McConnachie v. MNR, 91 DTC 873, [1991] 2 CTC 2072 (TCC)

Bonner, T.CJ.:—The appellants were directors of Friggstad Manufacturing Ltd. (the "Company") at the time of its collapse in the summer of 1984. The Company failed to remit to the respondent amounts withheld at source from the wages of its employees as required by section 153 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). The relevant remittances were due on the fifteenth of the months of May, June, July and August of 1984. The respondent sent to each appellant a notice of assessment dated January 9, 1987. The notices advised the appellants that:

Liability under subsection 227.1(1) of the Income Tax Act for $214,206.60, being the amount of unpaid deductions, interest and penalties payable by Friggstad Manufacturing Ltd. in respect of Notices of Assessment dated July 30, 1984 and September 3, 1984.

Subsection 227.1(1) of the Act makes the directors of a corporation jointly and severally liable with the corporation in respect of failure to deduct or withhold as required by section 153 of the Act and in respect of failures to remit amounts which have been withheld. The appellants relied on several aspects of section 227.1 both procedural and substantive but I will reproduce only the parts directly relevant to this decision viz.:

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.

(4) No action or proceedings to recover any amount payable by a director of a corporation under subsection (1) shall be commenced more than two years after he last ceased to be a director of that corporation.

No submissions were made on behalf of the appellants to the effect that the assessment process was never completed because the respondent had failed to provide proper notice. [1] However there are a few observations on this point which ought to be made. A piece of paper is not a notice of assessment simply because it bears that heading. The supposed notices of assessment sent to the appellants in this case are not just uninformative. They are also misleading. They do not indicate whether the alleged liability is founded on a failure to withhold or on a failure to remit. They do not indicate the number of failures or the dates on which such failures are said to have occurred. The deficiencies in the notices were not rectified by the reference to notices of assessments dated July 30,1984 and September 3, 1984, because the 1984 notices were sent to the Company not to the appellants. The notices which were sent to the appellants are misleading as to the composition of the amount shown thereon. The $158,657.56 figure in the box entitled "Tax" includes amounts withheld not only for federal tax but also for provincial tax and for unemployment insurance. The amount shown for interest is computed on the total withholdings under three statutes and not just on amounts for which directors may be liable under section 227.1. The statutory and factual basis for the assessment of penalty has not been identified.

The notices of confirmation sent by the respondent to the appellants are just as unsatisfactory as the notices of assessment. The confirmations read as follows:

Subsection 227(10.1) of the Act provides that the Minister may assess any director of a corporation for a corporation's failure to remit an amount of tax under Section 215 of the Act, accordingly you are jointly and severally liable, together with the corporation, to pay that amount of tax, any interest or penalties in accordance with the provisions of Subsection 227.1(1) of the Income Tax Act.

Section 215 of the Act is not in any way related to the assessments in dispute.

None of the deficiencies to which I have referred was rectified in the replies to the notices of appeal filed on behalf of the respondent. [2] The veil of secrecy surrounding the assessments was, I am told, swept away shortly before the hearing when counsel for the respondent provided to counsel for the appellants statements giving a detailed breakdown of the amounts assessed.

Because the validity of the assessments was not challenged on the basis of failure to give proper notice I need not express a conclusion on the point. I will note, however, that the only statute to which reference is made in the notices of assessment is the federal Income Tax Act. I will refrain from dealing with claims for relief under the Income Tax Act (Saskatchewan) not because I find that no completed assessment was made under that Act but because this Court has no jurisdiction to interfere with assessments made under it.

There is one more point which should be made before departing from the topic of the notices or assessment. The appeal process can never be made to operate fairly and effectively if the Minister fails to disclose the legal and factual basis on which the assessment rests. Notices of assessment and confirmations which are enigmatic or fatuous are unacceptable. A taxpayer who has not been told why the Minister thinks that he is liable for the amount assessed can neither determine whether the assessment is justified nor effectively attack one which is not. The Minister ought to make particularly careful disclosure in a case such as this where liability rests on events in which the person assessed may not be directly involved.

The Company was incorporated in May of 1970. It carried on the business of manufacturing agricultural implements, primarily chisel plows and air seeders, at a plant located just south of Frontier, Saskatchewan. There were three directors; Olaf Friggstad and his two sons, Terry and Dave. Olaf Friggstad was president and chief executive officer. Terry Friggstad was a vice-president and was primarily concerned with research and the development and improvement of the Company's products.

Initially the Company was profitable. In all years but one during the period from incorporation to 1981, the Company showed a profit. The Company's principal lenders were the Royal Bank of Canada which provided an operating line of credit and Saskatchewan Economic Development Corporation (hereinafter "Sedco"). The bank held security covering the Company's receivables and inventory and a floating charge debenture. Sedco held security on the land, buildings and equipment of the Company.

