Estate of Roger Gilbert and Therese Gilbert v. Minister of National Revenue, [1990] 2 CTC 2185, 90 DTC 1660

Lamarre Proulx, T.C.J. [Translation]:—These appeals were heard on common evidence. They concern the application of section 227.1 of the Income Tax Act ("the Act"), dealing with the liability of the directors of a corporation who fail to submit source deductions for income tax. Counsel for the appellants, [1] in addition to the defence of reasonable diligence exercised by the appellant as directors, which is allowed under subsection 227.1(3) of the Act, raised the question of the respondent's waiver in the trustees' favour of the exercise of its rights regarding the presumption of property held in trust, conferred on it by subsection 227(5) of the Act.

In 1986 the appellants were living in Ville La Salle and owned a kitchen cupboard manufacturing business in that town. In late February 1986 Mr. and Mrs. Gilbert became the majority shareholders in another kitchen cupboard manufacturing business in which they had some minority interest. This business was located in Granby, an hour's drive from the appellants’ residence, and was known as Cuisines Bo-Mod Ltée (hereinafter referred to as "Bo-Mod"). Mr. Richard Létourneau, who was the President of Bo-Mod, remained the senior manager after the appellants became majority shareholders. The appellants and Mr. Létourneau were the directors of Bo-Mod. Once a week Mr. Gilbert reviewed Bo-Mod's operations and signed the cheques.

According to Mrs. Gilbert's testimony, it was in late September 1986 that her husband learned of Bo-Mod's financial problems. He then went to Granby with the accountant to take inventory. In the evidence I was told of a difference in the amount of inventory between the balance sheet at August 31, 1986 and that at September 30, 1986—a change from $1,332,871.89 to $535,969.78. In actual fact, if one looks at all carefully at the figures under the heading "shortterm assets", it can be seen that the difference is in fact an amount of $136,476.57. Counsel apparently sought to infer from this difference that Mr. Gilbert had been deliberately misled by Bo-Mod's local managers.

The appellant Mrs. Gilbert remembered that it was in late September 1986, she said, that Mr. Gilbert was told of Bo-Mod's financial problems for the first time; on the other hand, she did not remember discussions she had with her husband about what had to be done to get Bo-Mod out of its disastrous position. Mr. Létourneau did testify but his examination was very short. Its only purpose was to show that he and Mr. Gilbert signed the cheques, but did not mail them. Another person did so but was not called to testify. Mr. Letourneau did not really provide any testimony regarding the financial problems experienced by Bo-Mod since July 1986. It in fact owed interest for late payment of deductions in July 1986 and for deductions, interest and penalties in August, September and October 1986. Bo-Mod made an assignment of its property under the Bankruptcy Act on October 24, 1986.

As evidence of diligence, I was given the cheques made out to the Receiver General, signed jointly by Mr. Létourneau and Mr. Gilbert, which were not sent. Counsel for the appellants argued that Mr. Gilbert acted with reasonable diligence and was not responsible for the fact that the cheques were not sent. No explanation was given in this regard. Mr. Létourneau said the secretary should have sent them and he did not know why she did not do so. The evidence further disclosed that Mr. Roger Gilbert telephoned the Department of National Revenue on October 14, 1986 to request a delay until the following week.

I am unable, based on the evidence submitted to me, to find that the appellants exercised reasonable diligence. No explanation was provided as to the reasons for the failure to submit tax deductions from employees' salaries to the Receiver General. Mr. Létourneau is the one who would have been in a position to explain the financial problems in the company's last month and the decisions taken to deal with these problems. Counsel for the appellants did not see fit to examine him about this. In the case of Mrs. Gilbert, she did not remember any discussion she had with her husband about what should be done to cope with the financial problems.

Subsection 227.1(3) of the Act reads as follows:

227.1 (3) A director is not liable for a failure 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.

