Margeson, T.C.J. [Orally]:—This is a decision in the matter of the appeals of R. Kendall Morash (89-1075(IT)), James A. George (89-1076(IT)) and Patricia Noonan (89-1020 (IT)). It was agreed at the beginning of these trials that all three cases would be heard on common evidence. The only matter with which I have jurisdiction to deal in these cases are the amounts that were allegedly owing by N & K Merchandising Ltd., a body corporate, for unpaid income taxes in the amount of $1,043.63 in respect of unremitted deductions of tax and interest under the provisions of subsection 227.1 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), assessed under subsection 227(10). The Minister alleges that Patricia D. Noonan is liable as a director of the company for the year 1985. With respect to the appellants James A. George and R. Kendall Morash, the Minister assessed them by notice of assessment dated December 2, 1987, as directors of A.V.S. Management Ltd., a body corporate, for federal and provincial income taxes unremitted by the company for the year 1985 in the amount of $3,900.94, including interest and penalties.
The evidence discloses that the appellants George and Morash entered into a business agreement in 1984 with the incorporation of A.V.S. Management Ltd., having the following shareholders: Orion Holdings Ltd.—1,250 shares, Robert Davidson—1,250 common shares, Geomor Ltd.—2,500 common shares. Geomor Ltd. was owned by the appellants George and Morash, who were also directors. Mr. Morash was also the vice-president operations and Mr. George was the secretary-treasurer. Orion Holdings Ltd. was controlled by the late G. Kanary. The purpose of the company, that is, the new company, was to promote and establish national video retail stores throughout Nova Scotia. Shortly after starting, the appellants realized there were management problems with Mr. Kanary, including the way he managed the stores, staffing problems, excessive cost of promotion and other matters. The appellants made an offer to Mr. Kanary to sell their shares to him in June 1985. They continued to vary the price downward, but Mr. Kanary was never able to put together the financial package to complete the deal. In light of the problems encountered with Mr. Kanary in the management of the company Mr. George joined the company full-time in December 1984 and left in May 1985, and acted basically as comptroller of the company during that period of time.
The appellants allege that all payments to the Minister were made up to that date during that time. When Mr. George left, Mr. Kanary took over day-to-day management again. He was in charge of budgeting forecasts and, according to the appellants, he painted a rosy picture of the operation. During the periods in question here, Mr. George and Mr. Morash signed the cheques, then they went to Mr. Kanary to sign and have sent out, including cheques to Revenue Canada. The evidence is, that before Mr. George was comptroller, the appellants had limited involvement.
Mr. Morash is an accountant and has had extensive experience in business in at least five different companies, and was an officer and a director of all of those. He got more involved in the company as time went on and particularly in 1984, as did Mr. George, because, as the witness said "Mr. Kanary was not going anywhere with National Video. He had to show changes or lose the franchise". Mr. George went in in December 1984 as things got busier, and so the company would not fall behind, as they put it. When he left in 1985, according to the evidence, there was a satisfactory accounting staff in place who were good at their jobs. Apparently, there were no specific instructions on deductions, although it was assumed that the staff knew about them. Mr. Kanary was the last person to see the cheques and he was left to mail them out. Mr. Morash, according to his evidence, remembers signing cheques, including cheques to the Receiver General.
When Mr. George went in, the financial position was quite good, but, subsequently, matters deteriorated. According to Mr. Morash, a computer system was installed called "Acc Pac.” A financial statement was produced monthly, at least when Mr. George was there. Meetings were also held and financial statements were discussed. There were no meetings in June or July 1985. By April 1985, the company had no cash or very little and was operating on payments of receivables. Both appellants were aware of the general deteriorating situation, but Mr. Morash said he would not know how much cash was there. It appears from the books and from the evidence that there was very little or none.
The September 30, 1985 trial balance shows an entry for "Tax deducted" of $1,314.02. The bookkeeper explained that this was an accounts payable only and not a deduction, although Mr. Morash indicated that the deductions were paid up to the time Mr. George left and he still felt that the $1,314.02 was a deduction for Revenue Canada and he felt that a cheque was sent to Revenue Canada. It was obviously not sent and the books do not reflect that. He admits that no specific account was set up for deductions, certainly no trust account was set up. Joyce Winters advised that the payroll and accounting staff were four in number and they knew their jobs well. She supervised them. She said the cash flow predictions were done on a weekly basis. Payments were made according to a schedule. Deposits were made to cover cheques written, including those to Revenue Canada. Cheques were signed by Mr. Morash and Mr. George and then put out for Mr. Kanary to sign. She said that the bank statements came in by the 7th of the month and the reconciliation was done by the end of the month. She said she knew the Receiver General's cheques were not signed and she told Mr. Morash and Mr. George at that point that there might have been two or three cheques outstanding. She brought this to their attention around August or September.
