Vogt v. MNR, 91 DTC 1326, [1991] 2 CTC 2760 (TCC)

Mogan, T.CJ.:—The appellant was at all relevant times a director of and the president of Dresden Drywall Contracting Limited ("Dresden") a corporation engaged in the installation of drywall in Nova Scotia. When Dresden had financial difficulties and was forced out of business by its bank in March 1984, certain amounts referred to as "source deductions" which had been withheld from the salaries and wages of Dresden employees had not been remitted to Revenue Canada, Taxation. When Dresden was unable to remit those amounts, the respondent made an assessment against the appellant under section 227.1 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

The appellant attacks the assessment in two different ways. He relies on the recent decision of this Court in Leung v. M.N.R., [1991] 2 C.T.C. 2268; 91 D.T.C. 1020 to argue that the assessment is incomplete because it fails to specify the amounts assessed under the four different statutes; the federal Income Tax Act, the Unemployment Insurance Act, the Canada Pension Plan and the Income Tax Act of Nova Scotia. He also argues that he exercised the required degree of care, diligence and skill under subsection 227.1(3). Counsel for the appellant stated that he relied on both arguments but the decision in Leung as a question of law could possibly be reversed in a higher court. I will therefore consider first the due diligence argument under subsection 227.1(3).

The appellant is an experienced Halifax businessman. At one time he was a chartered life underwriter and for the past 23 years he has been a real estate broker. In 1982, he was asked to invest in Dresden which was a new business begun by Edgar Chagnon, a dry wall plasterer, and Richard Woerz, a painter and decorator. The request came from one Jeff Gray, a retired bank manager, who was managing the Dresden business and soliciting investors. The appellant was impressed with the prospects of Dresden and invested more than $100,000 in the corporation. In December 1982, one of the original investors departed and John Filbee, a Halifax physician, became a shareholder of Dresden. Dr. Filbee had a prior business connection with Jeff Gray.

Although the appellant was president and a signing officer of Dresden, he had no active involvement with the day-to-day operations of the corporation. In November 1983, Jeff Gray told the appellant that a cheque to Revenue Canada, Taxation ("RCT") for $15,000 representing payroll source deductions had been returned NSF and the appellant was asked to advance the $15,000 to Dresden. In February 1984, the appellant learned that RCT had placed a garnishee (a third-party demand) against a Dresden project. The appellant then asked for a meeting with Donald C. Horne, Chief of Collections in the Halifax district office of RCT. What followed is really important because it goes to the heart of the appellant's claim of due diligence under subsection 227.1(3).

On February 27, 1984, the appellant and Mr. Horne met at Mr. Horne's office to discuss the amounts owed to RCT by Dresden and certain garnishees which RCT had issued to persons with whom Dresden was doing business. Both the appellant and Mr. Horne testified in this proceeding and there was no conflict in their evidence as to what happened at the meeting. As a result of the meeting, Mr. Horne sent two letters dated February 28, 1984. The first letter was to Dresden to the appellant's attention and stated:

This will confirm our arrangement to clear the outstanding arrears of $15,558.67 for the Payroll deduction account of Dresden Drywall Limited as follows:

(1) All garnishees are to be lifted except for Boyd Garland Construction Limited.

(2) Boyd Garland are to honour the garnishee the end of March, 1984.

(3) February deductions of $9,847.47 are to be paid at our office on March 15, 1984.

The calculations provided during your visit were incorrect as the employer’s portion of U.I.C. was not calculated properly.

The second letter was to Boyd & Garland with reference to the Dresden garnishee and stated:

Attached please find a revised Requirement to Pay for the above-noted company in the amount of $15,558.67. This Requirement cancels the previous two issued to your company in the amount of $8,152.62 and $19,168.67.

As per our recent telephone conversation, we are in agreement to this Requirement being paid the end of March, 1984 from the holdback of Dresden. Monies in the interim can he paid as they come due. We wish to thank you for your cooperation and assistance in this matter and if there are any questions, please contact myself at the above number.

Mr. Horne also wrote letters on February 28 to three other persons withdrawing garnishees against Dresden.

After the meeting at Mr. Horne's office, the appellant spoke with Dr. Filbee and they agreed each to advance $5,000 to Dresden to cover the obligation of $9,847.47 with respect to Dresden's February source deductions. Dr. Filbee testified and confirmed this arrangement. Exhibit A-5 is a cheque dated February 27, 1984 for $5,000 issued to Dresden by one of the appellant's companies and signed by the appellant. Exhibit A-7 is a cheque dated February 25, 1984 for $5,000 issued to Dresden by Dr. Filbee and signed by him. Both cheques are shown as having been deposited at the National Bank, 1861 Brunswick Street, Halifax (Dresden's Bank) on February 27, 1984. Dr. Filbee wrote to Jeff Gray on February 26 enclosing his cheque and stating that it was to cover the outstanding payroll cheques and income tax third-party demand. The appellant also wrote to Jeff Gray on March 7 stating:

As I told you last week we have just moved and everything is upside down, however, I gave you checks for my share of the money due the tax department, only because I told Don Horne it would be looked after.

I spoke to John, who said he had made a loan to cover his share . . .

The person referred to as "John" in the appellant's letter is Dr. Filbee.

There is no doubt that the two cheques for $5,000 were deposited in Dresden's account but Dresden did not make the payment of $9,847.47 (or indeed any payment) to RCT with respect to its February source deductions. Also, RCT did not recover any amount from the Boyd & Garland project because, apparently, other creditors of Dresden filed liens against the project which took priority over RCT. On March 15, 1984, the respondent issued an assessment to Dresden with respect to the delinquent source deductions but no further amounts were recovered. The respondent issued a notice of assessment to the appellant on January 16, 1986 in the amount of $21,841.06 under subsection 227.1(1) of the Income Tax Act. Following the appellant's notice of objection, a second notice of assessment was issued to the appellant on March 21, 1989 in the amount of $28,617.49.

