Blanchard v. The Queen, docket 98-402-IT-G

Date: 20000605

Dockets: 98-402-IT-G; 98-629-IT-G

BETWEEN:

PATRICIA BLANCHARD, PETER FRANCIS,

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Margeson, J.T.C.C.

[1] It was agreed at the outset that these matters would be heard on common evidence.

[2] The Minister assessed the Appellants as directors of Chateau Conservatories Ltd. (the “company”) for the failure of the company to remit to the Receiver General of Canada federal income tax withheld from the wages paid to its employees during the 1994 and 1995 taxation years. The Minister also assessed penalties and interest against the Appellants.

[3] The Minister took the position that the Appellants were properly assessed pursuant to sections 227 and 227.1 of the Income Tax Act, (the “Act”), as the Appellants, as directors, did not exercise the degree of care, diligence and skill to prevent the failure to remit the amount, by the corporation, that a reasonably prudent person would have exercised in comparable circumstances.

[4] From this assessment the Appellants appealed arguing that they had exercised the requisite degree of care, diligence and skill under the circumstances.

Evidence

[5] Peter Francis was a businessman who said that the company was viable and that his plan was to develop products and to grow even though it was “bootstrapped”. In 1990 he returned from Australia and started working with the company. At that time his brother had control of it. The Appellant worked there and as a result of financial success on the first job he was able to make a profit of $30,000 which he used to buy control of the company. The company was unable to obtain bank financing and consequently it was forced to use its cash flow to finance its operations. It set up manufacturing with another of its companies, expanded the space and went to Burnaby where it occupied 5000 sq. ft. of space. One by the name of Gerry Burgess came in as a working partner in the 1990s.

[6] The company did custom projects for local industry. It determined that it needed to mass produce products and sell them. In that regard they developed the “Wondergarden” Cold Frame. They sold 200 units at their first show. They also developed a product known as the “Garden Window” and they incorporated business procedures according to this witness.

[7] They were invited to take part in trade shows in British Columbia, decided to export to Japan and the company started to market there. In the fall of 1992 it developed another product which enabled them to laminate glass and to glaze windows.

[8] In September of 1992 they met a businessman by the name of Mohammad Rana who was an immigrant investor. He became a partner in the company. The company received $100,000 to $125,000 investment from Mr. Rana and he became a working partner.

[9] Around December the Appellant, Peter Francis and Mr. Rana had a falling out and they were unable to work together. Earlier they had bought a new property and were trying to decrease the cost of rent. The company gave a deposit to a realtor. There was a worsening of relations with Mr. Rana, who wanted his money back, but the company was unable to return his money at that time. The purchase was completed and the company moved into the premises in the spring of 1993. Then Mr. Rana commenced legal action against the company. Two more legal actions followed. One was a suit for wrongful dismissal and the other was a suit regarding the rights of a minority shareholder and an action for recovery of the $20,000 given by Mr. Rana to help purchase the building. The company could not hire a litigation lawyer so they used their own company lawyer. It was able to obtain some funding from the National Research Council for the “Wondergarden” and the company obtained good reviews for this product.

[10] The Appellant, Peter Francis made his first trip to Japan on behalf of the company to investigate possibilities in the construction market there. The company did not want to “have all of its eggs in one basket”.

[11] The company produced Elizabethean and Edwardian structures. It did some local work and some work in the United States. One half of the work was commercial and the remainder was residential. The company continued to send representatives to trade shows. The “Wondergarden” needed substantial investment to enable it to be mass produced and to be marketed. It received some investment over the next two years but could not come to terms with Mr. Rana. As this witness put it, “he poisoned the deals”.

[12] Between 1993 and 1995 the company was litigating. This took company resources. There was some success in Japan but the Appellant was forced to juggle his time between promoting sales and looking after the litigation.

[13] The company was selected by Mitsubishi to develop a prototype for linear sunrooms. It produced some and traded drawings with Mitsubishi but could not manage the cash flows. The Appellants were using all of their personal lines of credit and their credit cards and the company was using the profits from jobs and was still conducting the litigation. The Court date was set for the minority shareholders’ case but then the litigation was cancelled. After that the company started to attract other difficulties including zoning problems, employees’ claims for overtime and actions by “labour standards” to garnishee its bank accounts. The company had difficulty in refinancing the second mortgage.

[14] Another investor by the name of Mr. Prueter became interested. Settlement was made with Mr. Rana. The company had an agreement in place with Mr. Prueter to invest in the company and there was another interested person as well who was turned away as a result of the pending deal with Mr. Prueter. Mr. Prueter wrote to Revenue Canada indicating his intentions with respect to investing in the company and on the issue of solving the company’s problems with Revenue Canada. Exhibit A-1 was admitted into evidence by consent, subject to proof of contents. This was a letter to Revenue Canada from M.G. Prueter Management Ltd. dated March 14^th 1995. However, Mr. Prueter later backed away in spite of the fact that the company had made agreements with creditors to take part payment of their outstanding accounts.

[15] When Mr. Prueter’s investment did not materialize all of these plans came to naught. Then other problems arose and everything “ground to a halt”. “Labour standards” seized equipment to answer to their debts but Revenue Canada did not act until months later when there were no more assets available. The company continued to pay employees. They never went into bankruptcy. The Appellants’ position was that if the company had been able to finish the jobs that it had on the books it could have solved all of its problems including those with Revenue Canada. The company made plans to pay Revenue Canada and all others. After the company was sold the Appellant went with another company and managed the Chateau Conservatories Ltd. division which produced wooden sunrooms.

