Starkman v. R., [1997] 2 CTC 2040, 97 DTC 220

Sarchuk T.CJ.:

This is an appeal by Sharon Starkman from an assessment dated March 16, 1993 bearing number 38536, issued against her pursuant to section 227.1 of the Income Tax Act on account of the failure of Hope Tower Inn Limited to remit to the Receiver General an amount of federal income tax as required by section 153 of the Act, and interest and penalties relating thereto.

The issue is whether the Appellant is vicariously libel under subsection 227.1(1) in respect of that failure. The period of time at issue is January 1991 to August 1991. The basic facts in somewhat abbreviated form are as follows: At all material times the Appellant was the sole director of Hope Tower and of 709641 Ontario Limited which was the owner of all of Hope Tower’s shares. The Appellant also was the sole shareholder of 709641. Hope Tower carried on a hotel/motel business in Port Hope, Ontario which included a restaurant, bar, meeting rooms and a dance club.

The Appellant’s husband, Joel, is an entrepreneur who for a number of years was involved in the acquisition, renovation and resale of properties in the Niagara Peninsula area in and around St. Catherine’s and in Orillia and Barrie. In 1989 he decided to acquire Hope Tower with a view of making fairly extensive renovations, developing a customer base and ultimately reselling the property. Since a tavern/bar formed part of its business, an application to the Liquor Licence Board of Ontario for approval of the transfer of a licence was necessary. Joel Starkman was not eligible to apply because of a previous criminal conviction and for this reason the Appellant says she agreed to be the director of Hope Tower.

The Appellant says she was not involved in any of the purchase negotiations and that her husband attended to all aspects of the acquisition. As well, he was to run the business with the assistance of some of the former permanent staff including the bookkeeper and a lady who can best be described as the events manager. She acknowledges that her signature appears on the relevant corporate documents and on the banking resolution which incidentally, gave both her and Joel Starkman signing authority, but she maintains that she merely signed what was necessary in order to carry out her role which she perceived to be simply the acquisition of the liquor licence. With respect to the holding company, 709641, the Appellant says she does not recall becoming a director or shareholder and made no investment in it. In point of fact, it is fair to say that most of her responses amounted to statements along the line of “I do not recall or I never got involved”.

Substantial renovations to the hotel were undertaken by Joel Starkman in the fall of 1990. He testified that by January 1991, it was apparent that business was falling short of expectations and that the effects of the recession were affecting the operation of the inn as well as its other businesses. At some point in time in January of 1991 Hope Tower was experiencing cash flow problems and following a discussion with the bookkeeper, he decided not to remit source deductions as one of the mechanisms to assist the operations of the inn. No further remittances were made for the period January to August, 1991. In August of that year arrangements were made to reconvey the property to the vendor and this arrangement based on the the documents (Exhibits A-23 and A-24), was completed in October 1991.

The Appellant’s position is that she exercised the degree of care, diligence and skill to prevent a failure to remit that a reasonably prudent person would have exercised in comparable circumstances. The circumstances which she raised include the fact that she became the director at the request of her husband solely to facilitate the approval of the liquor licence. Furthermore, it was contended that she was a person with no real business experience, who, as a director, remained totally uninvolved with management, administration and the day-to-day operations of Hope Tower. As well, she says she had no knowledge of the rights, responsibilities and obligations of a director, and, if I understood the submissions which were made, that in the present circumstances, there was no need for her to enquire in order to find out.

Subsection 227.1(1) of the Act makes the director of a company vicariously liable for any failure by the company to withhold, deduct or remit source deductions. The section reads as follows:

Where a corporation has failed to deduct or withhold an amount as required by subsection 135(3) or section 153 or 215, has failed to remit such an amount or has failed to pay an amount of tax for a taxation year as required under Part VII or VIII, the directors of the corporation at the time the corporation was required to deduct, withhold, remit or pay the amount are jointly and severally liable, together with the corporation, to pay that amount and any interest or penalties relating thereto.

The rationale for the imposition of vicarious liability is obvious. The directors of a company are its directing mind. They are the persons responsible for ensuring that the corporation fulfils its financial obligations. It is not a question of rectifying or remedying a default. The obligation in this case is one of ensuring that it does not occur.

Subsection 227.1(3) of the Act affords directors what is often referred to as the due diligence defence. This section reads:

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.

