in their market position. In such circumstances directors will generally be held to have assumed the risk that the company will subsequently be able to make its remittances. Taxpayers are not required involuntarily to underwrite this risk, no matter how reasonable it may have been from a business perspective for the directors to have continued the business without doing anything to prevent future failures to remit.
[70] This point was recently made in Ruffo v. R., [1998] 2 C.T.C. 2203 (T.C.C.), affirmed by this Court on April 13, 2000 (A-429-97), where Lamarre-Proulx J.T.C.C. stated at paragraph [20]:
| I am of the opinion that the case law of the Court is consistent on the diligence that the director of a corporation must show to avoid the liability prescribed in subsection 227.1(3) of the Act. It is the diligence that is concerned with preventing the failure that can, in many instances, differ from the diligence that the director must exercise toward the corporation. |
[71] She went on to cite with approval the following statements by Rip J.T.C.C. in Merson v. R., 89 DTC 22, where he said (at page 28):
| The prudence required by subsection 227.1(3) in the exercise of care diligence and skill is different from that required by a director performing his duties, under corporate law, notwithstanding that subsection 227.1(3) and subsection 122(1)(b) of the Canadian Business Corporations Act, for example, both use identical words. The exercise of care, diligence and skill by the director contemplated by subsection 227.1(3) is not founded on the director's obligations to the corporation; it is based on one of the corporation's obligations under the Act and the failure of the corporation to fulfil such obligation. A director who manages a business is expected to take risks to increase the profitability of the business and the duties of care, diligence and skill are measured by this expectation. The degree of prudence required by subsection 227.1(3) leaves no room for risk. |
[72] I do not understand Rip J.T.C.C.'s statement that the "degree of prudence required by subsection 227.1(3) leaves no room for risk" to mean that section 227.1 imposes strict liability on directors whose company ultimately proves to be unable to make good defaults in its remittances. Such a view would clearly be contrary to subsection 227.1(3), which only becomes relevant when Revenue Canada is unable to recover the money that the company ought to have remitted.
[73] Rather, I take him to have meant that, if directors decide to continue the business in the expectation that the company will turn around and will be able to make good its remittance defaults after they have occurred, if the company nonetheless fails without paying its tax debts, it is no defence for the directors to say that the risk that they took would have been taken by a reasonable person. The subsection 227.1(3) defence only applies if it can be demonstrated that the directors exercised the care, diligence and skill that a reasonably prudent business person in comparable circumstances would have exercised to prevent a future default.
[74] Whether directors have exercised due diligence to prevent such failures from occurring has both a legal and a factual aspect. As matter of law, the liability of a director for unremitted source deductions and G.S.T. does not crystallise until the conditions prescribed by subsection 227.1(2) have been satisfied. Moreover, if the remittances are made in full, albeit late, the directors will not be liable for the company's previous failure to remit.
[75] However, the fact that, before crystallisation, the liability of the director is inchoate is not incompatible with a finding that there was a failure to remit when no remittance was made on the date prescribed in the relevant legislation as the date when the remittance was due. Thus, for example, subsection 108(1) of the Income Tax Regulations, C.R.C. 1978, c. 945 provides that amounts deducted from employees' wages in a month pursuant to subsection 153(1) of the Act shall be remitted to the Receiver General on or before the fifteenth day of the following month.
[76] Accordingly, in my view, the directors of Abel could not have obtained the benefit of subsection 227.1(3) on the basis of an assertion that they had continued the business, reasonably relying on Mr. Humphreys' advice that it could be turned around in eighteen months' time by which time the economy should have improved. Even if the company successfully positioned itself to take advantage of the economic upturn and became profitable, it would only have become able to discharge its accrued liability and to prevent future failures to remit. Following this advice could not have prevented any failures to remit that occurred prior the revival of the company's fortunes, even if the advice had proved to be correct.
[77] Given the limitations placed upon them by the bank's de facto control of the company's finances, I am satisfied that, on the facts of this case, the directors exercised the degree of care, diligence and skill to prevent failures to remit that would have been shown by a reasonably prudent person in comparable circumstances. That Ms. McKinnon continued to prepare remittance cheques, admittedly without a realistic hope that the bank would honour them all, also indicates that the directors were not unmindful of the company's debt to Revenue Canada.
[78] Much more important, in my view, were Mr. Humphreys' continued efforts to find a new investor, given his belief that the company could then quickly be turned around. He told the directors that he was confident that a new investor could be found. Indeed, he identified potential investors within two weeks of being hired, spoke with twelve people who expressed an interest in investing in Abel and produced one who was willing to invest, but who proved unacceptable to the bank for reasons that are not disclosed.
[79] As long as these efforts were being made in good faith by a person with a successful track record in rescuing companies in the construction industry, the directors of Abel could reasonably say that, if an investor were found and approved by the bank, the company would obtain bonding and be in a position to bid on lucrative contracts, which might well have persuaded the bank to increase its line of credit again or, at least, to honour Abel's next remittance cheque.
[80] Hence, if Mr Humphreys had succeeded in finding an investor acceptable to the bank, the failures to remit might have been prevented. The fact that, in the event, he was not successful and the failures occurred, does not render the directors liable if they had made reasonable efforts to prevent them. The Court would be reluctant to second guess the likely efficacy of the directors' efforts to prevent failures to remit from occurring.
[81] However, it would not have been open to the directors to have relied indefinitely on Mr. Humphreys' advice if there was no indication of potential investor interest in the company. The company's viability and the likelihood of its attracting new investors would have had to be reassessed from time to time in order for the directors successfully to invoke the due diligence defence provided by subsection 227.1(3).
G. CONCLUSIONS
[82] For these reasons, I have concluded that the directors satisfied the due diligence test in
subsections 227.1(3) of the Income Tax Act and 353(3) of the Excise Tax Act, and would therefore dismiss the appeals and the applications for judicial review with one set of costs, including taxable disbursements in each of the matters.
"John M. Evans"
J.A.
"I agree
A.J. Stone J.A."
Date: 20001024
Dockets: A-421-98
A-422-98
A-423-98
A-424-98
A-425-98
A-426-98
CORAM: STONE J.A.
ROTHSTEIN J.A.
EVANS J.A.
BETWEEN:
A-421-98
THE ATTORNEY GENERAL OF CANADA
Applicant
- and -
LYNDA MCKINNON
Respondent
- and -
A-422-98
HER MAJESTY THE QUEEN
Applicant
- and -
RONALD LAPOINTE
Respondent
- and -
A-423-98
HER MAJESTY THE QUEEN
Applicant
- and -
LYNDA MCKINNON
Respondent
- and -
A-424-98
THE ATTORNEY GENERAL OF CANADA
Applicant
- and -
BRAD WORRELL
Respondent
- and -
A-425-98
HER MAJESTY THE QUEEN
Applicant
- and -
BRAD WORRELL
Respondent
- and -
A-426-98
THE ATTORNEY GENERAL OF CANADA
Applicant
- and -
RONALD LAPOINTE
Respondent
CONCURRING REASONS FOR JUDGMENT
ROTHSTEIN J.A.
[1] I am in general agreement with the reasons of Evans J.A. However, I wish to emphasize that whether the due diligence defence will be successful is fact-driven in each case, i.e. always comparing what the directors did to prevent the failure with what a reasonably prudent person would have done in comparable circumstances. I agree with Evans J.A. that the due diligence defence is established on the facts of this case. However, I would prefer not to hypothesize as to what other facts or circumstances might or might not provide grounds for a successful due diligence defence.
[2] I agree with the disposition of the matter as set forth in the reasons of Evans J. A.
"Marshall Rothstein"
J.A.