[16] In the year 1998 the Appellants were divorced and Peter Francis’ new employer went bankrupt. The Appellant was contacted by two other manufacturers including Lyndal Cedar Homes and then he commenced Chateau Building Products with his engineering partner. This company ships products to Japan. He signed an agreement with China as well.

[17] The Appellant contended that the goals and plans of the company were viable. This is shown by the fact that he has continued with these ideas and they are now running a small successful business. They have a loan from BDC and a bank. Their ideas were viable and their product was saleable. The problem arose as a result of too many situations coming at them all at once. “They could not keep all of the balls up in the air all of the time.”

[18] This Appellant told the Court that he knew that the directors were liable for the remittances to Revenue Canada and that Revenue Canada was at the top of their list. Ms. Blanchard was in charge of the bookkeeping and was in touch with Revenue Canada. “We were not reactionary”.

[19] At this point in the proceedings the parties agreed that at all times from 1990 on, the Appellants were seeking investors for the company.

[20] The Appellant said: “When things got tight it was a question of who do we pay? We made the employees the highest priority. They were paid in order to ensure that all of the debts could be paid. If we don’t have employees we have no advances and no income to pay anyone. The officers and directors were not paid in an attempt to pay Revenue Canada. In 1993 the company had a similar situation and solved it by making the same decisions as they did in 1995. We had a reasonable belief that by doing the same thing we could achieve the same results.”

[21] The Appellants listed various things which the company decided to do in order to solve their financial problems. These included discontinued payments to officers and directors; using the personal credit of the Appellants to finance the operation of the company; increasing the mortgage on their house and selling personal assets such as vacation homes, vehicles etc. This in turn increased the level of the shareholders’ loans.

[22] In October 1994 the company was up-to-date with its remittances due to Revenue Canada. They had over a quarter of a million dollars worth of work in the books and then a cash flow problem arose in the months of October and November. They laid off some of the employees to reduce the expenses and by December they were left with three employees. Also, in November of 1994 they stopped making rental payments in order to enable them to pay Revenue Canada. They also stopped paying suppliers except for those materials which were needed to finish work for which they would in turn be paid and in turn would have money available to pay Revenue Canada.

[23] They listed their own home for sale in August of 1993. In February of 1994 it sold. Some of the funds went to pay Revenue Canada although the Appellants lost control of the funds because of a judgment against them. By February of 1995 an agreement was made with Revenue Canada to make payments to them and they were made. The Appellant said that in 1994 he paid $10,000 to Revenue Canada personally which he borrowed.

[24] In 1994 the company attempted to open up a trust account at the Bank of British Columbia which it intended to use to ensure that payments would be made to Revenue Canada but they were not allowed to open it. In the fall of 1994 they stopped making complete payroll payments in order to have money available to pay Revenue Canada. In February of 1995 Patricia Blanchard applied for a personal loan and it was declined. This loan would have been used to pay Revenue Canada. Over the period in question the shareholders’ loans increased by $85,000 for Peter Francis and by $90,000 for Patricia Blanchard.

[25] At this point in time the parties agreed that if Mr. Prueter had made the investment that he had originally intended there would have been enough money available to pay Revenue Canada.

[26] The witness said that in 1993 they had an accountant provided to them through Ernst & Young. When the year-end documents were completed the accountant made a $7,000 error indicating that the company had paid to Revenue Canada $7,000 more than it had paid. This mistake was discovered by Patricia Blanchard. The problem did not help their ongoing deteriorating situation.

[27] In 1994 several of the company’s employees had overstated their qualifications to the company and this resulted in their work being inadequate. There was customer dissatisfaction. This adversely affected their cash flow and the company did not receive the money when it expected to.

[28] Part of the problem in November and December was created by the company’s success in obtaining the work that it did. They took in new employees who made mistakes, which in turn resulted in dissatisfied customers not paying their accounts and Revenue Canada not being paid. The company stopped making mortgage payments and payments to Revenue Canada in November and December of 1994. Despite this the company was doing well in sales and the amount of work that it had on hand.

[29] At this point in time the witness addressed paragraph 3 of the Reply to Notice of Appeal and said that the company made every effort to prevent the failure by increasing the amount of work it did as soon as it could. Further, the company only released some funds to suppliers and staff that were necessary to complete the projects which in turn would enable them to obtain more money which could be used to pay Revenue Canada.

[30] The Appellant decried the fact that Revenue Canada did not move to attach the assets of the company in order to satisfy its claim. The company offered to instruct their lawyer to have funds disbursed to Revenue Canada but that did not happen. However, as soon as it became apparent that the company was in difficulty it communicated with Revenue Canada and worked together with it to make plans to retire the debt and to prevent the amount of the debt from increasing.

[31] Around the spring of 1994 the Appellants sold their house and used some of the money to clear debts and satisfy the second mortgage so that they could continue business.

[32] The legal actions by Mr. Rana were discontinued and the company was able to concentrate on business. They invested monies by increasing the shareholders’ loans from June of 1994 to May of 1995. These went up by $18,000. They applied for small business improvement loans from The Toronto-Dominion Bank, attempted to obtain separate bank accounts, focused on the business and attempted to increase sales and generate more funds. They also laid off Mr. Burgess in order to save money. After the company became very busy they ran into trouble because of the bad work of some of the employees. They laid off nine more employees by the end of 1994 and stopped making any payments to any person whose accounts were not related to finishing the work on hand. This they did in order to stay in business.

