Citation: 2008TCC299
Date: 20080522
Docket: 2007-3680(IT)I
BETWEEN:
TOM HOCHHAUSEN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
(Delivered orally from the Bench on March 19, 2008, in Edmonton, Alberta.)
Boyle, J.
[1] Spacial Management Systems Ltd. failed to
make its required employee withholding remittances in 2004. For part of 2004,
Mr. Hochhausen was a director of SMS. The only issue to be determined in
this case is whether Mr. Hochhausen exercised the degree of care, diligence,
and skill to prevent that failure that a reasonably prudent person would have
exercised in comparable circumstances.
I. Facts
[2] The facts are not
really in dispute. The Crown did not cross-examine Mr. Hochhausen much on
the facts he testified to in chief, although the cross‑examination
thoroughly brought out a fuller story. The facts as found by me are easily set
out below.
[3] Mr. Hochhausen
is a very experienced chartered accountant. The controlling shareholder of SMS,
Mr. Sutherland, was a friend of Mr. Hochhausen’s. While their
friendship had developed from their professional working relationship, in the
first part of 2004 Mr. Hochhausen was living in Mr. Sutherland’s home
while separated from his spouse.
[4] SMS began
operations in 2004 in the land survey business. Mr. Sutherland was a land
surveyor and had owned other land survey companies. Mr. Sutherland also
had other companies in his group of companies that were involved in other
pursuits.
[5] SMS had as many as
15 employees including a staff accountant. Mr. Hochhausen was asked
by Mr. Sutherland if he would become a director of SMS, and he did so in
February of 2004.
[6] At that time Mr. Hochhausen
was aware that Mr. Sutherland and some of his companies had a history of
financial difficulties, could be aggressive taxpayers, and had had tax disputes
with Canada Revenue Agency. Somewhat contrary to his evidence-in-chief, Mr. Hochhausen
did acknowledge in cross‑examination that he was aware that one of the
companies in the group had previously been in arrears in its withholding tax
remittances and that CRA had taken collection proceedings against that company.
While he was not employed by that company nor retained by it or Mr. Sutherland,
he understood the problem had been one of cash flow and that the company
involved had sufficient accounts receivable to pay off the arrears.
[7] Mr. Hochhausen
was never employed by any of Mr. Sutherland’s companies. Before 2001 he
had been retained to put together financial statements for a loan, to clean up
some financial statements, and to successfully resolve a CRA tax dispute over
one company's research and development tax credits.
[8] Mr. Hochhausen
was not paid as a director of SMS, and he was not otherwise an SMS employee or
consultant. He was not involved in its day-to-day management. In part that
would have been unnecessary since SMS had an accountant on staff. The staff
accountant had worked for Mr. Sutherland's group of companies for 15 years,
and Mr. Hochhausen knew the staff accountant and had worked with him in
that capacity over the years.
[9] Upon becoming
director it was arranged that Mr. Hochhausen, together with the staff
accountant, would have sole signing authority for banking as well as financial
commitments such as equipment leasing and would oversee and control the bank
account. Mr. Hochhausen was given electronic access to the financial
records of SMS.
[10] Mr. Hochhausen
virtually never signed any cheques for SMS. This was left to the staff
accountant since he was on site. Mr. Hochhausen signed two cheques
when the staff accountant was away and he was available. Mr. Hochhausen
had discussions with the staff accountant about the need for tax remittances
and had specifically instructed the staff accountant upon becoming director not
to make any money available from SMS to Mr. Sutherland unless tax
withholdings had been remitted.
[11] Throughout the
months he was a director of SMS, Mr. Hochhausen had monthly or twice
monthly meetings with Mr. Sutherland and the staff accountant. It is not
clear if other SMS management attended. In addition there were telephone
meetings. The meetings were held when Mr. Hochhausen was in town since he
travelled for business. He was provided an information package for each meeting
which included SMS’s profit and loss statement, accounts payable, and accounts
receivable statements. From February until September, Mr. Hochhausen
received assurances at each meeting that employee withholding remittances were
made. He would expressly ask and was told by Mr. Sutherland that CRA’s
cheque had been cut. The financial records provided, as well as those he had
access to and consulted, confirmed to Mr. Hochhausen that the CRA cheques
were recorded as payments of expenses.
[12] Sometime in
September 2004, Mr. Hochhausen was advised in a telephone call that SMS
was having financial problems. Mr. Hochhausen was out of town at the time
and arranged to meet with management upon his return in October. At that time
Mr. Hochhausen became aware that the withholding tax remittances were, in
fact, in arrears. It turns out that Mr. Hochhausen had not been told the
truth since the remittance cheques, once written to the government and recorded
as expenses paid, were never sent to the government. He also found out that the
staff accountant no longer worked for the company.
[13] Mr. Hochhausen
resigned as a director in October promptly after finding these things out.