What are the circumstances in this case? It is evident from the whole of the testimony that the Appellant made no enquiries as to her duties or responsibilities as director toward the company or toward third parties, either of her husband or by asking their lawyer. Furthermore, the Appellant often attended at the place of business, particularly on weekends. At some point in time, in April or May of 1991, the Appellant saw that things were not going well which, she said, she could tell by the number of guests and functions. What did she do? In one simple word, nothing. She asked no questions at this stage. She showed no concern. It is a fact that she had both access to such information and the opportunity to find out. She could have spoken to her husband and she could have spoken to the bookkeeper. Her failure to do anything at any time with respect to determining what her position was, what her liabilities were and so forth comes as no surprise since her stated position, indeed she stated it several times, was that she had no personal obligations as a director.

I note that she also had accepted the responsibility of being the licensee and the director of the corporation which would be applying for a licence with the Liquor Control Board. She made no enquiries with respect to her responsibilities in that context or for the corporation’s responsibilities, for whose affairs she was responsible as director, notwithstanding that the licensee is required to be in full control of the licensed premises. She agreed to put herself forward as such a person without enquiring what the potential ramifications of such actions were.

I turn next to the concept of skill in the section in issue. The Appellant’s business acumen and experience is clearly limited. She was a homemaker for much of her adult life. However, from 1986 through 1989 she ran her own business, Starkman Clinics Incorporated. She was the sole shareholder and director. It was also her testimony that the incorporation was her husband’s idea, and that even with respect to her own company and her own business, she had no knowledge and made no enquiries regarding her personal obligations. She even denied knowing that a corporate structure provided protection from personal liability. Although essentially a personal services business, for a short period of time she did hire and have an employee and became aware of the corporation’s responsibilities vis-à-vis payroll deductions and remittances. She also conceded that Hope Inn employees were governed by the same rules.

I am constrained to observe that the Appellant is an intelligent and articulate person and these efforts to portray herself as ill-informed, unskilled, unquestioning and totally disinterested in her own affairs or those of her husband and Hope Tower are most difficult to accept.

The position advanced by the Appellant vis-à-vis Hope Tower can be summarized in this fashion. The business as a whole was that of her husband, that is notwithstanding the fact that she owned 100% of the shares of the holding company. He managed it, controlled its affairs and she trusted him. Nothing occurred in the period of ownership which caused her any concern. She was not aware of the financial problems in January 1991 and thus there was no basis for her to make any enquiries. Joel Starkman’s testimony mirrored hers. He was the business manager of the project, he said, and indeed of all of his projects, and although he discussed matters with his wife in a general way, he did not go into detail so as not to burden her with his problems.

In essence, her position is that she was a director in name only. In Stuart v. Minister of National Revenue, [1995] 2 C.T.C. 2458 (D), (sub nom. Stuart v. R.) 95 D.T.C. 537 (T.C.C.), the director referred to himself as a puppet or titular director. He was entirely passive in his role, never asserting himself as such and never making enquiries about his responsibilities. The issue which the court had to deal with in that case was summarized by Christie, A.C.J.T.C. at page D.T.C. 539 as follows:

The significant question that arises is this: can an individual who consents to being appointed as director of a corporation escape liability under subsection 227.1 of the Act by, for all practical purposes, ignoring its existence thereafter? In my opinion, the answer is no.

Christie J. went on to say:

The Appellant relies on Pidskalny v. M.N.R., [1991] 2 C.T.C. 2192, 91 D.T.C. 1046 (T.C.C.), and he cites the headnote. In that case the Appellant was held not to be liable under subsection 227.1(1). The headnote reads in part as follows:

At all material times, the taxpayer’s directorship of R. Limited had been purely titular. He was wholly uninvolved with the company and had no knowledge of the rights, responsibilities and obligations of a directorship. He was therefore totally free of any personal liability for the unremitted source deductions in issue.

I cannot accept as a correct statement of the law, and it is noted that in Black v. The Queen, [1993] 2 C.T.C. 2825, 93 D.T.C. 1212 (T.C.C.) Bonner, T.C.J. considered Pidskalny.

In Black, Bonner J. made the following comment at page 1215:

The Appellant cannot take shelter under subsection 227.1(3) by claiming that his actions met the standard of a reasonably prudent person who was ill-informed as to the requirements of the Act. A reasonably prudent person who is aware that he is a director but who is uncertain as to the extent of his responsibilities as director is under a duty to at least to attempt to discover what is required of him and to discharge that duty.

