Bazinet v. R., [1997] 2 CTC 2793, 97 DTC 364

Dussault T.C.J.:

Accordingly, here is my judgment in these three cases: first, a technical matter.

After the appeals (the three appeals just mentioned) were brought against original assessments made pursuant to s. 227.1 of the Income Tax Act, assessments which were dated April 5, 1993, the Minister of National Revenue made reassessments dated December 2, 1994.

The Amended Notice of Appeal, filed in the three cases at the hearing by consent of the respondent, indicated that the appeals should be treated as appeals against the reassessments. The three appeals were heard on common evidence.

The only issue is whether the appellants could be exempt from the liability imposed by s. 227.1(1) of the Income Tax Act and s. 54(1) of the Unemployment Insurance Act for the failure by the company Les Coffrages Daca Limitée (“DACA”) to withhold and remit the amounts specified under those statutes for source deductions (“SDs”) for the 1990 and [sic] 1992 taxation years inclusive.

In this connection the appellants relied on s. 227.1(3) of the Income Tax Act. That subsection 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.

I will first make some comments on this provision.

First, the liability of a company director when the company has failed to deduct or withhold an amount, or has failed to remit it, as enacted by s. 227.1(1), makes no distinction between the directors, who are all held jointly and severally liable for the failure as well as for the interest and penalties related thereto. Thus, it does not matter whether they are active or passive. Equally, no distinction is made based on the respective duties of each director that they have decided to divide between themselves in the company.

From the outset, therefore, on cannot take the position that the only person liable is the director who has been most closely involved with management or the financial aspects of operating a company’s activities. All the directors are liable whatever each one’s duties may have been according to the division agreed on between them as to making decisions on the destiny of the company. As I said during the hearing, the obligations of the directors should not be confused here with the duties they perform as employees or which they carry out in the day-to-day operation of the company’s activities.

My second comment is that the evidence of the degree of care, diligence and skill must be assessed in terms of what was done to prevent the failure, not what was done to try to correct the situation after it occurred. In some circumstances evidence of ex post facto co-operation with the authorities may be a sign of good faith and honesty but it does not establish that the care, diligence and skill required to prevent the failure was present at the outset.

My third comment is that the test imposed by Parliament is that of a reasonably prudent person in comparable circumstances. It is clear because of this test that each case is to be decided on its merits, which must be considered in light of its particular circumstances.

Once the principle is established that liability under s. 227.1 is not absolute and that a person may be exonerated if he or she shows that he or she did not have the freedom to act, the case law does not have much application as the circumstances of one case cannot be readily substituted for those of another case.

In making the assessments which are the subject of the instant appeals the Minister relied on the facts set out in subparagraphs (a) to (y) of paragraph 11 of the Reply to the Amended Notice of Appeal; this Reply must be modified in accordance with the reassessments and the Notice of Appeal, as re-amended at the hearing. These various subparagraphs of paragraph 11 together with paragraph 12 and Schedule A, referring to the amounts assessed, are incorporated in these reasons for judgment without my having to read them or draw your attention to them.

[TRANSLATION]

11. He assessed the appellant with respect to his liability as a director of DACA after assuming the following facts:

(a) with Carl Bazinet (a close relative) and Daniel Charbonneau, the appellant was a director of a company called “Les Coffrages Daca Ltée” (hereinafter “DACA”) doing business in the construction industry in the Montréal area;

(b) the appellant and Carl Bazinet were also directors and shareholders of DACA; Daniel Charbonneau was also a director and was the de facto spouse of Isabelle Coulombe, who owned a majority of the shares in a business corporation, 162427 Canada Inc., which in turn held a majority of DACA’s voting shares, namely 60 percent;

(c) DACA’s books indicated that for a short time, that is from June 25 to July 12, 1991, Daniel Charbonneau ceased to hold the position of director, which was then held by Isabelle Coulombe;

(d) shortly after DACA began its activities it failed to remit on time the source deductions made from its employees’ pay for income tax and unemployment insurance premiums, together with the employer premiums owed for unemployment insurance;

