Vanguard Trailers Ltd. v. The Queen, 80 DTC 6001, [1980] CTC 42 (FCTD)

Collier, J:—At the conclusion of the hearing I said the plaintiff’s appeal would be dismissed. Written reasons would be later given. Those reasons now follow.

This section is, in many ways, a companion suit to one I heard in 1978: G Gahrns v The Queen, [1978] CTC 651; 78 DTC 6436.

The main witnesses for the plaintiff in the earlier case were the plaintiff himself, Gunter Gahrns, and his legal adviser, Mr Derrill T Warren. Those same two were the chief witnesses for the defendant in this action.

The key witness for the plaintiff in this appeal was Mr Paul Gordon, a Los Angeles attorney. He testified as to certain negotiations carried on in Los Angeles between himself, on behalf of the plaintiff and its parent companies, and Warren on behalf of Gahrns. The evidence of the two lawyers was, in certain essentials, in sharp conflict.

In the Gahrns case, the Minister of National Revenue had included in Gahrns’ income for his 1974 taxation year, an amount of $250,000. For so doing, the Minister had relied on four documents, all dated Sept 20, 1974 and all signed by Gahrns. Those documents were exhibits 5, 3, 4, and 7 at this trial.

I reproduce one of them (ex 7):

RECEIPT

This will acknowledge receipt of the sum of $250,000 relating to the termination of my employment with International Recreation Corp, the execution of a covenant not to compete on behalf of Open Road Industries, Inc, and their subsidiaries and my agreement to render services to said companies as outlined in separate documents.

The purchase price is to be allocated as follows:

1. $125,000 as a bonus for past services rendered.

2. $25,000 for my agreeing to be available to render consulting services to International Recreation Corp, and its subsidiaries for a period of one (1) year from the date hereof or as more specifically set out in our separate agreements.

3. $100,000 for the execution of the covenant not to compete.

DATED: September 20, 1974.

Gahrns, in his lawsuit, contended the documents he signed did not set out the actual transaction whereby, nor the basis upon which, a payment of $250,000 was made to him. That payment was made by the present plaintiff, Vanguard Trailers Ltd (Vanguard).

Vanguard sought to deduct, in its 1974 and 1975 taxation years, the amount paid, less $8,500.* [1] It asserted the outlay was a business expense. The Minister disallowed the deduction. Hence this appeal.

The issue is fundamentally one of fact. If the payment was, in reality, income to Gahrns, then logically it ought to be deductible as an expense to the plaintif, or, perhaps, spread among its allied companies.

In the Gahrns case, I said this:

At the conclusion of the hearing I said the plaintiff’s appeal would be allowed. Written reasons would be later given. Those reasons now follow.

The Minister of National Revenue included in the income of the plaintiff, for his 1974 taxation year, the sum of $250,000. The Minister relied on four documents all dated September 20, 1974, and all signed by the plaintiff (Exhibits 8, 9, 10 and 11).

I reproduce one of the documents (Exhibit 11):

RECEIPT

This will acknowledge receipt of the sum of $250,000 relating to the termination of my employment with International Recreation Corp the execution of a covenant not to compete on behalf of Open Road Industries, Inc and their subsidiaries and my agreement to render services to said companies as outlined in separate documents.

The purchase is to be allocated as follows:

1. $125,000 as a bonus for past services rendered.

2. $25,000 for my agreeing to be available to render consulting services to International Recreation Corp and its subsidiaries for a period of 1 year from the date hereof or as more specifically set out in our separate agreements.

3. $100,000 for the execution of the covenant not to compete.

DATED: September 20, 1974.

The plaintiff contends the documents he signed do not set out the actual transaction whereby, nor the basis on which, a payment of $250,000 was made to him.