In June the company was on a 30-day basis for payments, but by July, August and September, it was 60 days. Ms. Winters felt that they were not meeting their commitments. They were overbuying, sales were down, and the company was in a tight cash flow situation, as she put it. By mid-September, Mr. Morash called a meeting and gave notice to the staff of termination. On the advice of their lawyers and their own, they decided to close down the company, even though they said they were not sure whether they actually had the right to do so. They felt there was enough money to pay all debts. But the accounts receivable, as it turned out, were insufficient for various reasons and the appellants had to pay off the bank loans personally.
Insofar as Patricia Noonan is concerned, she was a minority shareholder and director of N & K Merchandising Ltd. She ran the store in Bedford, wrote cheques and made payroll remittances, and Mr. Kanary sent them out. Later, Gerard Kanary took over all mail and invoices and none was received at the Bedford store. She had to sign cheques and each month discussed finances.
Patricia Noonan says she had no knowledge of a problem until October or November 1985. She asked Mr. Kanary to buy her shares, but he did not. She says "he put it into bankruptcy”, and she did not know about it until Revenue Canada came in. She had Grade 13 education in Ontario and received a general diploma. She had worked in various cosmetic stores but never owned a small business. She invested $12,500 in shares. She knew she was a shareholder and she got paid $20,000 per year. She said she did not know she was a director or know what duties a director had. No directors' meetings were held. She never got legal advice, never felt she had to see the books. She expected a profit from her shareholdings. She saw the computer printouts but did not know much about it or what they meant. She did not know whether there was a deduction account. She says that when she saw the accounts there was a nil balance to Revenue Canada. She knew, according to her evidence, that deductions had to be made, but she did not know that they were behind. She said she found out she was a director when the government contacted her about the arrears. She did not know what cheques were going out and did not know if the payroll remittances came up as a separate topic at any time. Basically, those are the salient facts which have to be repeated here.
Argument
For the appellants, it is argued that they were, in fact, directors, but were under the influence of Mr. Kanary, a smart financial operator. According to their evidence, he could make things look good when they were not. There were management problems and, according to Mr. George and Mr. Morash, they tried to sell their shares and they thought they were going to sell them. They argue that they were not aware of the failure to make remittances until September 1985, and soon thereafter went to their lawyer and closed the business down.
Mr. Morash and Mr. George were aware of their duties, according to their own statements, but they say that they were not aware that they were personally liable. I take that to mean that they were aware of the fact that directors had duties of remittances, but they did not know that if they were not made, they could be held personally liable for them. Mr. Morash said the amount of $3,610 was a nil balance to him, and even if he had looked at the accounts payable list, it would mean the same to him. He says they acted as soon as they could over a short period of time.
For Mrs. Noonan, her case is basically that she did not know she was a director. She did not know she was responsible for remittances. She did not know remittances were not made. She thought things were okay for the business. She had no training or legal advice about deductions or responsibilities as a director and she felt that she was taken advantage of obviously by Mr. Kanary.
The respondent argues that after the evidence has been given, there are still more questions than answers, as often is the case in these matters where the results depend entirely upon the facts. He says we are not dealing with moral culpability here but simply a statutory duty imposed on directors under the Act, and it either applies to the facts or it does not apply. There was no trust account set up, he says. They signed the cheques and they were not sent out. He argues that that was probably because Mr. Kanary knew that there was no money to cover them. He says they are required to prevent the failure, not remedy it once it has happened, as in the case of James White v. M.N.R., [1990] 2 C.T.C. 2566; 91 D.T.C. 54 which he cites.
He says they did not act as reasonably prudent persons. He cites in support of that the case of Tuesday Chan v. M.N.R., 89-520(IT), Nov. 24, 1989 (unre- ported). He says they were too trustworthy of Mr. Kanary and that they are not entitled to abdicate their responsibility. His position is that they displayed a laissez-faire attitude about their duties. They knew there were problems. They had no cash to pay remittances. After May, when Mr. George left, they depended entirely on Mr. Kanary. They had no system in place to ensure remittances were made. He says they had the expertise and the due diligence test requires a high standard or them is his position. The Minister says that as in H. Fraser Estate in Bankruptcy v. M.N.R., [1987] 1 C.T.C. 2311; 87 D.T.C. 250, the taxpayer did nothing to prevent the failure.
