Date: 19990519
Docket: T-291-91
BETWEEN:
BRONSON SHORT
Plaintiff
- and -
HER MAJESTY THE QUEEN
Defendant
REASONS FOR JUDGMENT
EVANS J.
[1] The recession that hit the construction industry in Newfoundland in the 1980s left many casualties in its wake. One of them was the B. & R. Short Construction Limited, which went out of business at the end of 1986 owing approximately $40,000.00 for source deductions from its employees" wages in that year that it had failed to remit to Revenue Canada. The deductions were for federal and provincial income tax, unemployment insurance premiums, and Canada Pension Plan contributions.
[2] Since it was clear that the debt would not be paid by the company, Revenue Canada looked for payment to Bronson Short, the president of the company and a co-director with his wife. Subsection 227.1(1) of the Income Tax Act imposes liability on the directors of a company for amounts that the company has deducted from its employees" wages but failed to remit to Revenue Canada as required by the Act .
[3] The notice of assessment issued in 1989 by Revenue Canada with respect to the tax year 1986 showed Mr. Short as owing $52, 589.49 in respect of non-remitted deductions, interest charges and late payment penalties. Mr. Short"s appeal to the Tax Court against this notice of assessment was dismissed, and he has appealed to this Court against that decision.
[4] Subsection 227.1(3) provides a due diligence defence to a director whom Revenue Canada seeks to hold liable under subsection (1). The only issue in this appeal is whether Rip T.C.J. erred when he decided that Mr. Short had not satisfied the due diligence standard when he continued to operate the company throughout 1986 when the financial position of B. & R. Short Construction Limited was deteriorating, and took no effective measures to prevent the company from incurring additional liability to Revenue Canada which it was unlikely to be able to discharge.
[5] The parties agree upon the legal principles applicable to this appeal, commenced by way of a statement of claim, and, for the most part, they agree on the primary facts. Where they disagree is on the application of the statute to those facts.
[6] I heard from two witnesses: Mr. Short, on his own behalf, and Mr. O"Brien, a collection officer with Revenue Canada in St. John"s, who was responsible for the company"s tax file from August 21 to November 21, 1986.
[7] An inordinate length of time has been allowed to elapse since Rip T.C.J. rendered his decision, late in 1990. This is attributed to several factors: sporadic settlement discussions between the parties, a decision to await the result of potentially relevant litigation, and a change of the solicitors of record representing Mr. Short.
[8] In these circumstances it is not surprising that Mr. Short"s recollection of all the details of what occurred thirteen years ago is not perfect. On some matters he admitted that he was no longer sure, and on another a letter put into evidence by the Crown proved that he had been mistaken in the evidence that he gave. Mr. O"Brien, however, had made contemporaneous notes of the conversations that he had with Mr. Short and his bank in 1986. The notes were available to him as he testified, which he did in a considered and forthright manner. Accordingly, I have preferred the evidence of Mr. O"Brien to the extent that it differs from that given by Mr. Short.
[9] Neither side called as a witness a representative of the Bank of Montreal with which Mr. Short dealt. No doubt in the thirteen years that have passed since the tax year in question several managers have come and gone and there is no one at the bank with personal knowledge of B. & R. Short Construction"s financial situation at the relevant time.
| B. The factual background |
[10] Since leaving school in 1970 on completing grade 11, Mr. Short has spent nearly all his working life in the construction business in Newfoundland. He worked first as a labourer for a contractor who also employed his father. In the late 1970s Mr. Short and his father started up their own contracting business, which they incorporated in 1980.
[11] To assist him in his new responsibilities, Mr. Short attended night classes in business accounting offered through the extension programme at Memorial University. Mr. Short and his wife did the bookkeeping for the company which at that time undertook small contracts for repairs and maintenance, and some house building. From the late 1970s to the early 1980s the company"s annual revenue grew from $40,000.00 to $150,000.00.