The issue is fundamentally one of fact. The plaintiff and Mr Derril T Warren, his legal adviser, testified as to the facts. The effect of that testimony was to explain the real transaction and to endeavour to nullify the prima facie inference the payment was in the nature of income. Because of that, I considered very closely the evidence of the plaintiff and his legal adviser. I found them to be credible and trustworthy witnesses. I accept their testimony as to the matters that led to the receipt by the plaintiff of this large sum of money.

After hearing once more the evidence of Gahrns and Warren, and balancing it against the testimony of Gordon, I again accept, as to the matters which led to the signing of the key documents and the payment to Gahrns of this large sum of money, the testimony of Gahrns and Warren. Where there is conflict between the evidence of Warren and Gordon, I accept that of Warren. I do so for a number of reasons:

(a) Warren gave his evidence carefully and in considerable detail. He made notes shortly after the transactions in Los Angeles. A few days later he transcribed and expanded them fully. Gordon’s evidence was Skimpy, and largely consisted of a denial of certain testimony given by Warren in the Gahrns case. He apparently made no notes.

(b) Gordon knew little of the background or history of Gahrns, Vanguard and its parent companies. His firm acted for the main parent company, Open Road Industries, Inc (ORI). One of Gordon’s partners, L D Weinberg, was the secretary of that company. He, or others in the firm, did what Gordon termed the “nuts and bolts” of the legal work required. Gordon was enlisted, on a brief basis, to negotiate what he understood to be a dispute between Gahrns and the president of ORI, Alan Robin.

(c) Gordon’s memory as to what happened was, in comparison to Warren’s, vague. On certain matters, his evidence in chief and in cross- examination was somewhat contradictory. That remark does not, however, apply to the key matters on which there was sharp disagreement between the two lawyers.

I turn now to the facts.

Gahrns was the co-founder and 50 per cent owner, as well as director and the secretary, of Vanguard from its incorporation on May 18, 1962 until August 4,1969. On the latter date he became president. Vanguard made and sold recreation vehicles. From 1970 it operated in the Kelowna, BC area. It was a very successful business. In September of 1969, Vanguard’s shares were sold to an American company, International Recreation Corporation (IRC). Gahrns exchanged his shares in Vanguard for shares of IRC, plus a cash payment. In December 1969 he became a vice president and a director of IRC. In November 1971 he became president and chief executive officer. IRC carried on its operations at Boise, Idaho. It owned another company, securities Industries Inc (Security). Security made recreational vehicles at Boise.

In September 1972, Gahrns signed a formal three year employment agreement with IRC. The agreement included a covenant by him not to compete, during the duration of the agreement, in a similar business in certain areas.

In 1973 the shares of IRC were sold to ORI. The latter was a public company listed on two stock exchanges. Gahrns received $4.50 a share for his 109,884 shares of IRC. He was required, as a term of this take-over, to purchase shares of ORI to the value of approximately $175,000. He did so. The shares, (15,600 in number) were put in escrow.

Gahrns had been shown ORI’s financial statements. They indicated a surplus of approximately $20,000,000, and sales of $40 to $50,000,000.

At the time of the take-over by ORI, Gahrns signed a replacement employment agreement with IRC. it was to run for three years from April 17, 1973 (ex A to ex 1). He was to be paid a minimum of $5,000 a month. He was entitled to participate in any company bonus plans. He agreed he would not compete, during the life of the contract, in the recreational vehicle business in certain areas of the United States and Canada.

Gahrns had been shown ORI’s financial statements. They indicated a surplus of approximately $20,000,000, and sales of $40 to $50,000,000.

Things seemed to go reasonably well after the take-over. Gahrns was left to run Vanguard and Security through IRC. He thought sufficiently well of the whole operation that he bought, on the open market, another 1,500 shares of ORI. His total investment was a little over $190,000.

But early in 1974 problems arose. He was requested by ORI to loan funds from Vanguard to the parent company. It was to be a 30-day loan. The money was never repaid. He then found he was having difficulty obtaining credit from suppliers of Vanguard and Security. That problem had not existed before. It apparently arose out of lack of confidence by ORI creditors. In the middle of 1974 there was some interference in the operation of Security. Some assets were, on the instructions of ORI management, taken from certain divisions of that company.