(e) while the appellant made some effort to see that the amounts owed were paid he did not make similar efforts to collect the amounts owed from DACA until after they were outstanding and did not act with the degree of care, diligence and skill to prevent the failures by DACA which a reasonably prudent person would have exercised in comparable circumstances;

(f) the appellant allowed the company’s operations to begin and continue without ensuring that sufficient working capital was available;

(g) the appellant did not ensure that the shareholders were providing the company with sufficient capital to pay source deductions and employer unemployment insurance premiums on time; the appellant himself held 20 percent of the issued shares of DACA and his capital contribution did not reach $2,000;

(h) the appellant allowed advances to be made by DACA to directors and to related companies when payments of source deductions and unemployment insurance premiums were in arrears and he took no steps to ensure that those funds were returned to DACA;

(i) Daniel Charbonneau was involved in the management of DACA when he was involved in the management of other construction businesses, including Philbonneau Compagnie and Cathphil Construction Ltée, which had failed to remit source deductions and unemployment insurance premiums on time;

(j) DACA was incorporated on April 26, 1990;

(k) from May to October 1990 it failed to remit source deductions made and unemployment insurance premiums, with the result that the amount owing in this regard was $50,699.36;

(l) at the time of an audit of DACA pay slips made by Revenue Canada on November 26, 1990, a cheque for $25,000 dated November 29, 1990 was given to the auditor by the appellant with respect to the source deductions, together with a cheque for $17,000 dated December 23, 1990;

(m) a notice of assessment (No. 955774) dated December 7, 1990 was sent to DACA at its business address on or about December 10, 1990 showing a balance of $32,749.29; on July 24, 1991 a cheque for $4,900 made out to Cathphil Construction Ltée and Revenue Canada by Gerhard Friedrich and drawn on the Bank of Montreal in Lachute was given to Angelo Pizzardi of Revenue Canada by Daniel Charbonneau; Mr. Charbonneau indicated to Mr. Pizzardi at that time that the DACA controller would tell him of the amounts owed for May and June 1991 in the following week and would make arrangements for the outstanding amounts;

(n) a cheque from DACA in the amount of $16,228.07 dated January 23, 1991 and payable to the Receiver General of Canada was returned by the financial institution on which it was drawn because there were insufficient funds in the account; the same was true of two cheques dated June 20 and July 20, 1991 for $4,928 each;

(o) on November 27, 1991 a cheque for $54,125.96 made out to Philbon- neau Construction Management Ltd. and Regional Excise Office Montreal, by Gerhard Friedrich and drawn on the Bank of Montreal in Lachute was given to Mr. Pizzardi and the amount of $48,987.06 was applied to the arrears owed by DACA, the remainder being applied to the arrears of other companies;

(p) five post-dated cheques in the amount of $4,928 each and dated August 20, September 20, October 20, November 20 and December 20, 1991 were returned to DACA: these cheques were part of the same series as the cheques for $4,928 mentioned above in subparagraph (n);

(q) in August 1992 Daniel Charbonneau went to the Revenue Canada offices with a list of DACA’s accounts receivable and a summary report on form T-4 1991 regarding source deductions made by DACA for 1991: this T-4 summary indicated that the employer’s premiums were $25,211.47, the unemployment insurance deductions were $18,008.19 and the deductions for income tax, $101,591.78;

(r) DACA made applications for credit lines to financial institutions but none were granted; DACA’s account with the Caisse populaire was closed in April 1992;

(s) on October 7, 1992 Revenue Canada received the sum of $40,793 from Constructions D. Tardif Inc. (hereinafter “Tardif’), a debtor of DACA, against receipt and release, in payment of a requirement to pay sent to Construction D. Tardif Inc. on February 18, June 12 and September 11, 1992;

(t) the sum of $40,793 was received by Revenue Canada under an agreement for the distribution of funds owed to DACA, that is $85,000, by Tardif to various DACA creditors (including Revenue Canada); under that agreement DACA waived its claim against Tardif for an amount of $159,000;