[33] By the spring of 1995 they arranged payment plans with Revenue Canada and asked it to collect funds from their customers. They stayed in touch with Revenue Canada to let them know where the money was and what they were doing in an attempt to pay them until their hydro was shut off, their telephones were disconnected and the mortgage holder sold the building. They also had difficulty with “labour standards” who stepped in and attached their assets and took control of the company away from them. It was not until 1996 that Revenue Canada notified them about the collection of the accounts in issue in this appeal.

[34] The Appellant said that the choices and actions of the directors must be measured against what other reasonable people would do in similar circumstances. They had continuous problems during this time. Their decisions were made in very volatile circumstances. Revenue Canada was foremost in their minds. Funds paid to others were to enable the company to continue to do work and collect funds for Revenue Canada and some of their funds were taken by other creditors.

[35] At the end of the day the directors had no house, no assets, the debts were increased, the credit card liabilities were increased. They did not go into bankruptcy and the Appellant Peter Francis continued to realize on the plans that he had when the company was operating. Money did not go to the directors. No one else could have done anything else other than what they did.

[36] In cross-examination the Appellant admitted that he was a director from 1990 to the end of 1995. He also took business courses through the Federal Business Development Bank. He attended a New Enterprise Forum put on by the Simon Fraser University and took honors for a presentation that he made. He also took courses through Dale Carnegie and tried to keep informed. His expertise was homebuilding, manufacturing and construction.

[37] Insofar as the company was concerned he had general control over the operations. Ms. Blanchard was the office manager and in charge of the administration. She also did some sales and some marketing. She did data entry, accounts receivable, accounts payable and remittances. She handled the books quite regularly.

[38] This Appellant admitted that the company was undercapitalized since the beginning. Cash flow problems cropped up repeatedly from time to time in spite of the fact that they took a considerable number of cash deposits as advances on the work to be done for customers. He knew what was going on in the company. He did not recall the financial problems in 1993. He did not recall if he talked to Ms. Blanchard about them but he spoke to her about them from time to time. She did not mention to him what the financial picture of the company was like. However, he admitted that they lived together and that they would talk about them. From time to time on a weekly basis he would be informed about the financial position of the company.

[39] The remittances for December 1991 and early 1992 were one of the things that Ms. Blanchard dealt with. He was aware of the fact that Ms. Blanchard dealt with these problems. In 1993 he was unaware of the current remittance problems.

[40] Exhibit R-1 was introduced into evidence and the Appellant said that he did not remember receiving this letter. It was dated February 12, 1993. He admitted that the address on that letter was his, it referred to the same issue as involved in this case. It was the same company and it was purportedly sent to him. He knew that they had responsibilities as directors to make their remittances.

[41] He was not specifically aware of the shortfalls in remittances that had taken place in early 1994. He did admit that he and Ms. Blanchard had weekly meetings about when money was coming into the company. They discussed the problems in the fall of 1994 and in the spring of 1995. He did not recall specific conversations with her about this problem before 1994. He had no recollection of monies owing to Revenue Canada for the period before 1994 and he did not recall giving post-dated cheques for these periods.

[42] He took the position that it was impossible for the company to conclude that quitting the business would enable it to pay Revenue Canada. The Appellants priorized payments of the company and they did not pay themselves.

[43] At this point Exhibit R-2 was admitted into evidence. It contained copies of selected bank account statements and cheques for the company. As a result of reviewing these documents the Appellant admitted that he and Ms. Blanchard did take some money out of the company. Further, he identified cheques which were issued by the company to certain suppliers. One cheque was for a pay advance to himself for 1995. Further, some of the cheques were to pay employees. He said that he did not know whether the $10,000 loan from the Bank of Montreal was obtained at a time when the company was in arrears to Revenue Canada.

[44] He was referred to paragraph 10 of the Reply to Notice of Appeal and he said that a requirement to pay did go to his lawyer. He was aware that Ms. Blanchard and Revenue Canada had made agreements to pay the arrears.

[45] At different times the company arranged with customers to make payments directly to the labour standards and they offered the same deal to Revenue Canada. That was in 1995. He agreed that in the letter of March 16, 1995 from Ms. Blanchard to Mrs. Ducklow of Revenue Canada, which was admitted as Exhibit R-3, the issue of arrears was raised. However, he said that “labour standards” was more aggressive than Revenue Canada. They had a couple of garnishees against their bank accounts and there was less and less money to go around.

[46] In re-direct the Appellant said that he and his wife did take money to live on and that the payment of $10,000 was for a large project and he did obtain funds to pay several people.

[47] Patricia Blanchard was a fitness teacher and in May 1992 she joined the company and stayed there for three years. She had loaned the company $30,000 and could not get it back so she did the accounting for the company. She became a director because she had money in the company. She did data entry and accounting except for part of the year 1993.

[48] The company believed that one way of solving its problem was to switch accountants, so another accountant was hired to take her place. Then he left due to non-payment of his salary and she went back to work for the company. She understood the requirement to pay Revenue Canada. When the company could not pay from cash flow she borrowed money to pay into the company. One expected that investors would come into the company. By the end of 1992 Mr. Rana put money into the company. Then he tried to do a hostile takeover and tried to put his daughter into the position held by the Appellant. He was fired and after that he blocked financing for the company. He knew that other investors would come in after him and that they were needed by the company but he tried to get even and blocked other investors from coming into the company.

