Merson v. MNR, 89 DTC 22, [1989] 1 CTC 2074 (TCC)

Rip, T.C.J.:—Kenneth Merson, the appellant, appeals from a notice of assessment issued on August 6, 1986 pursuant to subsection 227.1(1) of the Income Tax Act ("Act") and subsection 68.1(1) of the Unemployment Insurance Act [1] for $89,882.78 being the amount of unpaid deductions, interest and penalties ("source deductions") payable by Canadian Porcelain Company Limited ("Company" or "Canadian Porcelain”), of which he was a director, pursuant to notices of assessment dated September 6, 1984, November 20, 1984 and December 20, 1984. As a result of a notice of objection, the Minister of National Revenue, the respondent, reassessed Mr. Merson by notice dated April 2, 1987 increasing his liability to $96,118.16.

Counsel for the respondent advised the Court the assessments dated September 6 and November 20 against the Company contained errors and consented to allow the appeal to correct the errors. The assessment of a penalty against the Company for late remittance, dated September 6, 1984, included in the assessment against Mr. Merson, was not pleaded in the reply to notice of appeal and the Minister agreed not to pursue the amount of the penalty against Mr. Merson. The nature of these errors do not otherwise affect the merits of the appeal which is from the assessment dated August 6, 1986. This appeal is concerned only with the failure by the Company to remit amounts withheld from employees in October and November 1984 and whether Mr. Merson exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances, as contemplated by subsection 227.1(3) of the Act.

This appeal was heard on common evidence with that of Mrs. Wendy Merson; the formal judgment allowing Mrs. Merson's appeal has been issued.

Mr. Merson is a chartered accountant. Prior to the spring of 1984 he worked as a financial analyst at various corporations including Genstar Ltd. and Molson's Ltd. where he was corporate treasurer for three years. He also carried on a truck leasing business from 1969 to 1981.

In 1981 Mr. Merson, through a family holding company, acquired the shares of Canadian Porcelain which had been incorporated in 1912 and has since been continued under the Canadian Business Corporations Act. Canadian Porcelain was the largest Canadian manufacturer of high voltage porcelain insulators used by utilities in the distribution of electric power. In late 1983 Canadian Porcelain acquired its only competitor, Ohio Brass Ltd., so that by 1984 it was the only manufacturer of porcelain insulators in Canada.

On acquisition of Canadian Porcelain Mr. Merson and his wife became directors of the Company. Mrs. Merson remained a director until July 14, 1984, when Mr. Merson became the sole director. Upon acquisition of Canadian Porcelain Mr. Merson was elected chairman of the board. Mr. Alex Maule, the Company's general manager prior to the purchase, became its president. Mr. Denis L'ami, a Company employee, became vice president and the company's former accountant, Mr. T. Crickmore, was named controller. Mr. Crickmore was responsible for issuing cheques and making remittances of amounts of source deductions to the respondent. Mr. Merson described him as "a typical responsible small business bookkeeper".

However, in the summer of 1983, Mr. Merson took a direct interest in the Company as a result of a reduction in market prices for the Company's product. He suspected that the price reduction was a premeditated plan on the part of Japanese producers, in particular NGK Insulators, to drive the Company out of business. The Company filed a complaint with Revenue Canada, Customs and Excise, in accordance with anti-dumping legislation at the time.

The dumping of insulators on the Canadian market caused a liquidity problem for Canadian Porcelain and a strain on the Company's financing with its banker, the Royal Bank of Canada (“Royal Bank’’). As a result Mr. Merson left Molson's Ltd. in the spring of 1984 to devote his full time to Canadian Porcelain. Previously Mr. Merson was not involved in the Company's day-to-day operations; he would meet with Messrs. Maule, L'ami and Crickmore on a regular basis to review the operations.

Mr. Merson testified that as a result of bank pressure most of his time was devoted to raising money for the Company and to finding a purchaser of the Company. At the same time he was actively engaged pursuing the Company's dumping complaint with Revenue Canada. He entrusted the operations of the Company to those persons who had run the Company in the past and in whom he had confidence.

Revenue Canada conducted a ten-month investigation of the complaint culminating with a finding in October 1984 that dumping did take place; tariffs were levied. The matter was then taken before the Anti-dumping Tribunal. The hearing before the Tribunal [2] started in December, 1984 and a decision in favour of Canadian Porcelain was received in January, 1985. The anti-dumping duties imposed are still in place.