[14] Early the following
year it was determined that the listings of SMS’s accounts receivable had been
significantly overstated. The staff accountant had not properly recorded
receipts. Mr. Hochhausen said he was floored to find out the information
provided was erroneous since he had had no reason to doubt the confidence or
honesty of the staff accountant.
[15] After ceasing to be
a director, Mr. Hochhausen worked with CRA to assist it with the tax
arrears of SMS. This included Mr. Hochhausen paying the former staff
accountant to help.
II. Analysis
[16] The test to be
applied for Mr. Hochhausen to be exculpated under subsection 227.1(3)
is the objective test of a reasonably prudent person. Mr. Hochhausen’s
particular knowledge and experience in accounting and business, his knowledge
of Mr. Sutherland’s group of companies, and his knowledge of past tax problems
make up part of the comparable circumstances to be considered. In order to
succeed in his defence, Mr. Hochhausen must show that he exercised the
degree of care, diligence, and skill that a mythical, reasonably prudent person
would have exercised in circumstances comparable to those Mr. Hochhausen
found himself in.
[17] The director’s due
diligence case law makes some distinctions between inside directors and outside
directors. See, for example, the Federal Court of Appeal’s decision in Soper.
Mr. Hochhausen said he always considered himself an outside director. The
Crown maintains that he was an inside director. I find that Mr. Hochhausen
was clearly an outside director. Apart from his unpaid directorship of about
eight months, Mr. Hochhausen did not hold any other position with SMS and
was clearly not involved in its day-to-day management, nor was there any
evidence he had any other influence over the conduct of SMS’s business affairs.
He did not have any equity or financial interest in the company.
[18] The Crown argued
that Mr. Hochhausen was an inside director, albeit an inattentive one,
because he had the potential to be involved in day-to-day management. This was
based in part on his having access to financial records. While I am sure that
in the right case a mere director could be an inside director because he or she
de facto exercised management functions, I am not satisfied the mere
potential to be so involved can suffice. In any event, there was no evidence in
this case to support the suggested potential of Mr. Hochhausen to become
more involved had he wanted to.
[19] I am satisfied that
in the circumstances in which Mr. Hochhausen found himself in February
2004 upon becoming a director, a reasonably prudent person would take positive
steps with respect to the remittance of tax withholdings. Given Mr. Hochhausen’s
profession as a chartered accountant and his knowledge of past tax difficulties
involving Mr. Sutherland and other of Mr. Sutherland’s companies,
including a period of withholding arrears, a reasonably prudent person could
not passively rely on company management to act responsibly. There were clear
grounds for suspicion on Mr. Hochhausen’s part. It was incumbent on Mr. Hochhausen
to take positive steps that included at least making inquiries of management in
respect of employee withholding remittances and receiving satisfactory answers.
[20] The real question to
be decided is whether what Mr. Hochhausen did as director with respect to
employee withholding remittances was sufficient. The facts above set out what
Mr. Hochhausen did. The Crown’s bottom line is that he should have done
more to not allow himself to be hoodwinked by deceptive management answers. The
Crown’s suggestion is that Mr. Hochhausen should have verified management’s
answers against SMS’s bank records. In my view, in these circumstances, that
would be going too far. I would agree that, had SMS cleaned up its arrears, and
had Mr. Hochhausen stayed on as director, insisting on bank records, CRA
receipts, or other third party records would be a reasonably prudent course of
action, but those were not Mr. Hochhausen’s circumstances.
[21] In these
circumstances, I am satisfied that Mr. Hochhausen did exercise the degree
of care, skill, and diligence that a reasonably prudent person would have in
comparable circumstances, specifically:
(1) From
the outset Mr. Hochhausen as director had regular meetings with
management. These included a review of the company’s accounts receivable and
accounts payable schedules and an income statement or profit and loss
statement;
(2) He
specifically asked for and received assurances that withholding remittances
were made. The controlling shareholder and principal’s answers were
corroborated by the company’s accounting records prepared by its staff
accountant which Mr. Hochhausen was both given at the meetings and
consulted electronically;
(3) Mr. Hochhausen
had no reason to doubt the competence or integrity of the staff accountant.
There was no evidence that the staff accountant was previously suspected of
being incompetent, deceptive, or complicit with any prior tax arrears of
companies in the group;
(4) He
was told that cheques to the government were cut, and those cheques showed as
expenses paid on the financial records;
(5) Upon
finding out the company had financial difficulties in September, Mr. Hochhausen
scheduled a meeting with management and the controlling shareholder for
October; and
(6) Upon
finding out in October that he had been extremely misled and deceived about the
status of employee withholding remittances, Mr. Hochhausen promptly
resigned.
[22] For these reasons, I
am allowing Mr. Hochhausen’s appeal with costs, which shall include
reasonable compensation to Mr. Hochhausen for his lost professional time
and opportunity to present his own case.
Signed at Ottawa, Canada, this 22nd
day of May 2008.
"Patrick Boyle"
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