[49] The company went to Ernst & Young and tried to get a bank account set up for the purposes of paying the Revenue Canada account. They were turned down. She said that she received $16,000 in wages in 1992, $14,000 in 1993 and no wages in 1994 and 1995.

[50] She referred to the cheques contained in Exhibit R-2 and said that the cashed cheques were to enable suppliers to be paid because the creditors had attached their bank accounts. Peter Francis was paid $2,000 in wages. The cheques made out to her were to pay her back for loans that she made to the company but that represented only a portion of the money she loaned to the company and indeed it was never paid back in full and the amount that she was owed increased rather than decreased.

[51] Her job was to speak to all suppliers, attempt to stop a receivership and to keep the company going. She knew that she had to pay Revenue Canada and when the company had no money she became more deeply involved. Peter Francis would not close the company down. Generally there was always an investor who was interested in the company.

[52] The car loan which came from the Bank of Montreal in the amount of $10,000 all went to Revenue Canada. She was always pro-active about the Revenue Canada account. She believed that she communicated all cash flow problems to Peter Francis but he may not have grasped everything that she told him. They worked 12 hours a day, seven days a week to help the company succeed and to pay the company’s debts. They had weekly meetings about cash flow, money coming in and accounts payable. The only accounts that were paid were those which were absolutely necessary. Old suppliers had to wait for their money.

[53] The bank accounts were seized on behalf of “labour standards”. After that she was required to obtain certified cheques or cash to pay suppliers. Some of the cash that she took from the company was to pay employees instead of obtaining a certified cheque which would cost them more money.

[54] As 1995 approached cheques would go directly to suppliers instead of going into their bank accounts. They tried to do the same thing for Revenue Canada. This could be seen from Exhibit R-3 as far as she was concerned. It became more difficult to get money to Revenue Canada. She sold everything she had to pay the bills of the company and ran up tens of thousands of dollars on her credit cards. She believed that the ideas of the company were good. She wished that Revenue Canada had taken money when others had. She thought that they went beyond the call of duty to satisfy their debt to Revenue Canada.

[55] In cross-examination she said that when she put the $30,000 into the company the accountant knew that she would not be paid back and her husband knew that as well but her husband may not have been aware of the finances as was the accountant. She was asked by her husband to put the $30,000 into the company. She was appointed a director in 1992 and remained a director until the company closed.

[56] Peter Francis’ duty was to oversee the work of the company. He wanted to make it a successful company. She did the accounting and administrative work. She did accounts payable, accounts receivable, remittances to Revenue Canada, payroll, data entry, she completed cheques, she even matched invoices and cheques, she monitored money in and money out, discussed what accounts were to be paid and went to weekly meetings about the work in progress.

[57] She was in contact with Revenue Canada over the years about the payments and wrote cheques for remittances. If she did not obtain money from the company she obtained it personally in order to settle the arrears. There were problems when she joined and Mr. Rana blocked investors who would have come in. If it were not for these actions the company would have met its objectives.

[58] There was a plan in place to solve the problems but it was blocked by Mr. Rana and the cash flow problems came back. There was something planned for early 1993 but Mr. Rana blocked this new lead on investors. When Mr. Prueter came on the scene Mr. Rana agreed that he come in as an investor.

[59] The Appellant was aware of the financial problems of the company and talked to Peter Francis about them. She was aware of the history of non-remittance problems. This problem existed due to the fact that the company was using the money to pay suppliers and others which, in turn, would enable the work to continue and at the end of the day they expected to obtain money from work done in order to pay Revenue Canada.

[60] When she started working with the company there were remittance arrears and she gave post-dated cheques to pay them. The bank reconciliations had not been done for some time when she arrived and the books were in bad shape. She did not remember discussing the non-remittance problems of 1992 with Peter Francis, but “absolutely I would have discussed these problems with him and the non-remittances to Revenue Canada.”

[61] She identified the letter that she wrote to Revenue Canada on February 19, 1994 and this was admitted as Exhibit R-5. This letter discussed the remittance problems with Revenue Canada. There was a shortfall of $5,387 due to Mr. Sato’s work. She recognized Exhibit R-6, admitted by consent which was an Auditor’s Statement of Account from Revenue Canada covering the period up to April 30, 1994. This statement showed payments by way of post-dated cheques remitted to Revenue Canada. She was in touch with Revenue Canada in December of 1994 again. She also identified Exhibit R-7 which was sent to Revenue Canada by her and dated December 16, 1994. The agreement was to keep current and to pay the arrears by post-dated cheques.

[62] Exhibit R-8 was an Auditor’s Statement of Account dated March 17, 1995 for the company and this showed that some $8,000 had been paid between the dates of Exhibit R-7 and Exhibit R-8. She also identified Exhibit R-9 which was a letter from Revenue Canada to herself dated February 12, 1993 with respect to directors’ liability for non-remittances or source deductions by the company. Exhibit R-2 contained cheques that she had signed.

Argument on behalf of the Respondent

[63] Counsel for the Respondent submitted written argument as follows:

Argument

Under subsection 227.1(3) of the Act, a director can escape liability under subsection 227.1(1) where the director “exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.”

It is important to note that reasonable steps must be taken to prevent the failure to remit. In other words, the steps must be taken before the failure has occurred, and not to cure defaults after the fact.

The test to be applied in determining whether a director has met the standard of care provided for in subsection 227.1(3) of the Act is an “objective – subjective” one. The standard of care is partly objective, in that subsection 227.1(3) talks of the “reasonably prudent person”, and partly subjective, in that the reasonably prudent person is judged on the basis of his or her personal knowledge and experience.