[12] At this latter point the senior Mr. Short decided to retire from the business: his "pay out" included the cash assets of the company. Its only other assets were a pick-up truck and a few tools. However, it had no debt and had been able to finance the start up costs at the beginning of each new construction season from the surplus left over from the previous year.
[13] It was after the departure of Mr. Short"s father that the business started to take a new direction: it sub-contracted to supply labour for larger jobs. By 1984 its annual revenue had increased to $500,000.00 as a result of obtaining a contract to supply labour to L. D. Fahey Construction Co. Ltd., the general contractor for the construction of senior citizens" homes. B. & R. Short was still operating with few assets, and with no outside sources of finance.
[14] In mid-1985 the company became a sub-contractor for Fahey for the construction of a fishermen"s service centre in Punch Bowl, Labrador, an isolated community, on a site owned by the federal Crown and being developed by the Department of Public Works.
[15] At this time the company employed around 8 employees during the construction season, which typically ran from May until December. The company was always able to meet its net payroll, but relied on progress payments on its contracts to enable it to make its remittances to Revenue Canada on the 15th of the month for the payroll deductions for the previous month. In other words, it did not transfer the amount of the deductions from its general account into a separate account, for the simple reason that it generally did not have the money available to do so.
[16] This system worked satisfactorily as long as contract payments came in when due. However, the company was late in making several of its remittance payments to Revenue Canada in 1985, although by early 1986 it had cleared off the arrears. The principal source of the problem appears to have been some missed progress payments in the latter part of 1985 by Fahey, which was getting into financial difficulties.
[17] In order to deal with B. & R. Short"s cash flow problem Mr. Short negotiated a $15,000.00 line of credit with the Bank of Montreal in 1985, which he had used up by early 1986. As a result of Fahey"s failure to make the scheduled progress payments for the work done by the company at Punch Bowl, Mr. Short attempted to place a lien on the site for $12,000.00, but was told that Crown property was exempt from liens. He testified that an official of Public Works told him at that time that he would be paid. When Mr. Short contacted Fahey"s bonding company he was advised that, if he wanted his money, he should complete the contract.
[18] On the basis of what he thought were assurances of payment from Public Works and the bonding company, Mr. Short decided to complete the contract. His belief that he would be paid, despite the financial difficulties into which Fahey also Construction had evidently fallen, also rested on the fact that Mr. Fahey owned a concrete business in St. John"s, and a stevedoring business and a hotel in Goose Bay.
[19] Accordingly, Mr. Short increased his line of credit with the bank to $30,000.00 which he used to finance the completion of the Punch Bowl contract. This involved chartering a plane and flying in employees, equipment and supplies for the three weeks or so that it took to do the work. The contract was completed by early June and, meanwhile, Mr. Short had obtained another contract on a site being developed by the provincial government.
[20] However, no payments were forthcoming for the completion of the Punch Bowl contract and Mr. Short issued a statement of claim against Fahey, which he was ultimately unable to prosecute for lack of money. Visits to Mr. Fahey produced only promises that the money would be paid. When Mr. Short approached Public Works, he was told, not surprisingly, that its liability was to Fahey, the contractor, and not to B. & R. Short, the sub-contractor. Since Public Works was apparently satisfied with the completed contract, the bonding company lost any interest in Mr. Short"s predicament.
[21] By mid-June of 1986 the financial position of Mr. Short"s company was far from rosy. It owed $34,000.00 to the Bank of Montreal on the overdraft and approximately $6,000.00 to suppliers. It had made no remittance to Revenue Canada for the deductions from the May payroll. Furthermore, as Mr. Short testified, the recession continued to make the prospects for the construction business in Newfoundland distinctly unfavourable. And the likelihood of recovering anything for Fahey was fading as the months passed.
[22] Nonetheless, he stated that he remained optimistic that the Fahey debt would be paid, and that he should just put his head down and "push ahead". In fact, B. & R. Short at this time had two contracts. However, since the provincial government, the site owner for one of the contracts, took ten weeks to make the first progress payment, this contract did little to ease Mr. Short"s immediate cash flow problem.