I understand that one of the appellants, Mr. Gilbert, is dead, but satisfactory evidence that Mr. Gilbert acted with the care, diligence and skill necessary to prevent the failure would have required testimony either by the accountant with whom Mr. Gilbert had discussions about financial problems or by the bank employees with whom Mr. Gilbert dealt. The bank in question was located at Granby, where Mr. Gilbert resided, and it was undoubtedly Mr. Gilbert who dealt with the bankers.

The absence of these witnesses, who would have been in a position to explain the facts surrounding the alleged failure, means that I can only infer that the fact they were not present meant that they could not corroborate the appellants' argument that they acted with the necessary degree of care. Mrs. Gilbert did not wish to present evidence different from that of her husband. In these circumstances, therefore, I am not able to find that the appellants exercised reasonable diligence to prevent the failure to perform their obligations regarding tax deductions.

Counsel for the appellants' second argument results from the rights conferred on Her Majesty by subsection 227(5) of the Act, which were not made use of by the respondent. That subsection reads as follows:

227(5) Notwithstanding any provision of the Bankruptcy Act, in the event of any liquidation, assignment, receivership, or bankruptcy of or by a person, an amount equal to the amount deemed by subsection (4) do be held in trust for Her Majesty shall be deemed to be separate from and form no part of the estate in liquidation, assignment, receivership or bankruptcy, whether or not that amount has in fact been kept separate and apart from the person's own moneys or from the assets of the estate.

Counsel for the appellants argued that a director who has reimbursed the respondent for the company's debts is in the position of a surety, that a surety is subrogated in the rights of the creditor, that the respondent decided not to assert his ownership rights over the property held in trust for Her Majesty, that as a result the appellants’ right of subrogation can no longer be exercised and that accordingly the appellants are discharged, as a consequence of article 1959 of the Civil Code of Lower Canada, from the duty imposed by subsection 227.1(1) of the Act.

Ownership rights of Her Majesty

In Dauphin Plains Credit Union Ltd. v. Xyloid Industries Ltd. and The Queen, [1980] 1 S.C.R. 1182; [1980] C.T.C. 247; 80 D.T.C. 6123, Pigeon, J. held at 254 (D.T.C. 6128; S.C.R. 1199) that deductions for the Pension Plan and unemployment insurance come before a general lien because the statutory conditions creating them specifically mention that the amount deemed to be held in trust for Her Majesty is deemed not to be included in the bankruptcy property, whether this amount was separate from the employer's own funds or the assets of the bankrupcty or not. It is now the language used by subsection 227(5) of the Act for money deducted or withheld after May 23, 1985. Accordingly, it must be said that the respondent's claims for taxes are not part of the general estate and were of the same nature as property subject to a fixed and specific lien.

In the case in question the respondent did not exercise his rights with respect to the property deemed to be held in trust for Her Majesty, as he acted in accordance with Directive 12 of the Superintendent of Bankruptcy, which the respondent had undertaken to observe. Paragraph 4 of the Directive says:

4. ... it is recognized that, in some bankruptcy situations, the property claim of the Department under Section of the Bankruptcy Act may exceed the realizable value of the property which is under the control of the trustee in bankruptcy.

6. In order to ensure that the claims of the Department do not cause undue disruption in the administration of the bankruptcy process, the Department will permit reasonable costs of administration to be deducted from the proceeds of realization of an estate prior to payment of its Section 59 claim where:

(a) the proceeds of realization of the estate are insufficient to satisfy in full both the reasonable costs of administration and the Section 59 claim of the Department; and

(b) other creditors, having deemed trust claims, under Section 59 of the Bankruptcy Act, which also must be satisfied out of the proceeds of realization of the estate, agree to:

(i) postpone their claims in the same manner; and

(ii) share the available proceeds of distribution with the Department.

7. The costs of administration are defined as the expenses and fees of the trustee and legal costs as described in paragraph 107(1)(b) of the Bankruptcy Act, and as taxed by the Court as required by law.