A distinction is made between a “reasonably prudent person” and a “reasonably prudent skilled person”. Therefore, if a “reasonably prudent person” is knowlegable (sic) a company’s affairs and has business experience, like Ms. Blanchard and Mr. Francis, then the Act requires that they exercise of a degree of care which is commensurate with that knowledge and experience. It is insufficient for either of them to assert simply that they did their best.

Although the numerous reported decisions dealing with subsection 227.1(3) of the Act are inevitably fact-driven and of little precedential value, some, like the Federal Court – Trial Division decision in Short v. The Queen, involve similar circumstances and are helpful in highlighting those facts to which particular attention should be paid when applying the test and determining whether a due diligence defence has been established.

Applying the test to the facts in this case, Ms. Blanchard and Mr. Francis have a high hurdle to overcome in establishing that they acted with due diligence. The Respondent submits that they did not act reasonably according to the knowledge and experience that they actually possessed and in the circumstances in which they found themselves.

Ms. Blanchard and Mr. Francis have made every effort to demonstrate their plight, and the rational for the non-remittances. However, both were familiar with the Company’s business and were active in its affairs. Each had knowledge of the payroll payment procedures, including their obligations, as directors, to Revenue Canada. They knew that these obligations were repeatedly being left unattended.

Ms. Blanchard and Mr. Francis continuously experienced substantial financial strain in keeping the Company operating. However, as informed and active directors, they were capable of taking, and were required to take, positive steps to prevent the remittance problems.

Instead, they decided to keep the Company operating, no matter what it took. To this end they deliberately chose that the Company would not remit and would continue to use unauthorized credit from the Crown to finance its operations. By doing so, they accepted the risk of becoming personally liable for these funds.

At a minimum, a prudent person, being fully aware of the Company’s previous bad experiences with payroll deductions, and its serious and ongoing financial difficulties, would have made payroll deduction remittances a first priority and instituted some sort of a system to deal with them. Ms. Blanchard and Mr. Francis did not do this.

The Respondent also submits that in extreme cases such as this, part of director’s care, diligence and skill is the prudence of knowing when to close down a business rather than prolong the agony by unlawfully using payroll deductions. This is something that Ms. Blanchard and Mr. Francis refused to contemplate.

Ms. Blanchard and Mr. Francis said that they did everything they could to get the Company out of its bad financial situation and that, at the time, they were making every effort to reduce its payroll deduction arrears. Unfortunately, and as mentioned above, it is not enough to hold out hope that failure to remit will be rectified sometime in the future.

In summary, Ms. Blanchard’s and Mr. Francis’s assertions that the Company cooperated with Revenue Canada, that they endeavoured to do their best to pay the arrears, and that they exercised due diligence to the best of their abilities, are not sufficient, in the circumstances, to allow them to escape liability. Although it is unfortunate that both of them lost quite a bit of money in this venture and suffered personal hardship as a result, these factors do not in any way contribute to a due diligence defence.

[64] Counsel for the Respondent also made oral argument and reiterated that in accordance with Soper v. The Queen, 97 DTC 5407 there is a positive duty on the directors to act and counsel argued that that was a high hurdle for the Appellants in this case to meet since they were acting from the position of inside directors. Counsel also likened the facts in the present case to that of Short v. The Queen, 99 DTC 5348 at pages 5352 and 5353 where the company relied upon the receipt of monies in the following months to pay the former month’s remittances. There was inadequate capitalization in that case as well as in the case at bar. There, as here, the director was intimately familiar with the company’s actions.

[65] In the case at bar counsel asked the question, “what did they have to do and what were they capable of doing?” As in Soper, supra, at page 5418, even an outside director has a positive duty to act when he becomes aware of the existing problems. In the case at bar the Appellants were inside directors and had a positive duty to act at all times. Yet they did little to cure the situation. Even though they loaned money to the company they took no positive steps to prevent the non-remittance.

[66] Counsel referred to the case of The Queen v. Leung, 93 DTC 5467 and relied upon that case as authority for the proposition that the monies owing to Revenue Canada were trust funds and a serious corporate obligation was imposed upon the directors. These funds cannot be put to any other use and certainly should not have been used to ease cash flow problems.

[67] As far as the offer of the Appellants to Revenue Canada to instruct that the company’s receivables be made payable to Revenue Canada, this was late in the day and it would not have prevented the failure in any event. It was not known when, if at all, the receivables would be paid over. Except for one in 1995 no receivable was current. There was no new business in the books at that time.

[68] The arguments of the Appellants are not sufficient to escape liability in this case. Sympathy could be had for the Appellants but that does not give them any relief.

[69] These appeals should be dismissed with costs.

Argument on behalf of the Appellants submitted by Peter Francis

[70] Peter Francis submitted an outline or summary of written arguments as follows:

ARGUMENTS.

Section 227 of the Act was brought in to prevent directors from acting to prevent making payments to the Crown.

Act does not call for perfection or impose absolute liability.

At no time did we try to insulate ourselves from our obligations or try to avoid meeting our responsibilities. Just the opposite we went to extraordinary lengths to resolve the difficulties that we faced and to meet our obligations.

I hope that the law has a similar test as section 227 in that we can only be expected to act with the degree of skill and experiece that a person with similar knowledge and experience.