As a result of all this, Gahrns became concerned about his financial planning for IRC and its two subsidiaries. He had to maintain certain working capital ratios. Further, there was a long-term loan by Prudential Life Insurance Company to IRC, or to ORI. There was some provision in the Prudential agreement funds would not be moved upstream to the parent company.

In July or August 1974 Gahrns was asked to transfer approximately $1,000,000 from Vanguard to ORI. That was a major portion of Vanguard’s surplus. Gahrns did not comply with the request. He was invited to attend an ORI directors’ meeting in Los Angeles. He did so. He was asked to join the board of ORI. He did not. He was told ORI had suffered a financial loss, in the past number of months, of $17,000,000. It appeared the previous surplus had practically disappeared.

On his return to Kelowna, continuing pressure was put on him to transfer the requested funds. He felt there were behind-the-scenes manipulations being carried out by the management of ORI. He did not feel the practices were compatible with his own business ethics. He tentatively decided the best course was to resign from IRC. On Labor Day, September 2, 1974, he went to Warren for advice. Warren was, at that time, solicitor for Vanguard. Gahrns told Warren about the ORI loss, the request for funds from Vanguard, his reluctance to join the board of directors of ORI, and other matters. Gahrns asked Warren for advice as to his personal position and that of Vanguard if the $1,000,000 was transferred to ORI. On the following day Warren advised Gahrns there might be some personal liability if funds were loaned to an insolvent company, or if Gahrns knew ORI was incapable of re-paying the advance.

Continuing pressure by telephone was exerted, by attorneys and others connected with ORI, on Warren and Gahrns. Warren said his telephone conversations, particularly those with Weinberg, became hostile. Finally, Gahrns came to the view he should resign all of his positions. He decided to go to Los Angeles. He asked Warren to accompany him.

En route from Kelowna, Gahrns and Warren met, in Vancouver, BC, with a Portland attorney. That attorney had been involved in the sale of IRC to ORI. The representatives of an accounting firm also attended the meeting. The accounting firm acted for Gahrns and Vanguard. Strategy was discussed. There were three main objectives. The first was to try and work out a compromise of some sort which would obviate Gahrns resigning. But Gahrns wanted, in that situation, to be able to control IRC and its subsidiaries, without interference from ORI management. Another alternative discussed was resignation, but a personal consulting contract by Gahrns. Lastly, if a compromise could not be reached, then it was decided Gahrns should resign; Warren would try and negotiate that resignation and the withdrawal from the employment contract without harm to Gahrns’ reputation. It was also decided some attempt should be made to try and recover the money Gahrns had invested in ORI. Gahrns felt he had been forced into this investment; that there had been misrepresentation in respect of ORI’s financial status and management.

Gahrns and Warren arrived in Los Angeles on Tuesday, September 17. Arrangements had been made to meet with a man called Sharp, a consultant to ORI and a director, and a man called Heller, an in-house attorney. Sharp was sympathetic to Gahrns’ misgivings about the management and financial affairs of ORI. He indicated the company had problems with the Bank of America, who were financing its operations. But Sharp tried to persuade Gahrns, because of his ability and experience, to remain with the organization. Arrangements were then made to meet the following day with Robin.

That was done. Robin did not want Gahrns to resign. Gahrns enquired into the problems with the Bank of America. Robin indicated that was in hand. But he declined to permit Gahrns and Warren to speak with Bank of America officials. There had been a failure by ORI to file certain documents with the SEC in Washington. Gahrns and Warren were told those documents had just been completed and mailed. Gahrns asked for a copy, plus copies of financial statements. Robin said he would have to consult his directors as to whether that could be done.

