Veilleux v. R., [1999] 4 CTC 2670, [1999] DTC 1251

Archambault T.C.J.:

André Veilleux is appealing an assessment made by the Minister of National Revenue (Minister) under section 227.1 of the Income Tax Act (Act) and under the Unemployment Insurance Act (UIA). In that assessment dated April 26, 1996, the Minister held Mr. Veilleux, as a director of Les Entreprises Melateck Inc. (Melateck), liable to pay amounts (source deductions) that Melateck should have withheld on salaries paid to its employees. The Minister also held Mr. Veilleux liable for premiums that Melateck failed to remit to the Minister under the U/JA. With penalties and interest, the Minister’s assessment came to $39,239.18 for the period from September to December 1994 (relevant period). On February 21, 1995, a receiving order was issued against Melateck under the Bankruptcy and Insolvency Act. The Minister filed proofs of claim with the trustee on March 30, 1995. The only issue is whether Mr. Veilleux, as a director of Melateck, exercised the degree of care, diligence and skill to prevent Melateck’s failure during the relevant period that a reasonably prudent person would have exercised in comparable circumstances.

Facts

During the relevant period, Melateck manufactured melamine furniture. Mr. Veilleux was the corporation’s sole shareholder and director. He had only a Grade 11 education. It was he who founded Melateck, on November 9, 1978. At that time, he had been a sales representative for an electronic products company for about 10 years. Tables for those electronic products were the first items of furniture manufactured by Melateck. Mr. Veilleux left his position as a sales representative in 1985 to devote all his time to Melateck.

In 1984, financial problems obliged Melateck to postpone the remittance of its source deductions. It subsequently resolved those problems and so paid its back taxes.

Although Melateck never made any substantial profits, it managed to carry on business successfully from 1985 to 1990. The advent of the new goods and services tax and the abolition of the provincial sales tax exemption had a negative impact on its sales, however. From 1991 on, it incurred losses: $54,000 in 1991, $55,000 in 1992 and a similar loss in 1993. The situation was also made worse by an attempt to break into the American market that turned out badly.

Generally speaking, Melateck had its most serious cash flow problems and made greatest use of its line of credit from July to September. That was when production of furniture for the fall season was in full swing.

At the start of the relevant period, Melateck’s line of credit was $400,000, $374,000 of which had been used. Given the recurrent losses and low profitability that had always characterized the business, Melateck’s banker lost confidence in its future and, at a meeting in October 1994, asked Mr. Veilleux to find Melateck a new banker. The bank did not change its decision even though Mr. Veilleux withdrew $80,000 from a registered retirement savings plan to invest in Melateck. In a report dated October 26, 1994, the bank said that it was going to check Melateck’s bank account every day to make sure it was not overdrawn, and it confirmed that it had told Melateck it would not hesitate to refuse to honour Melateck’s cheques if it borrowed more than the line of credit allowed or if doing so was necessary to properly protect the line of credit.

Around the end of October 1994, because of the concerns it had, the bank branch with which Melateck did business decided to transfer supervision of the loans made to Melateck to a special unit. Mr. Cayer, a representative of that special unit, testified at the hearing at Mr. Veilleux’s request. He said that he simply made sure at the end of each day that the line of credit account was not overdrawn and that he allocated the surplus to repayment of the loans. The bank did not write the cheques payable to Melateck’s suppliers or require that each of the cheques issued by Melateck be approved by it. However, Mr. Cayer admitted that it was necessary that the [TRANSLATION] “situation improve” and said that he would not have hesitated to refuse to honour a cheque if Melateck had been overdrawn. As far as Mr. Cayer could recall, the bank never refused to honour a cheque because of a lack of funds. Moreover, he acknowledged that he never dis- cussed payment of the source deductions owed to the Minister with either Melateck or its representatives. According to Mr. Cayer, Mr. and Mrs. Veilleux continued to run Melateck’s business.

In his testimony, Mr. Morrissette, a management consultant employed by Melateck on a part-time basis, confirmed that Mr. Veilleux’s spouse, Ms. Boisvert, was the one who wrote the cheques to be sent to the suppliers and the Minister. However, it was Mr. Morrissette who decided to whom the cheques could be sent. In the case of the Minister, he decided to keep the cheques because of a cash shortage. According to him, it was important to improve Melateck’s financial situation before paying the Minister. In view of the bank’s decision not to increase Melateck’s line of credit and to require it to find a new banker, it was imperative that all the cheques issued be covered by deposits. It was therefore necessary to focus on the essential expenses, namely the employees’ net wages and the accounts of the most important suppliers. Mr. Morrissette confirmed that Mr. Veilleux handled Melateck’s production and sales and was not involved in choosing the creditors that Melateck paid. Mr. Morrissette, like Mr. Veilleux, hoped that all the amounts owed to the Minster would be paid after a new banker and new financing were found.

Both were confident that they would find a new banker. The National Bank and the Laurentian Bank were approached. A number of meetings were held with representatives of the National Bank in the fall of 1994. However, in December of that year, that bank informed Melateck that it had decided not to finance it.