[23] Not surprisingly, the Bank of Montreal was less sanguine about the situation than Mr. Short professed to be, and took steps to protect itself. First, it required a list of the company"s receivables and payables, and then later in June it took over the receivables and applied them to reduce the company"s overdraft. According to Mr. Short, he was required to notify the bank weekly of any change in the company"s receivables and payables, and was permitted to write cheques only to meet the net payroll and to service the debts of the suppliers so as to ensure that the company had the equipment it needed to complete its outstanding contracts.
[24] In August the company received a progress payment of some $30,000.00 on one of the contracts, and in September it remitted more than $11,000.00 to Revenue Canada to cover the August deductions. Meanwhile, Mr. O"Brien had taken charge of the company"s file for Revenue Canada and was assured by Mr. Short at the end of August that the company would be remitting the deductions for May, June and July from money collected from the provincial government.
[25] Mr. Short testified that he had tried previously to contact Revenue Canada to discuss his arrears, but had not been able to speak to anyone who was knowledgeable about the situation because the file was constantly being shuffled from officer to officer. I think it unlikely that Mr. Short made very strenuous efforts in this regard.
[26] On September 22, 1986 Mr. O"Brien came up with a repayment package to clear off the company"s remittance arrears to date. First, he called the Bank of Montreal and was advised that no money would be forthcoming in response to the requirement to pay that Revenue Canada had issued to the bank in respect of the arrears owed by B. & R. Short. Second, he had a conversation with Mr. Short in which he proposed that the company would provide a cheque for $6,900.00 and three post-dated cheques for $8,000.00, which together would discharge his liability to Revenue Canada by the end of the year if the company also made its remittances for the deductions from the month of September onwards. Mr. Short agreed to this proposal. Third, Mr. O"Brien spoke again to the branch manager of the Bank of Montreal, who approved the agreement, and said that the bank would honour the cheques drawn in favour of Revenue Canada.
[27] I should note here that Mr. Short testified that he had not made remittances to Revenue Canada earlier because, after the bank took over the company"s receivables in late June, it only permitted cheques to be written for the company"s net payroll and to service the debts that it owed to the suppliers. However, Mr. Short did not specifically discuss with the bank the possibility of paying the arrears to Revenue Canada, and the bank"s agreement at the end of September to honour the cheques written to pay the debt to Revenue Canada suggests that it would have honoured cheques drawn in favour of Revenue Canada earlier if Mr. Short had asked it to do so. But he did not.
[28] On October 20, 1986 the company"s cheque for $6,900.00 to Revenue Canada was cleared, as was the cheque for $8,000.00 on November 20. However, despite Mr. Short"s undertaking, the company did not make remittances on the amounts due for the deductions made in September and October. As a result, Revenue Canada informed Mr. Short in a letter of December 23, 1986 that, because he had not complied with this aspect of the agreement, it was returning the other two post-dated cheques. In his testimony, Mr. Short had said that the cheques were returned by Revenue Canada because the Bank had not honoured them. However, the letter clearly demonstrated that he was mistaken about this.
[29] In any event, when Fahey Construction went into receivership in December, thus extinguishing whatever faint glimmer of hope there had been that the company would be paid what Mr. Short said was owing to it, the bank "closed down" B. & R. Short Construction by revoking its line of credit. Nonetheless, Mr. Short managed to pay off the money owing to the suppliers, and to the bank.
[30] I should also add that Mr. Short testified that he and his wife had often not drawn their salaries during the months when the cash flow was particularly acute, even though the company"s books showed the salaries as payables. The bank had exercised its rights under the personal guarantee of the company"s overdraft that Mr. Short had been required to give and debited his personal account for $10,000.00, which it credited against the overdraft liability. Furthermore, Mr. Short had been forced to mortgage property that he owned in order to deal with his debts, and to support his family.