In 1982, the Company suffered a very large loss. As a result of this loss Sedco and the Royal Bank recommended that outside consultants be retained. As a result of the consultant's recommendations made on October 28, 1982, Sedco advanced the Company an additional $1,750,000 and the bank increased the operating line of credit from $5,000,000 to $7,000,000 subject to a maximum limit fixed in relation to the value of inventory and receivables held by the bank as security. The board of directors was increased in size from three to seven members. Four "outside" directors were added, two being persons chosen by the bank and two by Sedco. The shares in the Company which were owned by Olaf and Terry Friggstad were transferred to a trustee under a voting trust agreement intended to remain in effect until repayment of the additional advance from Sedco, payment of all interest on the existing debt of Sedco, payment of all interest on the existing debt of the bank and finally until the debt to equity ratio of the Company dropped below 3:1. The trustee agreed that it would not, without the consent of the bank and Sedco, vote the trust shares to, inter alia, wind up the affairs of the Company or make a voluntary assignment in bankruptcy. The Company delivered to the bank and to Sedco a letter dated November 5, 1982 reading as follows:

In accordance with our discussions, we agree to continue to provide the Royal Bank of Canada with a list of cheques for any expense over One Thousand Dollars requiring a payment and that the Bank will give its consent to such payments prior to their issuance.

It is further understood and agreed that we will provide the Royal Bank of Canada with a list and obtain their consent with regard to any purchase orders covering materials or otherwise for amounts in excess of Five Thousand Dollars.

During the course of the restructuring of the fall of 1982, the bank and Sedco made it clear to Olaf Friggstad that it was felt that the Company needed a chief executive officer who was better qualified than Mr. Friggstad. The new man was Thomas Mundy.

On February 23, 1983 Olaf Friggstad signed and delivered to the Royal Bank a letter in which he expressed agreement to the hiring by the Company of a new chief executive officer to replace him. The letter states, inter alia, "I will report to and carry out the directions of the new chief executive officer. I will abide by his decisions. I realize that all of the above is necessary for the survival of the company." Under Mr. Mundy's direction the Company continued to produce goods which could not be sold due to adverse economic conditions. After Mr. Mundy's appointment, Olaf Friggstad had little to do with the day-to- day operation of the Company. He stated that he felt that the undertaking which he had signed prevented him from interfering.

Meetings of the expanded board of directors of the Company were held almost every month from November 30, 1982 to September 28, 1983. The minutes of the meeting held on December 20, 1982 record that: "Norman McConnachie expressed a concern regarding directors' liability. He wanted to be assured that all taxes whether past, current, or future have been or will be paid—every tax deduction whether payroll or non-resident." Mr. McConnachie and Mr. Fallis stated that Olaf Friggstad advised the meeting that all deductions had been paid, were being paid and would be paid. Unfortunately nothing was done by way of follow-up. The subject was not revisited. No formal meetings of the directors of the Company were held after September 28, 1983. Olaf Friggstad retained the position of chairman of the board. He did approach Mr. Mundy and asked if there should not be another board meeting. Mr. Friggstad testified that although he could not recall the exact words used, it was implied to him that the problems of the Company were such that the board really had nothing to meet about. Efforts were being made to further restructure the Company and it was thought that in the absence of such restructuring, receivership was inevitable.

On June 12, 1984 the Company prepared a list of cheques to be issued. The list was sent to the bank for approval. One of the cheques on the list was for $74,522.15 payable to the Receiver General. The bank did not authorize the issuance of the cheque. In mid-June, 1984 Olaf and Terry Friggstad were summoned to a meeting in Regina at which they were informed that the bank was going to put the Company into receivership. Olaf Friggstad then made efforts to form an investors' group with a view to raising additional capital and making a proposal to the creditors. The sum of $850,000 was raised and a proposal was prepared. The proposal, dated July 30, 1984, was rejected and the receiver took possession of the company property on August 14. The corporate existence of Friggstad Manufacturing Ltd. ended on November 29, 1985 when it was struck off the register. None of the directors resigned at any time prior to that date.

It was argued that the assessments of January 9, 1987 were actions or proceedings commenced beyond the two-year limit laid down by subsection 227.1(4). The appellants, it was said, ceased to be directors on July 30, 1984, the day of filing or the proposal to creditors which was rejected on August 14, 1984. Under section 39 of the Bankruptry Act, R.S.C. 1970, c. B-3 (references are to provisions in effect in 1984) where the creditors refuse to accept a proposal the debtor is deemed to have made an assignment on the date of the proposal. By virtue of subsection 50(5) of the Bankruptcy Act the Company ceased to have any capacity to dispose of or otherwise deal with its property on the day on which the proposal was filed. In consequence it was argued the directors had no power thereafter to deal with the property of the Company and to ensure that the remittances were made.