As a result of that turn of events, Melateck was unable to obtain its new financing and so could not pay the amounts owed to the Minister. The solution then adopted by Melateck was to sell its business assets to a new corporation owned by Ms. Boisvert, Mr. Veilleux’s spouse. That bulk sale occurred with the consent of Melateck’s banker. In a report dated January 17, 1995, the bank analyzed the situation and decided that it would be better to co-operate because that solution seemed to be the most promising one for the recovery of its debts. Mr. Cayer and one of his co-workers put it this

way: “We have considered taking control of this operation and maximizing the liquidation process; however, this alternative would expose us to a loss. In allowing the owners to self liquidate, it permits us to recapture all our funds.”

It appears that this strategy was successful. In the fall of 1994, the bank managed to recover about $60,000. The unpaid balance of the line of credit went from $374,000 on October 26, 1994, to $310,471 on January 10, 1995. It also seems that the bank subsequently succeeded in recovering everything it was owed.

According to Mr. Morrissette, Melateck was unable to pay the Minister because of a cash shortage and the constraints imposed by Melateck’s banker. Moreover, at the end (between mid-December 1994 and mid-Janu- ary 1995), the Minister seized some of Melateck’s accounts receivable, which Mr. Morrissette said made it more difficult to collect the accounts.

In his testimony, Mr. Veilleux explained that the last payments made by Melateck to its employees in December 1994 were for statutory holidays. He considered it important to pay them those amounts just before the Christmas holidays because of the low wages they were earning. When asked what steps he had taken to ensure that source deductions would be remitted to the Minister, Mr. Veilleux answered that he had approached other bankers to obtain new financing and had done everything he could to protect his business as a whole.

Analysis

The only reason given by Mr. Veilleux for challenging the Minister’s assessment is that he exercised “the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances”, as required by subsection 227.1(3) of the Act. The issue of whether Mr. Veilleux met that standard of care is above all a question of fact. A number of comments on the approach that the courts should take in assessing the facts can be found in the case law. Some guidelines to be followed have been set out in a recent decision by the Federal Court of Appeal in Soper v. R. (1997), [1998] 1 F.C. 124 (Fed. C.A.) and [1997] F.C.J. 881 (QL). In that decision, Robertson J.A. began by providing a helpful review of the legislative history and framework of section 227.1 of the Act. He wrote the following at paragraph 11 of his decision: [11] Prior to the coming into force of section 227.1 of the Act, the Department of National Revenue faced two related but distinct problems. The first was the non-payment of corporate taxes per se and the second was the non-remittance of taxes that were to be withheld at source on behalf of a third party (e.g. employees). The 1981 recession exacerbated both of these problems. As companies experienced difficult financial times, corporations and directors actively and knowingly sought to avoid the payment of taxes in a variety of ways. For example, some companies allowed themselves to be stripped of their assets by a related entity, and left with an uncollectable "l.O.U. \ with the result that the Crown’s claim for unpaid corporate taxes could not be satisfied.... Non-remit- tance of taxes withheld on behalf of a third party was likewise not uncommon during the recession. Faced with a choice between remitting such amounts to the Crown or drawing on such amour to pay key creditors whose goods or services were necessary to the continued operation of the business, corporate directors often followed the latter course. Such patent abuse and mismanagement on the part of directors constituted the "mischief’ at which section 227.1 was directed.... [Emphasis added.]

Robertson J.A. summarized as follows the approach the courts must take in applying the defence set out in subsection 227.1(3) of the Act:

[40] This is a convenient place to summarize my findings in respect of subsection 227.1(3) of the Income Tax Act. The standard of care laid down in subsection 227.1(3) of the Act is inherently flexible. Rather than treating directors as a homogeneous group of professionals whose conduct is governed by a single, unchanging standard, that provision embraces a subjective element which takes into account the personal knowledge and background of the director, as well as his or her corporate circumstances in the form of, inter alia, the company’s organization, resources, customs and conduct. Thus, for example, more is expected of individuals with superior qualifications (e.g. experienced businesspersons).

[41] The standard of care set out in subsection 227.1(3) of the Act I iS, therefore, sa purely objective. Nor is it purely subjective. It is not enough for a director to say he or she did his or her best, for that is an invocation of the purely subjective standard. Equally clear is that honesty is not enough. However, the standard is not a professional one. Nor is it the negligence law standard that governs these cases. Rather, the Act contains both objective elements — embodied in the reasonable person language — and subjective elements — inherent in individual considerations like “skill” and the idea of "comparable circumstances”. Accordingly, h standard can be properly described as objectiv subjective”. [Emphasis added.]

Robertson J.A. was a little more explicit about what an outside director must do if he or she wants the benefit of the due diligence defence. He stated the following:

[53] In my view, the positive duty to act arises where a director obtains information, or becomes aware of facts, which might lead one to conclude that there is, or could reasonably be, a potential problem with remittances. Put differently, it is indeed incumbent upon an outside director to take positive steps if he or she knew ought to have known, tha the corporation could be experiencing a remittance problem. The typical situation in which a director is, or ought to have been, apprised of the possibility of such a problem is where the company is having financial difficulties. [Emphasis added. }

Needless to say, no less can be required of an inside director, such as Mr. Veilleux.