[31] Except for the payments that I have already mentioned, Mr. Short made no other remittances to Revenue Canada with respect to the tax year 1986 because, as he put it in his evidence, he did not feel personally responsible for the debt. He seems to have regarded the money claimed by Revenue Canada as, in some sense, offset by the amount that he believed that he should have received on completion of the Punch Bowl project from another branch of the federal government, the Department of Public Works.
[32] Finally, I should note that the $52,589.42 for which Mr. Short was assessed in 1989 for the tax year 1986 has now more than doubled as a result of accumulating interest and late payment penalties.
| C. The Tax Court"s decision |
[33] On facts essentially as I have described, Rip T.C.J. held that Mr. Short had not succeeded in bringing himself within the statutory due diligence defence. He emphasized two aspects of the facts in reaching this conclusion.
[34] First, Rip T.C.J. characterized as "playing with fire" Mr. Short"s method of financing the remittance to Revenue Canada for the previous month"s deductions, namely his reliance on the receipt of payments due in the following month on the company"s contracts. The problem with this, he noted, was that there was always a "reasonable probability" that a progress or final payment would not be forthcoming and the company would be unable to make its remittance on time. Having assumed this risk, Mr. Short could not subsequently be heard to say when the inevitable happened that he had acted with due diligence to prevent his company"s default, since he had not put in place any system for dealing with such an eventuality.
[35] Second, the company was operating without adequate capital and hence was very vulnerable if any of the contractors to which it supplied labour got into difficulties. And when this happened to Fahey there was no evidence by the summer of 1986 that B. & R. Short Construction was financially viable. For Mr. Short nonetheless to continue to accumulate debt to Revenue Canada was not consistent with due diligence.
[36] The only immediately relevant provision of the Income Tax Act is subsection 227.1(3):
A director is not liable for a failure [to remit deductions] under subsection (1) where he exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.
Un administrateur n"est pas responsable de l"omission visée au paragraphe (1) lorsqu"il a agi avec le degré de soin, de diligence et d"habileté pour prévenir le manquement qu"une personne raisonnablement prudente aurait exercé dans des circonstances comparables.
[37] Although there is no shortage of reported cases dealing with this provision, most simply provide examples of its application to particular situations. Since these decisions are inevitably fact-driven they have little precedential value, and I do not intend to discuss them individually. However, some of the cases brought to my attention deal with situations which in their essentials are not unlike the case before me, and I have found these helpful in indicating the facts to which I should pay particular attention when determining whether Mr. Short has established the due diligence defence.
[38] More general guidance, however, is provided by the very useful judgment of Robertson J.A. in what is now the leading case of Soper v. R., [1998] 1 F.C. 124 (F.C.A.), where the standard established by subsection 227.1(3) was described as "subjective- objective". This means that whether the director exercised the care, diligence and skill of a reasonably prudent person is to be determined by taking into account some at least of the personal characteristics of the individual in question.
[39] Thus, the statutory comparator is the reasonably prudent person in "comparable circumstances" to the director in question. This requires the Court to take into consideration such things as the knowledge, experience and general business sophistication of the director and, I would have thought, the business circumstances under which the director was operating. There is thus to be a flexibility in the application of the standard, without at the same time its degeneration into a defence of "I did my best".
| E. Application of the law |
[40] Applying the statutory standard as elaborated in Soper to the facts of this case, I have taken into account that Mr. Short did not finish high school, and had acquired no more than an elementary knowledge of bookkeeping through attending night classes. On the other hand, he had considerable practical knowledge of the construction industry in Newfoundland and was, of course, intimately familiar with the situation of his own company which he had been running, either alone or with his father, for eight or nine years prior to 1986. Having had the benefit of seeing and hearing Mr. Short give his evidence I have the impression of an intelligent person with a good knowledge of his business.