In addition, so the argument went, on August 16, 1984 a receiver-manager was appointed by the bank under its debenture. Section 91 of the Business Corporations Act, R.S.S. 1978, c. B-10 provided:

91. If a receiver-manager is appointed by a court or under an instrument, the powers of the directors of the corporation that the receiver-manager is authorized to exercise may not be exercised by the directors until the receiver-manager is discharged.

Thus it was argued that for well over two years prior to the issuance of the assessments, the directors were stripped of effective power.

On behalf of the respondent, Mr. Softley argued that directors do not lose office by virtue of the bankruptcy of the corporation. He pointed out that the Bankruptcy Act contemplates that a corporation may apply for a discharge after it has satisfied the claims of its creditors in full (subsection 139(4)). Mr. Softley did not suggest that any such application was made by Friggstad Manufacturing Ltd. As well, he referred to Re Canadian Cereal & Flour Mills Co., 67 D.L.R. 234 which stands for the proposition that there is nothing in the Bankruptcy Act which places a company which has made an assignment in any different position from a natural person. Thus he argued the directors of the appellant still retained after August 1984 some of the powers of directors. He also pointed out that under section 103 of the Business Corporations Act, directors cease to hold office when they die, resign or are removed and no such event had occurred.

It was Mr. Softley’s position that Perri v. M.N.R., [1990] 1 C.T.C. 2071; 89 D.T.C. 723 was wrongly decided. He relied on the decision of this Court in Tuesday Chan v. M.N.R., (unreported). The reasons in that case were given orally on November 24, 1989. In those reasons, reference was made to the 227.1(4) limitation and the following was said:

Here the proceedings were not started within the two-year period of the event, but directors continued to be such although with reduced rights and powers, after the appointment of a trustee, receiver, liquidator or other like person acting in a similar capacity. Thus this requirement is met.

In Perri, supra, notices of assessment were issued to the directors more than two years after a receiver-manager was appointed. The corporation in question was governed by the British Columbia Company Act, section 110 of which provided:

110. Where a receiver manager is appointed, the powers of the directors and officers of the corporation cease with respect to that part of the undertaking for which he is appointed until he is discharged.

Christie, A.C.J.T.C. stated at page 2074 (D.T.C. 725):

As I understand it, it is the intention or object of subsection 227.1(4) to fix a limitation period that runs from a time when an individual ceases to be in a position in law and in fact to exercise the powers of a director to rectify the failure of the corporation to deduct or remit or both. I regard that as being the correct meaning of the phrase “ceased to be a director" in subsection 227.1(4). To hold that those words in all circumstances means that there must be a lapse of two years from the date an individual ceases to hold office as a director in accordance with the provisions of the relevant corporate legislation would in some instances, such as those under consideration, render the limitation period devoid of meaningful substance.

[Emphasis added.]

In my view the decision of this Court in Perri ought to be followed. Although Chan was decided subsequently it would seem that Perri was not brought to the attention of the presiding judge. Thus Chan does not represent a deliberate departure from the position laid down in Perri. In Perri the Court construed the meaning of the word "director" as used in subsection 227.1(4) so as to exclude persons who are directors in a technical sense only and who, by reason of receivership or bankruptcy of the company, are stripped of powers of the sort which led to the enactment of section 227.1 in the first place. That section was enacted because it is the directors of a corporation who, in normal circumstances, exercise the powers of the corporation and direct the management of its business and affairs and who are therefore in a position to ensure that the corporation discharges its duty to withhold and remit tax as required by section 153 of the Act. Directors of a corporation which has lost the capacity to dispose of or deal with corporate property are not the sort of persons who are the target of section 227.1. In my view, Perri follows the "modern rule” of statutory construction approved by the Supreme Court of Canada in Stubart Investments Ltd. v. The Queen, [1984] C.T.C. 294; 84 D.T.C. 6305 which rule is:

Today there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

The purpose of subsection 227.1(4) is to protect directors from indefinite exposure to collection proceedings in respect of liability under subsection 227.1(1). That protection would, as a practical matter, be diminished greatly if directors of a bankrupt corporation are by reason of vestigial powers which they hold after a bankruptcy to be treated as continuing in office until either they resign or the corporation is struck from the register. Few people in such circumstances would ever think of resigning and few bankrupt corporations ever pay their debts in full and are discharged. As a consequence in most cases the two-year period would not start to run until the time when the corporation is struck from the register for failure to file returns. I find it difficult to conceive that the construction for which the respondent contends was in contemplation of the legislature. For the foregoing reasons I have concluded that the appellants last ceased to be directors of the Company more than two years before the assessment were issued. The appeals will therefore be allowed with costs and the assessments of liability under section 227.1 of the Income Tax Act will be vacated.

Appeals allowed.