(u) as directors of DACA, the appellant and his fellow directors participated in the conclusion of the agreement between Tardif, DACA and DACA’s creditors, but the effect of this distribution was to partially remedy DACA’s failures in respect of source deductions and unemployment insurance premiums, not to prevent them;

(v) DACA ceased its operations in December 1991 and made an assignment of its property pursuant to the Bankruptcy Act on December 4, 1992;

(w) on or about December 21, 1992, and in any case within six months of the assignment of its property by DACA, the Minister of National Revenue filed claims for assets and money with the trustee in bankruptcy amounting to $20,058.79 and $41,386.26 respectively, and these claims have been not met;

(x) before the assessment under appeal was made the Minister of National Revenue’s representatives wrote the appellant on December 14, 1992 to

(a) tell him of the proposal to assess him for $61,525.68 and (b) invite him to submit reasons why he should not be assessed and request explanations if necessary;

(y) the appellant and his fellow directors then pleaded the efforts they had made to facilitate the collection by Revenue Canada of amounts already owed by DACA and the difficult financial situation in which it found itself: they gave no indication of what they had done to prevent said failures nor did they request any explanations of the amounts indicated or of the statutory provisions under which it was proposed to assess them;

12. The details of the amounts assessed under the Unemployment Insurance Act and the Income Tax Act were given to the appellant in the form of tables before his appeal was filed, and they are in any case set out in Schedule A.

Evidence:

I will first make some comments on the general situation. We are dealing here with a business, Les Coffrages Daca Limitée, which worked in the construction field and was a formwork business with certain special characteristics to which I will return.

Certain points should be noted: the evidence has shown that the construction industry suffers from chronic liquidity problems which are due partly to the system of progress payments and contract deductions. These problems existed in the spring of 1990 and were more acute than before. According to Mr. Charbonneau, they were noticeable at that time. They were certainly noticeable and predictable for the new company created by the three individuals who at that time sought to set up a formwork business. We also know that outside financing in construction businesses, and in particular in the formwork field, is extremely difficult.

The evidence has shown that there was also an additional problem here, that is the high cost of labour in a formwork business, which leaves little room for manoeuvre as labour costs make up an extremely high proportion of the total operating costs of the business.

DACA was created on April 26, 1990. Much was made of the fact that they relied at the time on the financial health of Cathphil (Cathphil is a general contractor), which was to become more or less DACA’s banker; as they said, without Cathphil DACA would not have been possible.

What were the circumstances in which Cathphil operated its business? Mr. Charbonneau, one of the appellants, was himself a director of Cathphil. We know that Cathphil had been having liquidity problems and encountering SD delays (source deductions and withholdings) since the end of 1989 (December was mentioned) or early 1990 (I refer to Mr. Charbonneau’s cross-examination). This was due in particular to its problems with two companies, Polama and S.R.C., which are formwork businesses that were engaged, if one may say so, in the Century Products project. The problems also resulted from differences with the promoters and eventual owners of a hotel to be built on Carling Lake in Ontario.

Contrary to what Mr. Charbonneau said in cross-examination, DACA was not incorporated when the contract with S.R.C. had ended (it had taken over the Polama contract) in February 1990: it was not created until some months later. I would note that in examination-in-chief Mr. Charbonneau had said that DACA was probably incorporated in late 1989 or early 1990. As we all now know, it was April 26, 1990.

The capital invested in DACA when it was incorporated was $10,000, that is the minimum to obtain a building permit. It is clear that with an invested capital of $10,000 DACA needed more money to operate. In my opinion, it is also clear that too much reliance could not be placed on Cathphil from the outset, since applications were made to financial institutions almost immediately and we know that the person principally concerned was well aware of the Cathphil liquidity problems and its SD delays: I refer here to Mr. Charbonneau.

The application to the Royal Bank for a bank loan was made in the spring of 1990. It was rejected in less than a month or a month and a half. An application was then made to the Caisse populaire in Laval in June or early July. The amount sought was $100,000 or $200,000: the evidence as to this remained unclear. In any case, it was 10 to 20 times the invested capital.