In Broome: Ontario Council of International Brotherhood of Painters & Allied Trades, Local 1590 v. Touche, Ross Ltd. (1986), 61 C.B.R. (N.S.) 233 (Ont. S.C.), it was held that all the money realized by the trustees belonged to the statutory trust for the Crown and that the trustees had to pay it to the Crown. Apparently, it was to deal with this situation that Directive 12, supra, was negotiated.

Suretyship

In support of his theory of suretyship, counsel for the appellants relied on Guenard v. Coe (1914), 17 D.L.R. 47; 6 W.W.R. 992 and Kucer v. Le Comité conjoint de l'industrie de la fabrication du métal en feuilles , [1973] C.A. 341 and on subsection 227.1(6) of the Act. This subsection reads as follows:

[Translation]

Where a director pays an amount in respect of a corporation's liability referred to in subsection (1) that is proved in liquidation, dissolution or bankruptcy proceedings, he is entitled to any preference that Her Majesty in right of Canada would have been entitled to had such amount been so paid and, where a certificate not related to such amount has been registered, he is entitled to an assignment of the certificate to the extent of his payment, which assignment the Minister is hereby empowered to make.

In Guenard, supra, Stuart, J. said this at page 51, regarding the statutory liability of directors in respect of employees' salaries in corporate law:

[Translation]

I think the principle upon which the statute should be interpreted is that it creates a statutory obligation quite apart from contract, and quite unknown to the common law. By statute the director is made, in effect, a surety. In a contract of suretyship it depends on the terms of the contract whether the creditor is at liberty to proceed in the first instance against the surety or guarantor, or whether proceedings must first be taken against the principal debtor before the surety can be sued.

In Kucer, supra, Dêschenes, J. said at page 346: [Translation] ”. . . That the employee first establishes this liability and he can then, on the conditions listed in s. 97, sue the directors as guarantors of the company's obligation.”

Also in that case, Dêschenes, J. used the word “caution” (surety) at page 346: [Translation] ”. . . accordingly, to support his action the respondent must claim under s. 97 of the federal Companies Act, which essentially makes directors sureties for the company's salary debt and lays down their joint and several liability with the company to its employees".

This treatment of directors' liability as suretyship is not absolutely settled in Quebec law. [Translation] "In the absence of an express provision to this effect, we do not think it is fair to say that by accepting their position of director they have undertaken to be sureties for the company's obligations to its employees. This is really a civil obligation associated with their function, which they cannot avoid". [2]

Nature of deductions

I think it is proper at this point to mention the nature of salary deductions for income tax, and in this regard I quote Pigeon, J. in Dauphin Plains, supra, at page 250 (D.T.C. 6125-26; S.C.R. 1191-92):

It is important to consider the nature of the deduction for income tax. It is not a deduction for the benefit of the employer, it is a withholding for the benefit of the employee because it is to be remitted to the Receiver General of Canada on account of the employee's tax indebtedness. By virtue of other provisions of the Income Tax Act if, as happens in a large number of cases, the withholdings exceed the employee's tax liabilities, a refund will be made to the employee by the Department of National Revenue. Therefore, the amount withheld remains a part of the wages, and, subsection 153(3) provides that it is "deemed to have been received” by him at the time the payment was made less the deduction . . .

It must also be considered that, by virtue of subsection 153(3) the employees are deemed to have received their wages in full, so that they are liable for income tax on that basis. But the position taken by the Credit Union means that it would get the benefit of the deductions so that the employees would have to pay income tax to the Department of National Revenue on what they have not received and for which they would get no credit.