In the afternoon there was a further meeting between Heller, Sharp, Gahrns and Warren. Warren, only, was given certain information in respect of tenative arrangements with the Bank of America. He said he would feel bound to pass it on to Gahrns. They did not demur. In addition, financial statements and the SEC documents had been given to Warren. Gahrns and Warren concluded, in the afternoon and evening, ORI was in serious financial trouble. Gahrns concluded he could not continue. He instructed Warren to take his resignation to Robin on Thursday, September 19. A letter of resignation was prepared by Gahrns (ex 14):

Gentlemen:

I regret that circumstances require that I resign as Director and President of International Recreation Corporation, and from all other directorships and offices of all affiliated subsidiaries of International Recreation Corporation effective immediately.

The policies recently adopted by the Board and the Senior Management of Open Road Industries, Inc, are not compatible with my personal and my corporate objectives for IRC and Vanguard Trailers, Ltd in too many of their aspects.

I will, of course, be available to assist my replacement and it is my hope the Company will continue on and the difficulties that are presently facing both the Company and its Parent Company will be resolved to everyone’s satisfaction.

Warren tried to persuade Gahrns to tone down the second paragraph. Gahrns was adamant.

On the morning of September 19, Warren took the resignation to ORI. He gave it to Robin. Robin appeared to be shaken. He asked Warren if “Gunter” was going to sue the company. Warren replied affirmatively. Robin inquired as to the grounds. Warren replied that he had information suggesting there was misrepresentation by ORI in respect of its original purchase of IRC shares; Warren and Gahrns were going to request the SEC to investigate the matter. He said Gahrns was going to claim damages for misrepresentation in respect of his employment contract, his sale of IRC shares and his purchase of ORI shares. Robin appeared disturbed and angry. He asked Warren if he would meet with the attorneys for the company. Warren agreed.

Shortly after noon, Robin came to the hotel at which Gahrns and Warren were staying. Robin attempted to persuade Gahrns to reconsider. Gahrns refused.

In the middle of the same afternoon Warren went to the offices of the ORI attorneys. He had understood he was going to meet Weinberg and two others (Zisler and Sterling). When he arrived at the offices he was asked if he would meet with Gordon. He agreed.

I turn now to the testimony of Gordon.

He said his partner Weinberg had told him of difficulty between Robin and Gahrns: there was a personality conflict and a dispute over money. Weinberg asked him to try and resolve the problem. This was probably on September 19. Prior to seeing Warren, he had not had any discussion at all with Robin. Gordon’s task was to try and persuade Gahrns to remain with the company; otherwise to negotiate a monetary settlement. Gordon had, however, not made any real inquiry into the nature of the dispute between Gahrns and ORI. He was not sure whether he first spoke with Warren by telephone, or at the Gordon office.

I return to Warren’s testimony.

Warren said some social amenities were exchanged with Gordon. Then he and Gordon had an extensive discussion. Gordon said his purpose was to try and persuade Gahrns to remain. Warren told him Gahrns had already resigned. Gordon had not been aware of that. Warren then set out the history of Vanguard and the relationship of Gahrns to it and IRC and ORI. He went into detail about the request for transfer of the $1,000,000, and the financial condition of ORI. He said he outlined the steps he proposed to take on behalf of Gahrns. He was going to commence suit. He was going to ask the SEC to investigate the transactions between IRC and ORI. According to Warren, Gordon asked what damages Warren was talking about. Warren replied, using the term “heads of damage”. He listed four. He said he felt Gahrns was entitled to damages in respect of his employment contract, in respect of the sale of his IRC shares to ORI, in respect of his own investment to ORI shares, and in respect of punitive damages for fraud. Warren told Gordon he had retained, in respect of the threatened suit, a Los Angeles firm of attorneys. Gordon indicated he would attempt to get instructions as to a possible settlement. Gordon expressed the view, that while he felt there was no liability, the only possible basis for settlement might be in respect of Gahrns’ purchase of ORI shares.