Canadian Porcelain had borrowed money from the Royal Bank on security of a Small Business Development Bond. It had also executed with the bank a guarantee and Postponement of Claim in the usual form and a general assignment of book debts. The bank also had a fixed and floating charge debenture of the Company, as well as security on its inventory, specific charges on its receivables in each province, as well as an overriding debenture and a mortgage on the Company's real estate. Mr. Merson personally guaranteed much of the company’s debt to the bank.

The Royal Bank had started pressuring Mr. Merson to inject additional capital into the Company in early 1984. He obtained financing incentives from the Federal Government in the amount of $600,000 to refurbish equipment owned by Ohio Brass Ltd. but funds were required from the Company's banker as well. Mr. Merson said the bank delayed in making a commitment until it was clear to him it was not going to support the Company. The Federal Government cancelled its proposed grant.

In May 1984 the Royal Bank insisted the Company's capital be increased by $1 million and reduced its line of credit to $2.9 million. Earlier the Company had requested an increase in bank funding from $3 million to $3.2 million. The Company's gross receipts were collected by the bank to pay down the reduction in the credit line. All disbursements required prior approval by the bank; otherwise the cheques were to be returned “NSF”. The bank confirmed in a letter dated June 15, 1984, that:

As is the current arrangement, a weekly listing of cheques to be issued is to be provided to the Bank for prior approval. Cheques not previously approved will be returned.

Mr. Merson confirmed that any cheques issued not previously approved by the bank "were in fact returned".

At the beginning of October 1984 the Royal Bank caused two employees of Peat Marwick Ltd. to be present at Canadian Procelain’s facilities. The senior employee of Peat Marwick Ltd., Mr. Robert W. Chambers, attended almost daily at the Company's offices until December 11, 1984. Mr. Merson said the Peat Marwick employees were at Canadian Porcelain in the dis- guised capacity as financial advisors and consultants for the bank” but their job, in particular that of Mr. Chambers until the Company was put in receivership on December 11th, was to monitor the financial operations of the Company, receive the receivables of the Company and approve disbursements of money for payables. The Royal Bank would honour cheques only if previously approved on its behalf by Peat Marwick Ltd.

Mr Merson also stated Mr. Chambers was to evaluate the Company from a financial perspective for the preparation of a report to the bank on the Company's financial status. Mr. Chambers was also involved in the dumping issue because it was fundamental to the Company. Mr. Chambers, said Mr. Merson, "was watching the place like a hawk" ensuring the managers of the Company were not trying to take advantage of the situation.

Mr. Merson was invited to a meeting to take place at 9:30 a.m. on December 11 at the Royal Bank. The meeting was attended by Mr. H.R. Shewfelt of the Royal Bank, Mr. Coulter, President of Peat Marwick Ltd., Mr. Chambers, Mr. Merson and Mr. L'ami who arrived later. Mr. Merson was informed at the meeting that Canadian Porcelain was being placed in receivership that day and that the gases for the kilns used to manufacture the porcelain were being shut off immediately. Mr. Merson explained that if the kilns were turned off quickly, rather than gradually over a seven to eight day period, they would suffer physical damage. Mr. Merson said he realized the bank had no intention to continue the business even though the company had sufficient accounts receivable to support the business for the time being.

At the meeting the bank presented Mr. Merson with a letter dated December 10, appointing Peat Marwick Ltd. the receiver and manager of the assets of Canadian Porcelain under a general security agreement and appointing Peat Marwick Ltd. as its agent to collect accounts receivable assigned to the bank by the Company pursuant to a general assignment of debts. Mr. Merson also signed the following Consent and Acknowledgement form:

CONSENT AND ACKNOWLEDGEMENT

TO: PEAT MARWICK LIMITED

AND TO: THE ROYAL BANK OF CANADA

Canadian Porcelain Company, Limited hereby acknowledges itself indebted to The Royal Bank of Canada and its inability to repay its loans upon demand and hereby consents to the appointment of Peat Marwick Limited as Receiver and Manager of the undertaking, property and assets of Canadian Porcelain Company, Limited.

When Mr. Merson arrived at the meeting, he said, he was not aware Canadian Porcelain had failed to make the necessary remittances of the October source deductions to Revenue Canada on November 15. He declared he learned of the failure while listening to discussions between representatives of the Royal Bank and Peat Marwick Ltd. on how to ensure the Royal Bank could “come in ahead of Revenue Canada" and keep the source deductions. He said that during the meeting an employee of the bank was sent to file a certificate with the Federal Court so that the Royal Bank would be entitled to priority of the amount of unremitted source deductions over the claims of Her Majesty the Queen in the Right of Canada.