Explain schooling and background

A director has many duties in addition to meeting the payments due to the crown. we must act honesty and in the best interests of the company.

a director can not be held liable for errors in judgement.

directors are not expected to be trustees, their duties can be more varied and complex. at times directors are required to exercise business judgement and to take business risks that can range from conservatism to outright speculation. we did not go so far as outright speculation, we took calculated risks based on sound knowledge and the expectation that other people would act rationaly, who would expect that an investor who wants to regain his funds would block any action that would allow him to achieve that end. in the end our position was correct and rana did come to the table, however it was too late.

as i do not have extensive schooling, no degrees but have relied on some night school to improve my business knowledge i should be expected to show a lower level of experience than an mba or fully trained manager, in that case we should rely on the skill of a professional and that we did. at all times we had consultants and mentors with years of professional experience to assist us.

bill humphries head of small business division of earnst and young

art brueton, ex manager for ibm, instrucor at ubc

peter mogan, lawyer

howard jones ex vp bank nova scotia

paul sabina director vantage house

section 227 should be considered in part with the canada business corporations act in that the wording is very close and it should be considered that the legislators intended the acts to work in concert with each other. in that event a director has other duties in addition to ensuring that the crown recieves there funds. a director must act honestly and in the best interests of the company. this means that we can not take deposits received from clients as these funds are taken so as to provide materials and labor to fulfill our contractual obligations. we must rely on profits to satisfy our debts.

the standard of care is inherantly flexable, it must mirror the situation and circumstances at the time and take into account the experience and knowledge of the directors.

the act requires directors to act proactively to prevent lapses and to remedy them if the occur. we did both to the extent of our resources and abilities.

at all times we had a reasonable expectation that the company could be saved and that rc and our creditors would be satisfied, this is in keeping with more of the requirments placed on a director than just section 227. we were not, in our opinion at the time, wasting our efforts and we were at no time planing or acting to avoid, hide or prevent payments being made to rc. just the opposite. when we realized that we would not be able to remedy the situation through our work and that we would have to rely on preuter as a white night we offered our ecievable to rc, names and amounts so that they could be collected by rc.

we met standard of care required. case should be dismissed. if not we should expect respite from interest.

(Typographical errors were not corrected)

[71] Mr. Francis also submitted in oral argument that section 227 of the Act was added to close loopholes where directors were avoiding liability for paying to Revenue Canada deductions made on behalf of the company. It was too harsh the way it was and so the due diligence test was brought in to make it more humane.

[72] The law as it stands does not call for perfection and does not impose absolute liability.

[73] There was no deliberate attempt by the Appellants to avoid paying Revenue Canada. They knew their duties and tried to fulfil them to the best of their ability. They went to extraordinary lengths to comply to the extent of their skill and ability.

[74] The Appellant said that he took some courses but he did not finish high school and did not go to university. A director has many duties. He has a duty to act as an agent for the Crown but also he has a duty to the company, to the employees, to the customers and he must balance them. He admitted that they were inside directors but they still had to act in the best interest of the company. He referred to the case of Ho v. M.N.R., 91 DTC 76 in support of his proposition that the duty imposed on the directors under the Act was not absolute but it did not require perfection.

[75] He also discussed at some length the case of Soper, supra, arguing that the Appellants were not trustees, they were not liable for errors of judgment and they are not bound to give continuous attention to the affairs of the company.

[76] His position was that the Appellants charted a middle course. They were not conservative and were not absolutely speculative. They had reason to believe that their goals would come to fruition and after the company went out of business they did come to fruition. Their belief, therefore, was not merely wishful thinking. They had advisors and consultants and relied upon them to make the company successful.

[77] Again, they as directors had to balance competing interests. They had to make decisions in the short run without receiving any advice. They had to act in the best interest of their customers. They acted to increase sales. The deposits had to be used to do the customer’s work. They had trouble with some workers who caused difficulties for the company.

[78] There was not a convenient time to close the company down as suggested by counsel for the Respondent. Up to the spring of 1995 there was considerable work on hand to be done. They had reasonable expectations that they would be successful in their larger strategic plan. They talked continuously to possible investors. They had concluded the Rana litigation against the company and this gave them a little more light.

[79] In accordance with the decision in Soper, supra, the standard of care expected from the directors is flexible and takes into account all the ability of the taxpayers. These directors used what skill they had as a whole and acted in the best interest of the company.

[80] Insofar as the requirement of the directors to prevent the problem, the Appellants took the position that they had done that. The company was undercapitalized, it was started by “bootstrapping”. The Appellant said that he had entrepreneurial ability and had great persistence. However, every small company has problems, they knew that they would have a cash flow problem.

[81] The company did suffer undercapitalization at all times. However, they did attract some investors. The company did not pay all of the payroll all of the time. The problem was that there was not enough money in the pot. The directors did do something to prevent the default.

[82] Having regard to all of the circumstances the plans of the company did in most cases come to fruition. They had a plan to obtain more investment and to make the cash flow sufficient. They solved it initially by having Ms. Blanchard invest cash into the company and took advantage of her abilities as a bookkeeper. This was a step to prevent the problem from happening in the future. This was a long term project. After Ms. Blanchard came in they obtained two other investors and for a short period of time had no cash flow problems or any capital problems.

[83] Mr. Rana acted in an unexpected way. Even at that the directors tried to solve the problem by looking for another investor but Mr. Rana blocked it. He acted unreasonably.

