Berdugo v. Ministre Du Revenu National, 99 DTC 5424, [1999] 3 CTC 585 (FCTD)

Richard A.C.J.:

Procedure

This is an appeal from a decision by the Tax Court of Canada dated September 28, 1995 and filed in this Court on September 7, 1995 by statement of claim.

Facts

Four witnesses were heard at the hearing. It appeared from the said testimony that on or about December 18, 1986, the plaintiff subscribed to the capital stock of a newly incorporated business specializing in the manufacture of ladies’ clothing, known as “Créations Tony T.” The plaintiff became a director along with Tony Tavarozzi, another majority shareholder in the said business and its president. Joseph Elbaz, the plaintiffs accountant, was also a minority shareholder in the said business.

It appeared from the evidence that Créations Tony T. served as a clothing supplier to a business held by the plaintiff which was already working in the export and import of clothing.

The plaintiff, or in his absence his accountant Joseph Elbaz, proceeded to co-sign cheques with Tony Tavarozzi in order to pay money owed by the business to its employees and to various suppliers and/or creditors.

According to the testimony of Joseph Elbaz in May 1987 the said business was already experiencing certain financial difficulties, resulting in its failure to pay certain financial obligations on time. At that time an arrangement was made with the duly authorized representatives of Revenue Canada for the payment of unpaid source deductions. It appeared from the testimony that a series of postdated cheques was signed to correct the nonpayment of the said deductions. However, Tony Tavarozzi, who was to have been responsible for sending the said cheques, did not do so, on the ground that he was waiting till he had sufficient capital.

Following these various events the plaintiff was obliged to negotiate a further credit line of $20,000 with the Toronto Dominion Bank which he had to guarantee personally for and on behalf of the business, so that the latter would be able to make the said payments owed to the defendant.

As a result of the storm which hit downtown Montréal in July 1987 it appeared from the evidence as a whole that the business suffered damage valued at nearly $110,000. On account of this situation the business had to extend the suspension of its operations and delay the return of employees who were on vacation at the time.

The plaintiff stated that he had to negotiate with the Toronto Dominion Bank to obtain an extension of the credit line; he also stated that negotiations went ahead in July and September 1987 to obtain the necessary financing to restart the business.

A new agreement was made with a duly authorized representative of the defendant for payment of the said charges owed for source deductions. The agreement in question involved the issuing of ten postdated cheques in the amount of $1,739, payable every week beginning on October 2, 1987. However, the Toronto Dominion Bank refused to advance the funds needed by the business and consequently to honour the first seven cheques issued to the defendant.

Créations Tony T. made an assignment of its property on December 11, 1987.

On April 7, 1988 the defendant filed proof of claim of property under the Bankruptcy Act for an amount of $17,774.40.

On September 8, 1989 the defendant assessed the plaintiff for an amount of $25,469.69, that is, the amount owed by the business Créations Tony T. as source deductions for the period from June I to September 28, 1987, to which the plaintiff objected by a notice of objection dated September 8, 1989.

On January 25 the defendant proceeded to issue a reassessment reducing the amount claimed to $17,774.40, to which the plaintiff again objected by the filing of a new notice of objection on April 5, 1990.

Following the said notice of objection the defendant issued a notice of confirmation on August 16, 1990.

On September 8, 1990 the plaintiff filed a Notice of Appeal with the Tax Court of Canada in respect of Notice of Assessment No. 5289, dated Janu- ary 25, 1990, issued pursuant to ss. 227.1 of the Income Tax Act and 68.1 of the Unemployment Insurance Act, 1971, as a result of the failure by Créations Tony T. to pay source deductions made pursuant to the Income Tax Act and unemployment insurance premiums owed by the employer and employees for the period from June to September 1987. The said appeal was dismissed by Judge Pierre Archambault on September 28, 1995.

Issues

Three questions were raised at the hearing:

1. Did the Tax Court of Canada err in fact and in law by dismissing the appeal filed from the assessment having No. 5289 and dated January 25, 1990, on the ground that the plaintiff did not establish that he had acted as a reasonably prudent person would have done in such circumstances in accordance with subsection 227.1(3) of the Income Tax Act?

2. Did the Tax Court of Canada err in fact and in law by dismissing the appeal filed from the assessment having No. 5289 and dated January 25, 1990 by finding that the defendant observed the six-month deadline required by paragraph 227.1 (2) (c) of the Income Tax Act?

3, Did the Tax Court of Canada err in fact and in law by dismissing the appeal filed from the assessment having No. 5289 and dated January 25, 1990 by finding that the recovery proceedings were brought within the two years in which the plaintiff ceased to be a director in accordance with subsection 227.1(4) of the Income Tax Act?

Analysis

When the proceedings were filed four questions were raised: nevertheless, as the question of this Court’s jurisdiction was not raised at the hearing I will only deal with the questions mentioned above.

I. Defence of due diligence

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

(3) Idem. A director is not liable for a failure under subsection (1) where the director exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.

(3) Idem. Un administrateur n’est pas responsable de l’omission visée au paragraphe (1) lorsqu'il a agi avec le degré de soin, de diligence et d’habileté pour prévenir le manquement qu’une personne raisonnablement prudente aurait exercé dans des circonstances comparables.