The receiver "took over the Company and we were shown the door", said Mr. Merson. His lawyer drafted a form of resignaton for his signature as director, president and secretary as of December 11, which he signed.

Mr. Merson stated Company policy was to pay remittances for tax and unemployment insurance and Canada Pension Plan. He described Mr. Crickmore, who had been with the Company for about 40 years, as a religious adherent in following the law. "He had,” said Mr. Merson, "a phobia” about making a mistake. Mr. Crickmore was with the Company "to the end”, although the presence of Peat Marwick Ltd. caused him to take time off occasionally for health reasons during October, November and December. Mr. Crickmore was not working his usual five to six day week at this time and did only what he had to do, Mr. Merson said, in a shorter time. "Mr. Crickmore did the important things and the rest waited.” The Royal Bank problem was stressful to Mr. Crickmore. Mr. Merson added that Mr. Crickmore was aware the source deductions were not being paid to Revenue Canada, although he thought they were.

In Mr. Merson's view Peat Marwick Ltd. was acting as a receiver and their presence in the plant and the office was disruptive and distracted everyone's attention. "Pressure got to Mr. Maule and he didn't do much" during October and November. Mr. L’ami was concerned with the "day-to-day" operations and Mr. Merson was concerned with the dumping problem and negotiating with prospective investors.

In cross-examination Mr. Merson said that his original understanding was that only major cheques required the bank's approval but about 15 cheques aggregating approximately $5,000, including payments for telephone service and retail sales tax, were returned. The authorized cheques were quite different from those requested by Messrs. L’ami and Crickmore. The bank only approved cheques necessary to carry on the business, that is, to essential suppliers. He testified he saw cheques approved by the bank. The only lists he may have seen after September were lists prepared by Canadian Porcelain with items checked off; he did not see any lists prepared by the Royal Bank. "The bank was very smart, they gave me verbal information only”. The lists for requested payments for October and November were prepared by Messrs. L'ami and Crickmore.

Mr. Merson would "check" to make sure essential suppliers were paid but he never verified if payments were being made to Revenue Canada; he assumed that they were since cheques for source deductions had been prepared and then approved for payment by the bank since June 1.

An assessment was made against the Company on September 6, 1984 with respect to a penalty for late remittance for July 1984. Mr. Merson assumed the assessment came to his attention; he would be surprised if it had not but he could not remember details at trial. He said this was Mr. Crickmore's responsibility and "he carried it out well”. Cheque signing was authorized to Messrs. Merson, Crickmore and L'ami but from October, when Peat Marwick Ltd. was present, “it was academic who signed the cheques".

In mid-October the dumping issue came to a head and Mr. Merson was involved with the Company's complaint with Revenue Canada; this required him to be in Ottawa at times. He was also "courting" two possible serious investors "attempting to close a deal” for refinancing the Company.

The appellant called an officer of the respondent, Mr. Henry Kotsier, to testify. Mr. Kotsier was the respondent's payroll auditor who audited Canadian Porcelain in November and December of 1984 to verify the amounts of source deductions that ought to have been remitted. In November his audit was for the period January 1, 1984 to the end of October 1984; the December audit was for November. His audit notes for November 19 corroborate Mr. Merson's evidence that the Royal Bank “appointed Peat Marwick to keep a daily tab on this business and that only those cheques approved by Peat Marwick will be honored by the bank”. Mr. Kotsier said he saw a payment schedule prepared by the bank; according to his notes the "schedule states that remittances for source deductions must be deferred". The notes reflect that management refused to give him a copy of the schedule, although they did show him another schedule prepared by the Company in which the remittances for source deductions were to be made in time as required, "but this was rejected by the bank”.

Mr. Kotsier's audit revealed that the Company remitted excess amounts of source deductions of $8,177.36 in June and $8,752.40 in July of 1984.

By the time of the second audit on December 17th, the Company had been placed in receivership and only five people out of a previous work force of 120 were at the plant; manufacturing had ceased. Mr. Kotsier determined the source deductions for November which had not been remitted by December 15.

Mr. Kotsier explained that the payroll of Canadian Porcelain was prepared by the Toronto-Dominion Bank and the payroll cheques would be drawn on the Toronto-Dominion Bank account of the Company. When the amount of payroll was determined the Toronto-Dominion Bank would advise the Royal Bank which would transfer the amount out of the Company account to its account at the former bank. Only the net payroll would be transferred, the difference between the gross payroll and the net payroll remained in the Royal Bank account.