Gordon, on the other hand, denied, in his testimony, there was any discussion of “heads of damage”. He also denied there was any threat by Warren of a lawsuit. He agreed there was some mention of seeking the intervention of the SEC. He interpreted that as an “oblique reference” to a lawsuit. He said he told Warren the SEC threat did not bother him; any settlement could not prevent a possible investigation.

As I have earlier said, I accept Warren’s evidence as to what transpired at this meeting.

After leaving the Gordon office, Warren reported to Gahrns. Later they met Robin and Sharp. Robin and Warren discussed matters separately from the other two. Warren was reluctant, in view of his still current dealings with Gordon, to have any discussion at all with Robin. Robin was anxious to know how much Gahrns wanted. Warren gave a figure of $500,000. Robin was angry and upset. Warren, because of the ethical position, felt there should be no further discussion.

On the following day, September 20, Warren and Gahrns discussed the matter. They both agreed they should try and arrive at a possible settlement before the weekend. Otherwise, the initiative, which Warren felt they had, would be lost. Warren telephoned Gordon to tell him he had met Robin the previous evening, and of what had gone on between them. Gordon agreed that, at some stage, Warren told him of the $500,000 figure given to Robin.

Gordon and Warren both concurred on this. There were a number of phone calls between them, endeavouring to arrive at an agreement, during Friday. Monetary figures were exchanged; the usual bartering and manoeuvering, particularly as to amount, went on. I need not recount those details.

At some stage Gordon asked, that as part of any settlement, Gahrns should give a covenant not to compete for one year. That was discussed between Warren and Gahrns. The existing agreement had nineteen months to run. Warren, correctly or incorrectly, felt that agreement, regardless of the position he had taken with Robin and Gordon, might be binding. He advised Gahrns to agree to the proposal on the basis non-competition for one year was less than that which presently existed. Gahrns had pretty well decided he did not intend to go back into the recreational vehicle business. He agreed to Warren’s recommendation.

Finally, around 4.15 pm, after having obtained Gahrns’ authorization, Warren made a final offer to Gordon. The terms were a cash payment of $250,000, a mutual release, a covenant not to compete and the turn-over of Gahrns’ ORI shares. Payment was to be by way of a certified cheque from Vanguard. It was also understood Warren would re-draft Gahrns’ letter of resignation; it would be worded on much more friendly terms. Warren agreed to draft the document in respect of shares. Warren said there was no discussion between him and Gordon as to any break-down or allocation of the sum of $250,000.

Gordon, in his testimony, agreed, speaking generally, with the essence of the telephone conversation between Warren and himself; the final figure of $250,000 was reached without any discussion as to a break-down. He could not really remember discussing a turn-back of the shares held by Gahrns in ORI. But he agreed it might well have been canvassed.

The documents, other than those to be drawn by Warren, were to be prepared in Gordon’s office. It was hoped they could be executed around 6 pm. Warren went to the Gordon office between 5.30 and 6. He brought with him the “flowery” letter of resignation, and the draft documents regarding Gahrns’ shares. According to Warren’s recollection, Weinberg, in return, gave him the other documents to be executed, either as a group, or as they were typed.

Warren looked at the receipt (ex 7) which allocated the sum of $250,000. Warren was surprised. He said to Gordon “This was not our deal”. The mention of consulting services had, among other things, caught his eye. He pointed out there had never been any arrangement about consulting ser- vices; that in fact he had made it clear to Gordon and ORI that Gahrns would not have any part of such an arrangement. He pointed out there had never been any discussion as to a bonus for past services or any discussion as to an amount, if anything, to be assigned to the covenant not to compete. He said Gordon agreed it was true; they had not discussed all this; it had not been part of the agreement reached.