[84] The company solved that problem as well. They were as proactive as they could be to put the company on a stable footing. The problem with Mr. Rana was settled and they went about their business and obtained a large number of sales. Then their sales caused the company further problems as a result of poor workmanship by some of their employees. The Appellants solved this by doing the job themselves. This took away from their ability to do their other jobs.

[85] By the spring of 1995 they had new problems as well as new opportunities. They offered the receivables to Revenue Canada. They had receivables that would go a long way to satisfy the claim by Revenue Canada. Revenue Canada could have attached them. They had strong reasons to believe that the company would be successful even without obtaining a “white knight”.

[86] In the end Mr. Prueter did not come through. They had no reason to believe that he would not come through. They did what they could with the revenues remaining to “make Revenue Canada whole”.

[87] Communication with Revenue Canada was ongoing until nearly the end when the telephone and power was cut off. “Labour standards” received money, why did Revenue Canada not receive money? By the time Revenue Canada acted, nothing was left.

[88] The directors did not try to avoid their responsibilities. They did more than their best. They had adhered to a system. This appeal should be allowed on the basis that the Appellants have met the due diligence test. The company contributed money to the finances of the country. The government does not wish to be punitive. The company received money from government agencies and they must have thought that the company was doing well.

[89] The appeal should be allowed.

Argument of the Appellants submitted by Patricia Blanchard

[90] Patricia Blanchard said that she joined the company involuntarily in order to guarantee the payback of her loan but when she was a director she did all that she could to keep the company going. She only took wages for one year.

[91] She was lied to by the previous accountant. It took her a year to clean up the mess that the previous bookkeeper had left. Then Ernst & Young found Mr. Sato. He did no more than the Appellant did. There was also an accountant provided by Ernst & Young but then the wages could not be paid to Mr. Sato and so the Appellant went back in as bookkeeper.

[92] If the company had been successful in obtaining a new bank account monies would not have been attached and there would have been monies for Revenue Canada. Also, if the workers had done their work there would have been money available for Revenue Canada. Mr. Rana took a very malicious stand against the company. Revenue Canada was paid up-to-date at one point.

[93] Exhibits R-3 and R-7 show that Revenue Canada was offered the receivables and it would have paid the account in full which can be seen, after the fact.

[94] The Appellant addressed the question of why the company was not closed down earlier. She said that it was because there was viable investor interest in the company. It was not just a vague hope. These appeals should be allowed and the Minister’s assessments vacated.

Analysis and Decision

[95] The facts in the case at bar make this case quite unlike the majority of cases which are heard under this section of the Act. In many cases the taxpayers take the position that they did not even know that they were directors but if they were directors they were unaware of the responsibilities that the Act places upon them in their position as directors. Further, they normally argue if they were directors they were what is commonly referred to as “outside directors”, were unaware of what was going on in the company and were prevented from taking any action to prevent the failure to remit to Revenue Canada. Ultimately they argue that even if they were inside or outside directors, they acted reasonably under all of the circumstances to prevent the failure and thus should not be held accountable for the failure of the company to remit the requisite amounts to Revenue Canada.

[96] In the case at bar, this is not the case. Both Appellants, through their own evidence, have testified that they knew that they were directors of the “company”, that they were actively involved in the daily operations of the company; that the company was undercapitalized almost from the beginning and suffered ongoing cash flow problems; that they were aware of the financial problems of the company; that the company had a history of non-remittances of payroll deductions and were aware of the fact that discussions had taken place with Revenue Canada with respect to these deductions and for a considerable period of time the remittances were in arrears.

[97] Both of the directors testified that Revenue Canada had made arrangements with the company to pay off the arrears and to keep the deductions current but this very rarely ever took place. It is only reasonable to conclude on the basis of all of the evidence that both of the directors must be classified as so-called “inside directors” as referred to in Soper, supra. That being said, both of these directors must be charged with a high standard of care when one considers the test of “reasonable care” as set out in Soper, supra and the other cases.

[98] According to the evidence of the Appellants themselves they considered their duty as directors to collect and remit the deductions to Revenue Canada as a very substantial duty and they were both aware that if the company did not make the requisite deductions and remittances that they could be held liable as directors. Thus, both directors in this case, based upon the objective-subjective test as set out in Soper, supra, had a positive duty to act when they obtained information or became aware of facts which might lead them to conclude that there was, or could reasonably be, a potential problem with remittances.

[99] Insofar as this Court is concerned it must conclude that both of the directors in this case were aware almost from the outset of their involvement with the company that potential problems existed with respect to remittances and indeed, that for most of the time the problem with the remittances was not only potential but was indeed real.

[100] As Mr. Justice Robertson said in Soper, supra, “it is indeed incumbent upon an outside director (the underlining is mine) to take positive steps if he or she knew, or ought to have known that the corporation could be experiencing a remittance problem. The typical situation in which a director is, or ought to have been, apprised of the possibility of such a problem is where the company is having financial difficulties.”

[101] A fortiori, where the taxpayers are inside directors, as they undoubtedly were in the case at bar, they would have been expected to take positive steps to prevent the non-remittance and to cure any deficit in the remittances up to that point. Given the clear duty that was upon both of the directors here to act positively to prevent the remittance problem from occurring again and to cure the remittance problem that had existed up to that date, one must ask what reasonable steps the Appellants took in order to cure both of these problems?