Subsections 227.1(1), (2) and (3) of the Act provide that:

(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 of Canada under subsection 223(2) and execution for such 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 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 he exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances. [3]

A certificate in accordance with subsection 227.1(1) was registered pursuant to paragraph 227.1 (2)(a) in the Federal Court on March 8, 1985.

Submissions

Counsel for the appellant submitted that Peat Marwick Ltd. was the de facto receiver of the Company from October 1, 1984 and from that day on the Company's business was controlled by Peat Marwick Ltd. and the Royal Bank. Once Peat Marwick Ltd. employees entered the premises, Mr. Merson no longer had effective control of the business operations. Mr. Kotsier's testimony that he saw a schedule of payments indicating the Royal Bank's instructions to defer source deduction remittances after such a request for payments was made confirmed, counsel argued, that the Royal Bank dictated any payment by the Company. He added that the Company had a good system to ensure timely remittances and it was only with the arrival of Peat Marwick Ltd. on October 1, 1984 that the remittances were not made.

Appellant's counsel stressed that facts in the case at bar are not similar to those in appeals recently decided by this Court in favour of the respondent. In Barnett v. M.N.R., [1985] 2 C.T.C. 2336; 85 D.T.C. 619 the taxpayer instructed the company's comptroller to pay essential suppliers before source deductions were remitted. In Lloyd Youngman & Company Inc., Trustee of the Estate of Harold Fraser in Bankruptcy v. M.N.R., [1987] 1 C.T.C. 2311; 87 D.T.C. 250 the taxpayer knew the corporation was experiencing some kind of an income tax problem but, when assured by the other directors who were responsible for financial matters that the problem was being taken care of and he was not to worry, did nothing. No instructions were given by a director who relied on other people to ensure payments of source deductions were made even after a visit of a Revenue Canada auditor: Quantz v. M.N.R., [1988] 1 C.T.C. 2276; 88 D.T.C. 1201.

The respondent's counsel argued that the relief described in subsection 227.1(3) is not available to Mr. Merson since the words of that provision offer relief to a director ”. . . where he exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised . . .”. She submitted that Mr. Merson did not exercise such degree of care, diligence and skill since he in fact did nothing to prevent the failure to remit the source deductions.

Mr. Merson, in her view, acted no differently from Messrs. Barnett, Fraser and Quantz. He did not pay the slightest attention to the performance by the Company of its duties under subsection 153(1) and subsections 227(4) and (5), preferring to rely on others. He complacently went along with the Royal Bank's decision and failed to inform himself.

Counsel referred the Court to its decision in Beutler v. M.N.R., [1988] 1 C.T.C. 2414; 88 D.T.C. 1286, which, she said, was close to the appeal at bar and notwithstanding the “extraordinary steps" taken by Mr. Beutler, the Court decided against him. However in the Beutler appeal it was admitted by the taxpayer that he knew the company was using "government" funds as a loan and that he and his associate made a decision not to pay Revenue Canada. This was not the case with Mr. Merson.

(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.

The appeal of Ralph M. Moore v. M.N.R., [1988] 2 C.T.C. 2191; 88 D.T.C. 1537 contains many facts found in that at bar. By the end of the summer of 1982 Ralph M. Moore Industrial Installations Limited ("RMMII") was experiencing revenue cash flow difficulties and had extended its borrowings from its banker, the Canadian Imperial Bank of Commerce, to full credit lines. On October 15, 1982, at the request of the bank, RMMII appointed Arthur Andersen Inc. to investigate the company's financial affairs and report to the bank concerning same. On October 28, 1982, the bank appointed Arthur Andersen Inc. as receiver and manager of the undertaking, property and assets of the company that were charged and mortgaged to the bank. However, even before the appointment of Arthur Andersen Inc. to investigate the company's affairs, the bank had taken full control over payments of the company's accounts payable. The company had told the bank that it wanted to remit source deductions for September 1982 but was refused permission by the bank to make such payments; the bank informed the company it would refuse to honour any cheque issued in respect of source deductions. Mr. Moore also executed a form of consent to the appointment of Arthur Andersen Inc. on substantially the same form as that signed by Mr. Merson.