Warren asked the reason for this break-down. Weinberg said it was for internal accounting purposes of the company. Warren asked Gordon for assurance the documents did not represent the agreement he and Gordon had reached. Gordon agreed that was so. Warren then telephoned Gahrns. He asked him to come to the Gordon premises. He met him, by arrangement, outside the building. He told him the documents presented did not represent the agreement reached. He then took him upstairs to a separate office to let him read them. Gahrns testified he was upset and disturbed at the documents; they did not reflect the agreement he had authorized; they set out matters that were neither discussed nor agreed to. Warren told Gahrns the documents were a sham in that they did not reflect the actual agreement; he told him Gordon had agreed this was, in effect, the case. Gahrns was reluctant to sigh. But he did so on Warren’s advice: the documents were a sham; if he did not sign, the settlement would probably collapse; the best thing to do was “take his money and run’’.

Warren said the documents were then signed, in his presence only, by Gahrns. The arrangements for the turning over of a certified cheque in Kelowna were put in motion.

I go to the evidence of Gordon as to what transpired on Friday evening.

He said after he and Warren had reached, on the telephone, the figure of $250,000, he discussed the matter with Weinberg. Weinberg came up with the allocation. Weinberg either prepared, or was responsible for, the preparation of the documents. Gordon said that when Warren and Gahrns came to his offices, the documents were, without any question, complaint or comment by either of them, signed. Gordon emphatically denied there was any discussion between Warren and him as to the allocation, or anything said by Warren that the documents did not represent the true agreement between the parties.

I do not, for the reasons earlier given, accept Gordon’s evidence on that aspect of the matter.

Warren and Gahrns agreed, before me, the mutual release, the letters regarding delivery of Gahrns’ ORI shares and the covenant not to compete (other than the $100,000 allocated to it), were real documents. They said, and I agree, the true bargain behind those three documents was the agreement not to pursue a threatened lawsuit for damages in respect of Gahrns’ sale of IRC shares and purchase of ORI shares.

Tax implications did not, at any time in Los Angeles, cross the minds of either Gahrns or Warren.

I am satisfied the documents signed, other than the mutual release and the letters regarding Gahrns’ shares, do not reflect the real agreement between the parties. The allocation of $125,000 for past services cannot be supported. There was never any claim by Gahrns or Warren in respect of past services. Gordon did not give any evidence to suggest there was. He Said an amount was allocated to that category, on behalf of ORI, in case there could be at some time in the future a claim for bonuses or other matters. I do not accept that suggestion or argument.

In respect of the allocation of $25,000 for consulting services, I am satisfied Gahrns, in fact, never agreed to provide such services. I am further satisfied, on the evidence, that ORI never demanded nor expected to receive any consulting services. Gordon gave no testimony that he had stipulated for, as part of the settlement arrangement, consulting services.

The object of Gordon and ORI, as I see it, was to settle and head off a potential lawsuit, and to acquire as well, all of Gahrns’ shares, so he could not launch a minority shareholder’s action. Gahrns’ object was to recover his investment and something for damages.

There remains the covenant not to compete for one year, and the allocation of $100,000 to that aspect. There is no doubt Gordon stipulated for, and Gahrns and Warren agreed to, a covenant of that nature. But on the facts which I have outlined and accept, there was never any agreement to allocate any amount of money for that agreement. Gahrns and his legal adviser felt there would be, in view of the pre-existing agreement, no harm or prejudice in giving such an undertaking.

Counsel for Vanguard argued that I should permit the plaintiff to deduct the sum of $100,000, or a lesser sum, as a business expense. It was said the covenant was admittedly given; it obviously had some monetary value to the parties to the contract. But on the facts I have found there was never any monetary value assigned to that particular covenant. It was part and parcel of an over-all settlement figure reached. It cannot be fragmented out, either at $100,000 or some lesser sum.

In the result, I have come to exactly the same conclusion in respect of this $250,000 sum, as I did in the Gahrns case.

The plaintiff’s appeal (action) is dismissed.

The defendant is entitled to costs.