In the spring of 1990, the fact that people did not pay was predictable, as Mr. Charbonneau said in cross-examination. An additional fact which we also know was that in the summer of 1990 Cathphil’s credit with the Royal Bank was cut back. The liquidity problems were known in Cathphil and anticipated in DACA: Mr. Charbonneau’s testimony on this point could not have been clearer.

DACA’s arrears developed in May 1990, barely a month after it was incorporated. They nevertheless continued paying employees their net pay. Mr. Charbonneau said that this was a priority. It may be wondered why Cathphil was not approached at once to pay the SDs as well. The answer is not difficult to find: Cathphil already had its own problems paying SDs.

Reference was made to efforts by the three shareholders and directors and arrangements with Cathphil. Cathphil provided the office and administrative services. Cathphil often advanced the money needed to pay the net salaries. Cathphil also provided materials. The directors of DACA were not paid as such: Mr. Charbonneau received no pay from DACA; Carl and Charles Bazinet reduced their salaries as DACA’s employees, which Mr. Charbonneau said was a form of additional capitalisation in DACA.

It is clear that these efforts to reduce costs did not suffice and that these efforts were not made so as to pay the SDs, since no one had paid the government from May to November 1990. Nevertheless, there were contracts, the business operated and the employees were paid.

In short, Cathphil already had liquidity problems and delays in paying SDs when DACA was incorporated. Minimum capital was invested in DACA and reliance was placed on Cathphil, which already had liquidity problems with two large contracts and was also encountering SD delays. External financing was also refused almost immediately after incorporation and this was quickly known. Cathphil’s credit was then cut back: this occurred in the very short term, in the following months, that is in the summer of 1990 according to the evidence. Nevertheless, they continued to operate, to pay employees, to arrange for suppliers to be paid, but no SDs were paid on time or paid at all before the auditor arrived in the fall of 1990.

A payment of $25,000 was made in November 1990 and another of $17,000 in December 1990, followed by two NSF cheques in February and April of 1991.

How can it seriously be said that a business was still viable when, as Charles Bazinet admitted, more than 70 NSF cheques had been issued, as a result of which no suppliers had any confidence in the ability of the business to pay and it was necessary to use a subterfuge, of which I still do not quite understand all the details, as it is described in the financial statements as advances to directors, in order to extract over $163,000 from the company to pay suppliers and continue operating, without in so doing regularizing the situation with Revenue Canada once and for all?

In this way the business continued operating for 12 to 14 months more and was always in arrears until its operations ceased. According to the chronology established by Charles Bazinet, this was in August, September or October 1991, he was not too sure, but in any case, he said, before the cold weather.

Conclusion:

The modus operandi was to finance the company with SDs and hope that someday the situation would improve. Mr. Charbonneau was aware of and familiar with it and had had several earlier experiences with other companies, including Dan Bonneau, from 1982 to 1985: I will return to this below. Mr. Charbonneau also had concomitant [sic] experience with Cathphil and Phil Bonneau: liquidity problems and systematic delays in paying SDs.

It was always the same system: financing with the aid of SDs as operations progressed. One waits for the assessment or audit, a payment is made in settlement, it is accepted, but the failure occurs again, or cheques are issued and they are not honoured. The problem continues with time and one is continually and systematically in default.

Those are my comments on the business. Now, what of the individuals? Daniel Charbonneau had experience on several previous occasions as a director and also with the SD type of problem, or the equivalent. It will be recalled that the failure to pay premiums to the C.C.Q. with respect to the Dan Bonneau business led to that company’s bankruptcy. Mr. Charbonneau was aware of his responsibility to make source deductions: his testimony on that point was quite clear. Furthermore, he was in charge of the management and finances of DACA. He also knew of the concomitant SD problems with Cathphil and Phil Bonneau, in which he was involved at that time.