In delivering judgment, Judge Taylor stated that Mr. Moore:

. . . cannot plead that he was unfamiliar with the operation of his company. He cannot plead that he had no direct contact with payment procedures. He cannot plead that he was unaware the obligations to Revenue Canada were being left unattended. He cannot even plead that he did not on a regular basis deal with the remittance of the deductions. He can say that he had substantial financial strain in keeping the company operating during the work stoppage, which included the period of time at issue. He can say that he had very limited, if any, financial flexibility (he would probably say responsibility or authority) for the period before the receiver-manager took over, and certainly it was curtailed after that point. He can say that he would have paid the deductions if the money had been available — in essence if the bank had allowed him more credit. And that is the crux of the problem. The bank had indeed curtailed his credit—would provide no more operating advances—and would only honour cheques which were absolutely vital to keep a minimum operation going—usually after prior approval from the bank. While the general description provided by counsel for the appellant—"that by September the bank had frozen the company's accounts, and was in control of all payments", may be a little extreme, I certainly accept that Mr. Moore had no further access to credit or funding from the bank. Intending, as he did, that he would keep the company operating, no matter what methods it took, he used and continued to use unauthorized credit from the Crown—the unremitted employees' income tax deductions—as part of the operating capital of the corporation.

There are, however, differences between Mr. Merson's travails and that of Mr. Moore. Mr. Merson was not aware the obligations to Revenue Canada were being left unattended. He had no reason to believe the source deduction payments were not being made. Mr. Merson's primary concerns were to obtain financing for the Company or sell it and to assist in the prosecution of the litigation before the Anti-dumping Tribunal; these took up much, if not all, of his efforts and, in the circumstances, it was reasonable for him to permit officers of the Company to continue to exercise their offices without his interference, in particular since the regular routine was being disrupted by the presence of Peat Marwick Ltd. Mr. Merson did not deal on a regular basis with the remittance of the deductions; this was left to Mr. Crickmore who was experienced and competent. Mr. Crickmore, according to Mr. Kotsier’s evidence, had requested approval of payment of the source deductions to Revenue Canada but was refused. His absences from the premises during the months of October, November and December may have aggravated the communication between him and Mr. Merson thus denying Mr. Merson of the knowledge of the Company's failure to remit. There is no evidence Mr. Merson used and continued to use the unremitted source deductions as part of the operation of the Company; the evidence suggests the funds were being maintained for the benefit of the Royal Bank. According to Mr. Merson, an amount equal to the amount of source deductions was a Company asset on December 11.

The circumstances of this case are unusual but not exceptional. The question to be answered is whether Mr. Merson exercised a degree of care, diligence and skill which would have prevented the failure of the Company to remit the amount of source deductions which a reasonably prudent person would have exercised in comparable circumstances. Counsel for the Minister said no one knows what Mr. Merson could have done because he did nothing. She insisted that when a business decision is made to borrow money from a bank on whatever conditions available, the owner of that business must accept the consequences which fall, in this case, on the interference of the bank in the business operations. She stated that Mr. Merson did not verify if cheques were being paid to the Receiver General for the source deductions, although he did ensure essential suppliers were paid. She added he could have done "something" about non-payment to the Receiver General but did nothing.

"Prudent" is defined by the Shorter Oxford English Dictionary On Historical Principles as follows:

. . . Of persons, etc.: Sagacious in adapting means to ends; having sound judgment in practical affairs; circumspect, discreet, worldly-wise. . . . 3. Of conduct, action, etc.: Characterized by, exhibiting, or proceeding from prudence; politic, judicious . . .

The same dictionary defines "reasonable" as:

. . . 2. Having sound judgment; sensible . . . . 3. Agreeable to reason; not irrational, absurd or ridiculous . . . . 4. Not going beyond the limit assigned by reason; not extravagant or excessive; moderate . . . .

The words "reasonable" and "prudent" in some instances of use are synonymous: having sound judgment. A director manages or supervises the management of a business: he must have sound judgment and in any given set of circumstances must proceed with a degree of prudence. 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 Canada 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. However, the exercise of care, diligence and skill by a director contemplated by subsection 227.1(3) requires a degree of prudence that is not as great as that of a trustee since a director, it must not be forgotten, is neither the trustee of the fund represented by the unremitted source deductions nor is he the insurer of the Receiver General for Canada. Subsection 227.1(3) does not require the care, diligence and skill that is exercised with an unduly excessive measure of prudence.