Regarding Mrs. Noonan, the respondent says this is a different case, as she did not really know about her responsibilities. But, again, he says, she made no effort to inquire either. She left everything up to Mr. Kanary. He asked the question, "what is she capable of?”, equating that, I suppose, to the subjective part of the test of reasonableness. He says, "taking someone else's word, as she did, is not enough for a director. There is a duty on directors to take an active management regarding remittances, and she did not do this. If she did not know she was a director, she should have known,” is his position, " she had 25% of the shares and she invested $12,500, so it is not reasonable she would not have known who were the directors," according to him.
Analysis and Decision
There is no question here that all three appellants were directors and, consequently, the relative burdensome duties as imposed upon them under subsection 227.1(1) of the Income Tax Act make them liable for the assessments under appeal, unless they satisfy me, on the balance of probabilities, that subsection 227.1(3) offers them a defence. To obtain the relief sought, they must be found to have acted by exercising the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances. As I have said before in other cases, the test to be applied is both subjective and objective. Did the appellants act reasonably, having due regard to their knowledge, skill, experience, abilities, considering all the circumstances disclosed here? Insofar as Mr. Morash and Mr. George are concerned, I place them in a very high category as regards the standard of care required of them.
Mr. Morash and Mr. George were accountants, experienced businessmen in other companies. They knew they were directors. They knew they were officers. They were involved in the management of the company. They knew that remittances had to be made. They were signing authorities. They had access to the company books and accounts. They had regular meetings to discuss the business of the company. They were aware, or should have been aware, of the financial status of the company. They knew, or should have known, that there was no system in place for ensuring that remittances were made, and, indeed, according to the evidence of their own witness, they were told that the remittances to Revenue Canada were not made and they did nothing about it.
It is not sufficient for them to merely say or infer that they were taken advantage of by Mr. Kanary or that they left it all to him, when they knew of their responsibilities. Indeed, the most telling evidence is that of Mr. Morash himself, when he said they knew about the responsibilities and what they were but they did not know that they could be held personally responsible. To me, that is tantamount to negativing the very defence that they seek to take advantage of under subsection 227.1(3).
There is no suggestion by either of them that they were prevented in any way from acting to prevent the default, and they simply did nothing in that regard. It would seem that they were preoccupied in selling their shares to Mr. Kanary or were satisfied that there were sufficient assets to cover all debts, including Revenue Canada. But in that, they were mistaken. The Court is not satisfied that the appellants Morash and George acted as contemplated by subsection 227.1(3), and I find that that defence is not made out. Their appeals are therefore dismissed and the Minister's assessments are confirmed relative to them.
The Patricia Noonan case poses a much greater difficulty on the facts for me to reach the same conclusion. As I referred to earlier, she was not an accountant, a bookkeeper nor an experienced businessperson. She was not involved with other companies or enterprises, as were Mr. Morash and Mr. George. Further, her evidence was that she did not even know she was a director. She readily admitted that she was a vice-president. But from the facts as she presented them, and accepted by me, and from any reasonable inferences I am entitled to draw, I find that this title had little meaning either to her or to the company in which she was a shareholder. I find that she believed that any interest she had in the company and any hope for profit came from her position as a shareholder. I find that she did not know what a director was or what a director's duties were. She did not attend or know about any directors' meetings, and even though she knew that remittances had to be made, she at no time had anything to do with them, had no access to the company books or records except the financial statements about which she knew little or nothing. At no time should she have known that the remittances were not made until she was contacted by Revenue Canada.
Apart from her investment in the company, I find she was little more than an employee, and the degree of care that she was required to display was at the lower end of that required of directors. In answer to the respondent's question, “what was she capable of?" in that context and how much could she understand about the duties, I think very little.
I do not agree with the respondent that the requisite duty of care requires her to have an active part in the company management. Indeed, I do not see how she could have under the circumstances displayed here. I find that the defence under subsection 227.1(3) is made out by Mrs. Noonan on the balance of probabilities, and I will allow her appeal with costs and her assessment will be vacated.
Appeals of R. Kendall Morash and James A. George dismissed.
Appeal of Patricia D. Noonan allowed.
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