He went on to say:

The decision of this Court in Pidskalny appears to suggest that subsection 227.1(3) protects a director who failed to try to prevent a failure to remit because he had no knowledge of the rights, responsibilities and obligations of a directorship and was uninvolved with the management of the company. If that were the ratio of the decision it would be very difficult to reconcile it with the language of 227.1. Nothing in that language suggests the existence of a legislative intention to offer relief to a director who fails to act because he is ignorant of and indifferent to his responsibilities and those of his company. It is illogical, for example, to suggest that a person who drives his vehicle in heavy traffic with his eyes firmly shut cannot be negligent because he is unaware of the existence of a duty to those he is about to injure. It is equally illogical to suggest that a director who is ignorant of his responsibilities and who fails to attempt to identify and fulfil them can meet the 227.1(3) standard.

And:

The purpose of 227.1 cannot be ignored. In clear language subsection (1) imposes liability on all directors and not just on those who are aware of the relevant provisions of the Act. Subsection 227.1(3) offers protection to those who exercise the degree of care that a reasonably prudent person would have exercised in comparable circumstances. It is illogical and inconsistent with the evident purpose of the section to suggest that the legislature contemplated that the standard of a reasonably prudent person is met by directors who make no effort to discover what the law requires of them and to comply with it.

I add only that in my view this is a correct statement of the law.

As a sidenote, I add that a similar position is also expressed in several texts on corporate law. It is a general statement which applies to the duties of a director vis-a-vis the corporation itself and has now been statutorily incorporated into most Business Corporations Acts and can be found in section 134.1 of the Ontario Business Corporations Act. The language used therein is virtually identical to what is found in subsection 227.1(3). In this context, the text Corporate Law in Canada [1] , contains the following comment with respect to current legal standards:

The diligence requirement, on the other hand, appears to have been upgraded substantially. Managers are required to exercise the diligence of a reasonably prudent person. It seems a convincing argument that a reasonably prudent person in the position of a director or officer would, at minimum, be diligent in going about his duties. If he happens to be skilled, then he should be expected to use his personal skills. If he happens to be unskilled, then surely the prudent approach would be to recognize his lack of skills and to seek competent outside advice. In seeking the advice, the director or officer could once again be expected to select it prudently, rather than haphazardly as tended to be allowed in the English common law cases....

The author then makes reference to a country gentleman in Re Denham, [1955] 2 All E.R. 561 “who did not even bother to look into the books and who did not attend corporate meetings” and noted that “he could hardly be said to have been reasonably diligent.”

In this case, the Appellant’s husband was a reasonably knowledgeable businessman. One might have thought that at the very least due diligence would have required that the Appellant, if not prepared to seek independent legal, accounting advice, would in these circumstances, have asked her husband what her duties and responsibilities were and questioned him in this regard. Not even that simple basic step was taken. Her actions were, in my view, a complete abdication of her responsibilities.

It also appears to have been suggested inferentially that special circumstances exist here not only because the Appellant was a passive director but that she was a passive director in a familial situation, akin to the circumstances which were found to exist in Taillefer c. Ministre du Revenu national [2] and Fitzgerald v. Minister of National Revenue [3] On this basis, it was argued that it would not be appropriate to hold her liable for the corporate failure.

I am not able to reach the same conclusion. The mere fact that one becomes a director in a family context is not by itself sufficient to permit a director to turn her back on the affairs of the company, to ignore it for all practical purposes, to ignore her responsibilities and indeed to fail to ask even the most rudimentary and fundamental questions as to what those responsibilities are and thereby to escape liability under the provisions of the Income Tax Act.

It should be noted that she was also the shareholder and the person who would benefit from the profitability of the company if that occurred. Although Joel Starkman and the Appellant both said it was his business, there was some evidence that other commercial considerations were involved in her ownership of the shares. In any event, the fact remains that she was the shareholder, she owned the company which owned the Hope Tower, and there is no evidence to suggest that she was holding these shares in trust. One has to assume that she was the beneficial owner of that property with all that that implies.

The Appellant does not, in my view, meet the criteria in subsection 227.1(3). The appeal is dismissed, costs to the Respondent to be taxed.

Appeal dismissed.