When Mr. Merson's holding company acquired the shares of Canadian Porcelain, a system was either put in place or was in place that ensured payments of amounts of source deductions to the Receiver General of Canada as and when required by the Act and its regulations. The system continued to operate subsequent to the time Mr. Merson took a more active interest in the Company and the Royal Bank insisted on approving cheques for payments. Until Peat Marwick Ltd. arrived at the Company on October 1, 1984 there was no failure by the Company to remit the source deductions. The amount of source deductions required to be remitted on or before October 15 were in fact remitted; payment obviously had been approved by Peat Marwick Ltd. and the cheque honored by the bank. There was no reason for Mr. Merson to doubt that the amounts deducted at source during October would not be paid to the Receiver General on November 15, 1984; nothing had changed in the past month as far as he was aware.

Apparently something did change in November: Peat Marwick Ltd. refused to approve payment of the amounts of source deductions. Mr. Merson was not advised. The person who was aware of the refusal, Mr. Crickmore, was not in the office on a regular basis because the situation within the Company was causing him health problems. Contrary to his past practice he failed to notify Mr. Merson of the Company's failure to remit. In the meantime Mr. Merson's energies were directed to finding financing for the company or a purchaser for the Company and to the hearing before the Antidumping Tribunal; at the time of Mr. Kotsier's first audit Mr. Merson was in Ottawa for purposes of the scheduled hearing. In some cases [4] heard by this Court dismissing the appeals, the taxpayer made a decision to apply the amount of source deductions to the corporation's working capital. This Mr. Merson did not do. The decision not to pay the Receiver General was made by Peat Marwick Ltd. and the Royal Bank for their own purposes.

Canadian Porcelain had a system in place to pay amounts of source deductions according to the law. Mr. Crickmore was described as an able employee dedicated to making sure the Company did not default in its obligations under the Act. There was no reason for Mr. Merson to look over Mr. Crickmore's shoulder; he had done his job well in the past and it was not necessary for Mr. Merson to assume he would not continue to do his job well in the future. A director has an obligation to be aware of what is happening within the corporation of which he is director. Effective lines of communication between him and the corporation's responsible employees must be present to ensure the director does not fail his statutory obligations. However, when all reasonable measures are taken and these measures have been successful in the past, he may reasonably be expected to rely on the measures in the future. Peat Marwick Ltd.'s refusal to approve a cheque for the November 15 payment to the Receiver General was unexpected and because of the stress generated by Peat Marwick Ltd.'s presence at Canadian Porcelain, coupled with Mr. Merson's energies being diverted to other areas important to the Company, it is not surprising that Mr. Merson was not aware of the failure of the Company to pay the amount of source deductions.

When the salaries and wages were paid to employees of the Company in November Mr. Merson was director of the Company; he was not a director when the amount of source deductions ought to have been paid on December 15. However, subsection 247.1(1) provides a director "at the time the corporation was required to deduct (and) withhold”, that is, when the salaries and wages are paid, is liable for the corporation's failure to remit the amount of source deductions. However, at the time of the payments of the salaries and wages he was not aware the Company had failed to remit the earlier amount of source deductions and that it would not remit the amount of source deductions due on December 15. The only way he could have been aware of the failure at the time, in the circumstances, was to have conducted himself at a level of prudence not contemplated by the Act or corporate legislation. During the months of October and November and up to December 11, he conducted himself as director with the care, diligence and skill contemplated by the Act.

Counsel for the respondent is wrong in her view that Mr. Merson did nothing positive to prevent the failure of the Company to remit the source deductions. [5] Mr. Merson did perform a positive act: he caused, or allowed to remain, a system to operate within the Company that was tried and tested and had been shown not likely to fail.

For a person to be in a position to prevent an act or an omission that person must know or reasonably should have known, having regard to all the circumstances, that the act or omission would occur. In the case at bar Mr. Merson had no knowledge that the Company would fail to remit the amount of source deductions on November 15, 1984; it is also clear that Mr. Merson was not in a position where circumstances would have permitted him to acquire such knowledge prior to the failure to remit on November 15. Prior to December 15, 1984, he knew the Company would fail to remit the source deductions due on that date but the failure was not due to him or anything he did or could have done in the circumstances. Mr. Merson was not an impassive, uncaring actor but was actively involved in attempting to ensure the Company's survival. When he learned of the failure to remit he was not in a position to cause or influence the Company to make the payments. The circumstances of this appeal did not require any further positive assertion on the part of Mr. Merson to bring himself within subsection 227.1(3); he did all that could reasonably be expected of him.

Mr. Merson's appeal therefore will be allowed with costs.

Appeal allowed.