The appellant claims that he exercised the required degree of care, diligence and skill under subsection 227.1(3) when he made the arrangement with Mr. Horne on February 27, 1984 and honoured that arrangement by his subsequent agreement with Dr. Filbee to provide $10,000 to Dresden. It is apparent from Mr. Horne's letters of February 28 that both he and the appellant thought that the arrears prior to February ($15,558.67) would be covered by the Boyd & Garland garnishee and that the February source deductions ($9,847.47) would be paid by Dresden under the appellant's promise. The appellant's letter of March 7 to Jeff Gray states: ”. . . I told Don Horne it would be looked after". The respondent has not suggested that the appellant was not acting in good faith when he made the arrangement with Mr. Horne on February 27 and obtained the two payments of $5,000 for Dresden immediately thereafter.

Mr. Jeff Gray, the manager of Dresden, does not look very prudent in these circumstances. As a retired bank manager, he should have known that if Dresden's line of credit was overdrawn at the National Bank, then it would scoop the $10,000 from the appellant and Dr. Filbee and leave no funds to pay RCT. In retrospect, Mr. Gray should have advised the appellant and Dr. Filbee to issue their $5,000 cheques directly to the Receiver General of Canada for the account of Dresden or he should have deposited their cheques only on condition that the National Bank would issue its money order to the Receiver General in the amount of $9,847.47. The appellant's counsel concedes that his client relied on Mr. Gray and, if he should not have done so, then his appeal should fail. By way of support, however, appellant's counsel points out that another independent and intelligent director, Dr. Filbee, also relied on Mr. Gray.

The respondent argues that the appellant as an experienced businessman received a warning in November 1983 when the Dresden cheque for $15,000 was returned NSF and, thereafter, he should have asked more questions and not relied on Mr. Gray. Also, the January source deductions were in default as of February 15, 1984 and the meeting on February 27 was too late "to prevent the failure" within the meaning of subsection 227.1(3). When making the assessment, the respondent assumed that Dresden repaid a loan to the appellant in May 1984 in the amount of $12,450. While this assumed fact was not specifically addressed by the appellant in evidence, he did state that he was required to pay a substantial amount to the National Bank in or after March 1984 to honour his guarantee after the Bank had put Dresden into receivership. It seems unlikely, therefore, that he received the amount of $12,450.

Although Mr. Horne's letters are not specific concerning amounts owing as source deductions for particular months, it appears that the amount of $15,558.67 claimed from Boyd & Garland represented source deductions for January 1984 and prior months whereas the amount of $9,847.47 is identified as February deductions. The amount of $15,558.67 was in default after February 15 and this default seems to have triggered the meeting at Mr. Horne's office on February 27.

In many situations, "the failure" in subsection 227.1(3) would be one or more isolated events after which the care and diligence of a director would be too late and irrelevant. That was the situation in White v. M.N.R., [1990] 1 C.T.C. 2566; 91 D.T.C. 54 and Van Leenen v. M.N.R., [1991] 2 C.T.C. 2442; 91 D.T.C. 1265. In that sense, it may have been too late on February 27 for a director of Dresden to "prevent the failure" with respect to an amount in default after February 15. But in a broader sense, Dresden was still carrying on business on February 27 and there were a number of Dresden projects against which RCT had garnishees with a reasonable expectation of recovering the amounts in default. No one knew on February 27 that the National Bank would put Dresden into receivership in March although the corporation did have an ongoing financial crisis concerning its ability to pay creditors. In these circumstances, I regard the amount of $15,558.67 (in default after February 15) as an ongoing failure which still could be prevented by a director's care and diligence in the latter days of February. The source deductions of $9,847.47 for February were not yet in default on February 27.

In my view, the appellant's good faith efforts on February 27 to secure payment of the amount in default through the Boyd & Garland garnishee plus his personal promise and payment for the February source deductions were adequate to satisfy the standard of care and diligence in subsection 227.1(3). It was the appellant who sought the meeting with Mr. Horne on February 27. He thought that the amounts due from the Boyd & Garland project would be adequate to discharge the liability of $15,558.67 for January and prior months and he promised personally to secure the funds to pay the February deductions. He kept his promise and, as a result, he and Dr. Filbee each lost an additional $5,000. At the time, I think that the appellant and Dr. Filbee were entitled to rely on Mr. Gray even though subsequent events proved that Mr. Gray was neither shrewd nor prudent when depositing the two cheques in the National Bank. The appellant did all that a reasonably prudent director would have done in the circumstances which existed on February 27, 1984.

It is trite to say that the liability imposed on a director under subsection 227.1(1) is not absolute. The director does not become a guarantor or an insurer. He is relieved of his vicarious liability if he exercises the degree of care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances. I hold that the appellant exercised that degree of care and diligence when he made the arrangement with Mr. Horne on February 27 and, on the same day, delivered two good cheques for $10,000 to Mr. Gray, the manager of Dresden, with specific instruction that the $10,000 was to go to RCT.

Having decided that the appellant exercised the required degree of care and diligence under subsection 227.1(3) of the Income Tax Act, it is not necessary for me to determine whether the recent decision of this Court in Leung v. M.N.R., supra, applies to the notice of assessment dated March 21, 1989 which is under appeal herein. I would simply observe, however, from the details in paragraph 4(i) of the respondent's reply to the notice of appeal and from the words appearing in the notice of assessment that the decision in Leung appears to apply. The appeal is allowed with costs.

Appeal allowed.