In Soper v. R. (1997), [1998] 1 F.C. 124 (Fed. C.A.), at 155, the Federal Court of Appeal indicated what the standard of care applicable under the wording of subsection 227.1(3) 1s:

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).

The standard of care set out in subsection 227.1(3) of the Act is, therefore, not 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, the standard can be properly described as “objective subjective”.

At 156, the Court made distinctions between a company’s inside and outside directors:

At the same time, however, it is difficult to deny that inside directors, meaning those involved in the day-to-day management of the company and who influence the conduct of its business affairs, will have the most difficulty in establishing the due diligence defence.

On an outside director’s duty to act, it indicated at 160:

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, or ought to have known, that 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.

The plaintiff argued that in accordance with the rule laid down by the Federal Court of Appeal he was only an outside director, as he alleged that he had not actively participated in managing the business except in signing cheques used to pay employees and other creditors of the business, since he had owned his own clothing importation business for twenty years and worked actively in it.

The plaintiff further argued that from June 1987 onwards he was no longer involved in the management of the business with the other director, and it was actually his accountant Joseph Elbaz who performed the various duties relating to the said management and thus who signed the cheques for payment of employees and other creditors.

The plaintiff further submitted that the main reason Créations Tony T. was unable to make the payments owed to the defendant as source deductions arose essentially out of a fortuitous event, the storm which hit downtown Montréal on July 14, 1987 and caused damage estimated at $110,000 to the said business.

The company’s assets had been undervalued by it, with the result that only 25 % of the value of the damage caused by the storm was covered by the insurance.

Nonetheless, it appeared that the financial difficulties of the business appeared in May 1987, before the said fortuitous event occurred. Further, in his testimony Joseph Elbaz noted that he had told the plaintiff about the said problems.

It appeared from the evidence as a whole that the plaintiff was actively involved as a director of the business and was kept well informed of the problems the business had paying amounts owed as source deductions, since he alleged he had had to negotiate an additional line of credit of $20,000 on or about June 1987, which he had had to personally guarantee with the Toronto Dominion Bank, in order to make the said payments owed to the defendant.

The plaintiff further stated that he had again negotiated an additional line of credit, also with the Toronto Dominion Bank, in order to get the business going again after the damage suffered, and the said negotiations had taken place between July and September 1987.

The plaintiff also maintained that he had actively sought to prevent the failure by the business to remit the money owed to Her Majesty the Queen for source deductions. In his testimony the plaintiff stated that he continued to rely on Tony Tavarozzi’s management methods in July, August and September 1987, despite the events which had occurred earlier and the increased financial problems following the storm.

In view of the fact that the plaintiff has extensive experience in managing a clothing manufacturing business, as he has himself owned a similar business for twenty years, and that he had been given sufficient information to be alerted to the financial irregularities in the business, I cannot subscribe to the conclusion that he acted with the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.

The plaintiff was not simply an investor or silent partner. The business Créations Tony T. in which he held a major investment was founded to supply clothing to his other business, in which he was the majority shareholder. He was an experienced director who, in addition to acting as cosignatory for the cheques issued by the business, regularly visited the production plant. In May and at latest in June 1987 he was told of the financial problems of the business, including the failure to make remittances. He still continued to rely on Tony Tavarozzi and nothing changed in the management, although the business was in financial difficulty.

I conclude that the plaintiff was an inside director. Even if I had come to the conclusion that he was an outside director, he knew or should have known that the business might have a problem with remittances.

Joseph Elbaz noted that he had learned of the irregularities in May 1987 when the suppliers were not paid on time. Consequently, he concluded that the company was no longer able to pay certain obligations on time.

The plaintiff continued to rely on Tony Tavarozzi even after the events in June and the increased financial problems resulting from the storm. He changed nothing in the operations of the business.

Although the insurer refused to give the business the compensation it claimed, the plaintiff decided to resume operations after the storm. It appeared from the evidence that the employees of the said business were paid during that period and that the source deductions were withheld but not remitted to the defendant.

In accordance with the reasons of Robertson J.A. in Soper, since the standard of care is both objective and subjective it is not enough for a director to say that he did his best: [this] cannot relieve him of his liability as a director of the business, since the objective facts clearly allowed him to see that the company was having financial difficulties and was having a problem with remittances.

In these circumstances, I conclude that the plaintiff did not meet the standard of care laid down by the Federal Court of Appeal in Soper.

2. Deadlines

I can conclude on the evidence submitted to this Court that a claim was in fact proven within the deadline specified by paragraph 227.1(2)(c) of the Income Tax Act and in these circumstances the Tax Court of Canada judge, who ruled on the evidence before him, did not err in fact or in law.

I am also satisfied with the evidence submitted in this Court indicating that the recovery action or proceedings brought by the defendant were brought within the two-year deadline specified in subsection 227.1(4) of the Income Tax Act, and that the Tax Court of Canada consequently did not err in fact and in law in answering this question in the affirmative either.

Conclusion

This appeal is dismissed.

Appeal dismissed.