Tax deductions are in the nature of wages or earnings. The Companies Act, R.S.Q. 1977, c. C-38, s. 96 and the Canada Business Corporations Act, R.S.C. 1985, c. C-44, s. 119 provide that directors will be liable for employees' wages. However, there is no defence based on reasonable diligence: the defences provided are the procedure and deadlines for taking action. [3]

Can it be said that section 227.1 of the Act is legislation along the same lines as that providing for the statutory liability of directors for employees' wages in corporate law, even though unlike that law, tax law permits the defence of reasonable diligence? If this is so and if the rules of suretyship apply to directors in corporate law, they would also apply to directors in tax law. In the absence of specific provisions in the Act the rules of suretyship could guide the Court in its decision, in a subordinate way (Olympia and York Developments Ltd. v. The Queen, 34 D.T.C. 6184, at pages 269-70 (D.T.C. 6187)).

Recourse of surety

The principal recourses available to the surety are the benefit of discussion of the debtor's property under article 1941, Civil Code of Lower Canada, the benefit of division in the event of joint and several liability under article 1946, Civil Code of Lower Canada and the benefit of article 1959, Civil Code of Lower Canada, which provides for release of the surety when the creditor has by his own act prevented the surety from being subrogated in the rights, privileges and hypothecs of the creditor.

Where these recourses are concerned:

(a) the Act contains no requirement of prior discussion of a debtor's property in the event of bankruptcy: unlike paragraph 227.1(2)(a), paragraph 227.1 (2)(c) of the Act does not require than the claim made against the bankrupt corporation shall have been returned unsatisfied before the respondent is entitled to assess the directors, which in my opinion means that, at any time after the respondent files its claim with the trustee, he may assess the director of a bankrupt corporation. He does not have to have received from the trustee a notice that his claim cannot be paid;

(b) the benefit of division is provided for by subsection 227.1(7) of the Act;

(c) the principle of subrogation is mentioned in subsection 227.1(6) of the Act;

(d) there is nothing in the Act which specifies a situation contrary to article 1959 of the Civil Code of Lower Canada, which reads as follows:

Article 1959. The suretyship is at an end when by the act of the creditor the surety can no longer be subrogated in the rights, hypothecs and privileges of such creditor.

After reviewing the various parts of the appellants’ proposition, I feel it is useful to recall what it says: counsel for the appellants argued that, by allowing the trustees in the bankruptcy of Bo-Mod to collect their fees and expenses in priority to the amount mentioned in the assessment, the respondent had prevented the subrogation contemplated by subsection 227.1(6) of the Act from operating in the appellants’ favour, and that therefore article 1959 of the Civil Code of Lower Canada was fully applicable and the appellants should ipso facto be discharged of the liability upon them.

The question that must be asked and should have been asked at the beginning of this exercise is, did the respondent prevent the subrogation from existing?

I do not think so, as it is well-settled law that an administrative policy cannot alter a statutory provision (The Queen v. Catagas (1978), 81 D.L.R. (3d) 396; [1978] 1 W.W.R. 282 at page 397). Consequently, the respondent's action did not prevent the application or terminate the existence of the subrogation provided for by subsection 227.1(6) of the Act in the appellants’ favour. The subrogation provided for in that subsection remains intact (Re Pathe Freres Phonograph Co. of Canada Ltd. (1922), 64 D.L.R. 628; 50 O.L.R. 644 (Ont. S.C., bankruptcy side)).

Since I have come to the conclusion that article 1959 of the Civil Code of Lower Canada cannot be applied, because the subrogation privilege was not cut off, I do not have to decide whether the Civil Code rules of suretyship apply to administrators. Incidentally, it would seem possible, if the liability of directors does not fall under suretyship, to refer to the rules relating to obligations in cases of payment with subrogation. [4]

Since evidence is lacking regarding what was done to prevent the failure contemplated by subsection 227.1(1) of the Act, therefore, I am unable to conclude that the appellants exercised the necessary degree of care to avoid the liability imposed by subsection 227.1(1) of the Act.

Further, the respondent did not terminate the subrogation privilege granted to the appellants by subsection 227.1(6) of the Act, and therefore I do not have to decide whether article 1959 of the Civil Code of Lower Canada applies.

The appeals are accordingly dismissed.

Appeals dismissed.