[41] Counsel for Mr. Short relied heavily upon the fact that, from the time that the Bank of Montreal intervened in late June to take "control" of the company, Mr. Short was himself no longer a free agent. In particular, when the bank took over the receivables to reduce the amount of the company"s overdraft, and permitted cheques to be written only to cover the net payroll and to make payments to suppliers that were necessary to enable the company to continue to work, Mr. Short ceased to be responsible for the company"s failure to remit the source deductions.
[42] On the other hand, for all intents and purposes counsel conceded that Mr. Short was liable for the unremitted deductions for the months of May and June, because these failures occurred at a time when he was free to decide, not only whether to continue operating the company, but also which debts the company would pay, and when.
[43] After examining the evidence carefully and reading the authorities provided by counsel, I have concluded that Mr. Short did not show the degree of care, diligence and skill required by subsection 227.1(3) in the other months either.
[44] First, there was no formal assignment to the Bank of Montreal and the evidence about the degree of control that it in fact exercised was by no means clear. In particular, Mr. Short did not specifically raise with the branch manager the question of whether the bank would honour cheques drawn in favour of Revenue Canada to meet the source deductions. Nor am I satisfied that he made the appropriate efforts to discuss the situation with Revenue Canada in a timely fashion. If it was possible for the bank, Revenue Canada and Mr. Short to agree on a repayment package late in September, I do not see why a similar agreement could not have been made much earlier if Mr. Short had taken the proactive steps required.
[45] Second, the under-capitalization of the company, and the absence of a sufficiently reliable method for ensuring that the source deductions were remitted, despite the chill winds then blowing through the construction business in Newfoundland, suggest that Mr. Short failed to take the positive steps required of a director to prevent the failure to remit. Indeed, although B. & R. Short had operated for some years by covering the deductions from subsequent receivables, the company had run into difficulties with making remittances on time in several months in 1985. Mr. Short should have learned from this experience, and put the company"s financial position on a more stable basis for the 1986 construction season.
[46] Third, Mr. Short did not comply with important aspects of the arrangements made with Revenue Canada in September 1986: that is, he did not honour his undertaking to remit the source deductions made for the current months.
[47] On the other hand, I have no doubt that Mr. Short was telling the truth when he gave evidence that he and his wife had foregone salary payments and that the collapse of B. & R. Short had caused them personal hardship. This is not a case where the director has looked after his own interest at the expense of Revenue Canada"s.
[48] It is impossible not to feel sympathy for Mr. Short, who has worked hard and has been overwhelmed by circumstances that are by no means all of his own making. Nevertheless, the responsibilities of a corporate director require more than an honest effort to do one"s best, and a willingness to oil the squeaky wheels by complying with the demands of the company"s most immediately demanding creditors, and ignoring the obligations owed to the public, represented by Revenue Canada.
[49] For these reasons the appeal is dismissed.
"John M. Evans"
J.F.C.C.
TORONTO, ONTARIO
May 19, 1999
FEDERAL COURT OF CANADA
Names of Counsel and Solicitors of Record
COURT NO: T-291-91
| STYLE OF CAUSE: BRONSON SHORT |
Plaintiff
- and -
Defendant
DATE OF HEARING: MONDAY, MAY 10, 1999
| PLACE OF HEARING: HALIFAX, NOVA SCOTIA |
REASONS FOR JUDGMENT BY: EVANS J.
DATED: THURSDAY, MAY 19, 1999
APPEARANCES: Mr. Nicholas Avis
For the Plaintiff
Mr. John Bodurtha
For the Defendant
SOLICITORS OF RECORD: Avis and King
| Suite 312, Millbrook Base Mall |
| Corner Brook, Newfoundland |
For the Plaintiff
Morris Rosenberg
Deputy Attorney General
of Canada
For the Defendant
FEDERAL COURT OF CANADA
Date: 19990519
Docket: T-291-91
Between:
Plaintiff
- and -
Defendant
REASONS FOR JUDGMENT
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