In short, he was aware of the situation. Management was computerized, everything was run scientifically, he said, he knew exactly where he was going and he was aware of the arrears.

The other two shareholders and directors, Carl and Charles Bazinet, trusted him completely. They too were aware of the situation because they were kept informed weekly or at most every two weeks. They too were aware of their responsibilities and relied on him. They decided to continue operations, hoping that Mr. Charbonneau would finally be able to resolve the problem.

Listening to counsel for the appellants, I had the impression that he wanted to pass the Bazinet brothers off as incompetents or complete innocents compared to Mr. Charbonneau, the “boss”, as he was described.

First, they had experience in the construction industry. Second, they started as labourers but climbed up the ladder in the industry: one is a site foreman and the other a contracts appraiser, which is not insignificant. Third, they both belonged to family businesses, though only for short periods. Fourth, they did not join DACA on impulse: there were a few months of reflection and probation while they were employees of Cathphil. Fifth, they were fully informed and they relied on Mr. Charbonneau: relying on someone does not mean giving up the exercise of all judgment. Sixth, there was nothing in the evidence to indicate that anyone lied to them, tricked them, that they were not informed or that they had lost their freedom to think, exercise judgment and act as adults who are aware of their responsibilities.

There was also nothing in the evidence about control of DACA’s operations or finances being taken over by a bank or a third party. Furthermore, nothing in the evidence indicated any of these three individuals to be excluded from the decision-making process in DACA.

Seventh, as I said a moment ago they were both aware of their responsibilities as directors with respect to source deductions (they admitted this in their testimony). Eighth, they were aware of the liquidity problems and they knew that the SDs had not been deducted and paid. As they said, they were kept informed in broad terms so to speak weekly, even though they were not given all the figures in detail or they did not want to have all the figures in detail. Ninth, they discussed and participated in decision-making with Mr. Charbonneau at their weekly meetings. Tenth, in the testimony of both it could be seen that their attitude was to finish the contracts and pay employees first.

In the circumstances, the defence that Carl and Charles Bazinet were not liable is an inadmissible defence of childishness. There are limits to the control one person has over another. In civil law, unless there are exceptional circumstances, an adult is always responsible for his actions.

In conclusion, anyone can operate a business but he or she must do so in compliance with the law. It is first essential to obtain the necessary financing and liquidity and not to rely on the government. Source deductions are not an option or an alternative means of financing the day-to-day operations of a business. Even though the practice is widespread it is prohibited and constitutes a serious offence, severely punished by penalties and interest.

If a person knowingly agrees to take the initial risk despite the circumstances and an unfavourable situation, including the state of the market at the time, a minimal capital of $10,000 and reliance on another company which has already had significant problems, and wishes to continue in spite of everything and despite the lack of financing for over a year and a half, he or she is placing himself or herself personally at risk and must take the blame and bear the consequences.

It is not prudent to start a business without obtaining the necessary financing and liquidity when problems of this kind could easily have been foreseen. It is even less prudent to do so when it is seen from the outset that one cannot operate without immediately committing an offence against obligations imposed by law. That is the time to turn the key in the lock, or alternatively a business should never have been started in such circumstances. It becomes still less prudent when it can be seen that adequate financing cannot be obtained from one’s own resources or from lending institutions and that offences against obligations imposed by law are continuing, repeated and systematic over a period of months.

In my opinion acquiescing in such behaviour or, with full knowledge of the facts, failing to act has certain similarities to participating in acts of tax evasion which are too readily tolerated. That is not the correct behaviour of a reasonably prudent person in comparable circumstances. If an individual cannot himself or herself terminate the operations of a business in such circumstances, he or she should at least completely dissociate themselves from it by leaving and handing in a resignation.

I recognize that the construction industry is an extremely difficult sector: however, that does not mean that persons working in it are exempt from the application of the law.

As a consequence of the foregoing, the three appeals are dismissed with costs in favour of the respondent, but those costs are limited to the cost of a single appeal since all three were heard on common evidence. Thank you for your attention.

Appeal dismissed.