[102] It is clear from the evidence that the Appellants did not act in a manner which was different from the way they had acted before when the remittance problem first came to their attention. They continued to pay other suppliers, even though the evidence of the Appellants was that they paid only the suppliers which were necessary in order to finish the job which they had on hand. They continued to try and make arrangements with Revenue Canada to pay on the arrears and to keep the other remittances current although it is obvious that this was not successful and the amounts that were owing increased. They continued to pay employees, even though their evidence was that they paid only the necessary employees which would ensure that work would be continued by the company and in due course that monies would be received when those jobs were completed which in turn might be sent to Revenue Canada. This of course did not happen to any great extent.

[103] They continued to seek investors for the company in the hope that all of their financial problems would be solved. This of course did not come to fruition.

[104] They continued to take some payments out of the company to support their own living, although it is true that they did not take all that was owed to them and indeed even borrowed considerable amounts of money personally to invest into the company to assist it. However, in spite of these endeavours the problem was not solved and indeed the problem appeared to worsen.

[105] The Appellants at no time were prepared to conclude that this company was in such financial difficulties because of the cash flow problem and because of the undercapitalization problem that it could not continue to function and that the company would be unable to meet its commitments to Revenue Canada unless a suitable investor could be found. Both Appellants knew that there had been difficulty in obtaining the appropriate investor even though on several occasions they appeared to be on the brink of doing so. The end result was that the saving investment was never made and the company was unable to obtain the funds to satisfy the remittance requirements to Revenue Canada.

[106] From a business point of view it would appear that this decision was the incorrect one but even if it were not it is small consolation to the Appellants here because at the end of the day, despite the fact that they continued on in business, they were unable to make the requisite remittance payments to Revenue Canada.

[107] When Soper, supra, and other cases refer to positive steps that need to be taken by the directors, they are referring to steps which would guarantee not only that funds are available to pay the remittances to Revenue Canada, that these funds are set aside and made available for Revenue Canada but that these funds are remitted to Revenue Canada when they are supposed to be. It is not an answer to that duty for the directors to say that “we attempted to establish a separate account for these remittances” when that was not done. Even though it is not a requirement that a separate fund be established, this would clearly be one way of ensuring that monies are available to make the requisite remittances to Revenue Canada. In this case there was a suggestion that this was attempted but it did not come to fruition and there was no reasonable explanation as to why the Appellants would have been prevented from establishing this separate account.

[108] It is not an excuse for the Appellants in this case to say that they made an offer to Revenue Canada to take action similar to actions taken by provincial officials under the Labour Standards Legislation which resulted in seizing of some of the property of the company. It is no answer for the Appellants to say that these accounts were settled and if Revenue Canada had acted similarly then their accounts would have been settled.

[109] Revenue Canada was entitled to expect that the payments would be made on a regular basis to it on behalf of the company which continued to operate and, absent some bad faith on the part of the agents of Revenue Canada, in failing to attach assets of the company which would satisfy its claim, it is not of any assistance for the Appellants to say that Revenue Canada should have acted differently, more quickly and in a way similar to others to ensure that the claims were settled.

[110] The Appellants also criticised the actions of Revenue Canada in not accepting the accounts receivable of the company to satisfy the debt and possibly in not being ready to accept payments through their solicitor, even though there was insufficient evidence to satisfy the Court that either of these actions would have resulted in satisfaction of the outstanding indebtedness. It is of little consolation to the Appellants to argue that Revenue Canada did not take positive steps to collect the accounts by all means possible when indeed the duty to act positively is upon the company and both Appellants knew this from the beginning.

[111] The Appellants argued that as directors of the company they had a number of different responsibilities to creditors, to suppliers, to employees and not just to Revenue Canada. However, this hardly excuses the Appellants from fulfilling the duty that is imposed upon them under subsection 227.1(1) of the Act and nothing in the Act or in any other legislation such as The Canada Business Corporations Act would derogate from that imposed duty.

[112] It is not sufficient for the Appellants to argue that they believed that by continuing on in business as they had done before, by allowing the arrears to continue, by failing to keep the remittances current, by hoping for a new investment, by hoping to meet the requirements by using whatever cash deposits they had available and by waiting to obtain funds from customers when the work was completed, that everything would be satisfactory because, as the facts showed, these actions did not have the desired effect and at the end of the day the remittances to Revenue Canada were not made.

[113] A reasonable analysis of the law and a reasonable application of the law to the facts of this case force the Court to conclude that both taxpayers were under a positive duty to act throughout the period when the remittances were in arrears, they should have concluded that the company was in extremely serious financial difficulties, any actions that they took were not the positive steps which were referred to in Soper, supra, any actions that they took did not have the effect and could have not have had the effect of preventing the difficulties nor indeed of curing them.

[114] The Court is satisfied that the difficulties in the present case were caused by the fact that this company operated on so-called “bootstrapping”, the company was undercapitalized from the beginning, the company needed a substantial infusion of working capital in order to make it viable and no steps taken by the Appellants here were those positive steps as contemplated by Mr. Justice Robertson in Soper, supra, nor by the other cases on this issue.

[115] The Court has great sympathy for the two Appellants where, as in many cases, it is obvious that they expended considerable amounts of their own money in an attempt to keep the business afloat, even going to the extent of selling their own residence, their summer residence, extending their credit cards and using up other cash resources when none of these actions were able to produce the desired result. However, under the circumstances it is obvious to this Court that the Appellants did not act as reasonable directors would have acted and the defence of due diligence is not available to them.

[116] The appeals are dismissed with costs and the Minister’s assessments are confirmed.

Signed at Ottawa, Canada, this 5^th day of June 2000

"E.Margeson"

J.T.C.C.