I will now analyze the relevant facts of this case. First of all, it must be noted that Mr. Veilleux was Melateck’s sole director and shareholder during the relevant period. He was involved in Melateck’s operations on a daily basis. It was he who started the business in 1978. Although he had only a Grade 11 education, he had worked in business for many years. During the relevant period, Mr. Veilleux had already been running Melateck for 16 years. Moreover, he had had some financial problems in 1984, which had led him to postpone the remittance of the source deductions that Melateck owed the Minister. We are therefore dealing with a director who knew or at least ought to have known that it was important to remit source deductions to the Minister.

In 1994, Mr. Veilleux was aware of Melateck’s financial problems. His banker had told him that he had to find another banker and obtain new financing. Mr. Veilleux was, of course, involved in the steps taken to obtain that new financing. When asked what he had done to prevent the failure to fulfil the obligation to remit source deductions and premiums under the UIA to the Minister, Mr. Veilleux merely referred to the steps he had taken to obtain new financing from a new bank. He spoke only of what he had done to save the business as a whole.

The evidence did not show that Mr. Veilleux took steps to ensure that the source deductions and unemployment insurance premiums would be remitted to the Minister. Nor did the evidence show that he contacted representatives of the Minister to discuss what should be done to eliminate the arrears. Mr. Cayer testified that the matter of paying Melateck’s source deductions was never raised. Nor is there any evidence that the bank prevented Melateck from paying the Minister.

In my opinion, Mr. Veilleux did not exercise the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances. This is a typical case of a business that, when faced with very serious financial problems, must choose which of its creditors it will pay. Melateck chose to pay its employees’ net wages and certain essential suppliers first. By allowing Melateck to give priority to some of its creditors at the Minister’s expense, Mr. Veilleux ran the risk of becoming personally liable if his attempts to obtain new financing proved unsuccessful. That is in fact what occurred, and Mr. Veilleux must therefore accept the consequences of Melateck’s choice. I con- sider this outcome all the more reasonable given that Melateck’s bank seems to have been repaid everything owed to it and that Mr. Veilleux’s family managed to save his business by allowing Melateck’s business assets to be transferred from a corporation owned by Mr. Veilleux to another corporation owned by Ms. Boisvert. Had it not been for section 227.1 of the Act, out of the bank, the Veilleux family and the Minister, only the Minister would have lost out.

In his argument, counsel for Mr. Veilleux attached great importance to the decision rendered by my colleague Judge Rip in Grigg v. R., [1998] 4 C.T.C. 2758 (T.C.C.). I do not think that Mr. Veilleux’s situation is analogous to Mr. Grigg’s. First of all, unlike Mr. Veilleux, Mr. Grigg did not have much experience in business. More importantly, the bank of Mr. Grigg’s corporation exercised a degree of control that is not found in the instant case. Unlike what is the case here, it was the bank of Mr. Grigg’s corporation that decided which creditors could be paid. Mr. Grigg tried to convince his banker to pay the Minister. He even attempted to pay what was owed to the Minister, but his bank refused to honour the cheque.

Finally, it is important to note that Mr. Grigg was held liable for the failure to fulfil the obligation to remit the tax deductions owed by the corporation of which he was a director up until the time he took steps to pay the Minister. Judge Rip described the situation as follows:

[58] Up to and including the end of February 1993 Mr. Grigg did nothing to prevent the Company’s failures to remit. That the Company was in an intolerable relationship with its banker is not by itself a valid due diligence defence. It is only when Mr. Grigg learned of the failures and got in touch with Revenue Canada in an attempt to right the failures and Ms. Cunningham requested the Bank’s approval of cheques to Revenue Canada did Mr. Grigg start to exercise a degree of care, diligence and skill to prevent future failures.

In the case at bar, the evidence clearly shows that the bank did not decide which of Melateck’s creditors were to be paid. There is no evidence that the bank ever refused to honour a cheque to the Minister for the payment of source deductions and employment insurance premiums. The bank honoured all cheques, provided that there were sufficient bank deposits to cover them. The evidence also shows that it was Melateck and more particularly Mr. Morrissette that decided which creditors were to be paid. It is quite obvious that Melateck had little room to manoeuvre and could not expect all its cheques to be honoured if it paid each of its creditors. It therefore had to make a choice, and the Minister was not one of its important creditors. It was precisely to prevent such a situation occurring that section 227.1 of the Act was enacted. Having decided to pay its employees their wages, Melateck had to remit the corresponding source deductions and premiums under the U/A to the Minister. Since he did not take the necessary steps to prevent the failure to fulfil that obligation, Mr. Veilleux cannot escape the liability that results from subsection 227.1(1) of the Act.

For these reasons, Mr. Veilleux’s appeal is dismissed with costs to the respondent.

Appeal dismissed.