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Citation: 2009 TCC 451
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Date: 20090911
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Dockets: 2005-4271(IT)G
2005-3409(GST)G
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BETWEEN:
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THOMAS GERALD (GERRY) LIDDLE,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Campbell J.
[1] These
appeals deal with the liability of the Appellant, in his capacity as director
of AquaNorth Farms Inc. (“Farms”) in respect to the failure of Farms to remit
net tax – GST under the Excise Tax Act (“ETA”) together with
payroll source deductions under the Canada Pension Plan (“CPP”)
and the Employment Insurance Act (“EIA”).
Penalties and interest were also imposed. The Appellant was assessed for these
amounts pursuant to subsection 323(1) of the ETA and subsection 227.1(1)
of the Income Tax Act (the “Act”).
[2] Subsections
21.1(1) of the CPP and 83(1) of the EIA make the directors of a
corporation, where the corporation is an employer, jointly and severally liable
with the corporation, for failure to remit amounts under these provisions:
Liability
21.1(1) If an employer who fails to
deduct or remit an amount as and when required under subsection 21(1) is a
corporation, the persons who were the directors of the corporation at the time
when the failure occurred are jointly and severally or solidarily liable,
together with the corporation, to pay to Her Majesty that amount and any
interest or penalties relating to it.
[3] Similarly,
subsection 83(1) of the EIA states:
Liability of directors
83.(1) If an employer who fails to deduct
or remit an amount as and when required under subsection 82(1) is a corporation,
the persons who were the directors of the corporation at the time when the
failure occurred are jointly and severally, or solidarily, liable, together
with the corporation, to pay Her Majesty that amount and any related interest
or penalties.
[4] Subsection
21.1(2) of the CPP and subsection 83(2) of the EIA provide that
subsections 227.1(2) to (7) of the Income Tax Act apply to a director of
such a corporation under the CPP and EIA.
[5] Section
227.1 of the Act states:
Liability of
directors for failure to deduct
227.1.(1)
Where a corporation has failed to deduct or withhold an amount as required by
subsection 135(3) or 135.1(7) 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, or solidarily, liable, together with the corporation, to
pay that amount and any interest or penalties relating to it.
Limitations
on liability
227.1.(2) A
director is not liable under subsection 227.1(1), unless
(a) a
certificate for the amount of the corporation's liability referred to in that
subsection has been registered in the Federal Court under section 223 and execution
for that amount has been returned unsatisfied in whole or in part;
(b) the
corporation has commenced liquidation or dissolution proceedings or has been
dissolved and a claim for the amount of the corporation's liability referred to
in that subsection has been proved within six months after the earlier of the
date of commencement of the proceedings and the date of dissolution; or
(c) the
corporation has made an assignment or a bankruptcy order has been made against
it under the Bankruptcy and Insolvency Act and a claim for the amount of the
corporation's liability referred to in that subsection has been proved within
six months after the date of the assignment or bankruptcy order.
227.1.(3) A
director is not liable for a failure under subsection 227.1(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.
Limitation
period
227.1.(4) No
action or proceedings to recover any amount payable by a director of a
corporation under subsection 227.1(1) shall be commenced more than two years
after the director last ceased to be a director of that corporation.
Amount
recoverable
227.1.(5)
Where execution referred to in paragraph 227.1(2)(a) has issued, the amount
recoverable from a director is the amount remaining unsatisfied after
execution.
Preference
227.1.(6)
Where a director pays an amount in respect of a corporation's liability
referred to in subsection 227.1(1) that is proved in liquidation, dissolution
or bankruptcy proceedings, the director is entitled to any preference that
Her Majesty in right of Canada would have been entitled to had that amount
not been so paid and, where a certificate that relates to that amount has been
registered, the director is entitled to an assignment of the certificate to the
extent of the director's payment, which assignment the Minister is hereby
empowered to make.
Contribution
227.1.(7) A
director who has satisfied a claim under this section is entitled to
contribution from the other directors who were liable for the claim.
[6] The wording of
section 323 of the ETA is almost identical to section 227.1 of the Act.
It states:
Liability of
directors
323.(1) If a
corporation fails to remit an amount of net tax as required under subsection
228(2) or (2.3) or to pay an amount as required under section 230.1 that was
paid to, or was applied to the liability of, the corporation as a net tax
refund, the directors of the corporation at the time the corporation was
required to remit or pay, as the case may be, the amount are jointly and
severally, or solidarily, liable, together with the corporation, to pay the
amount and any interest on, or penalties relating to, the amount.
Limitations
(2) A
director of a corporation is not liable under subsection (1) unless
(a) a
certificate for the amount of the corporation's liability referred to in that
subsection has been registered in the Federal Court under section 316 and
execution for that amount has been returned unsatisfied in whole or in part;
(b) the
corporation has commenced liquidation or dissolution proceedings or has been
dissolved and a claim for the amount of the corporation's liability referred to
in subsection (1) has been proved within six months after the earlier of the
date of commencement of the proceedings and the date of dissolution; or
(c) the
corporation has made an assignment or a bankruptcy order has been made against
it under the Bankruptcy and Insolvency Act and a claim for the amount of the
corporation's liability referred to in subsection (1) has been proved within
six months after the date of the assignment or bankruptcy order.
Diligence
(3) A
director of a corporation 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.
Assessment
(4) The Minister may assess any person for any amount payable by the
person under this section and, where the Minister sends a notice of assessment,
sections 296 to 311 apply, with such modifications as the circumstances
require.
Time limit
(5) An
assessment under subsection (4) of any amount payable by a person who is a
director of a corporation shall not be made more than two years after the
person last ceased to be a director of the corporation.
Amount
recoverable
(6) Where
execution referred to in paragraph (2)(a) has issued, the amount recoverable
from a director is the amount remaining unsatisfied after execution.
Preference
(7) Where a
director of a corporation pays an amount in respect of a corporation's
liability referred to in subsection (1) that is proved in liquidation,
dissolution or bankruptcy proceedings, the director is entitled to any
preference that Her Majesty in right of Canada would have been entitled to had
the amount not been so paid and, where a certificate that relates to the amount
has been registered, the director is entitled to an assignment of the
certificate to the extent of the director's payment, which assignment the
Minister is empowered to make.
Contribution
(8) A
director who satisfies a claim under this section is entitled to contribution
from the other directors who were liable for the claim.
The Facts:
[7] Farms began
operations in 1983. The Appellant started the company as a tree nursery
operation, growing tens of millions of trees from seed to seedlings for
delivery under contract to forest companies involved in reforestation. The
Appellant was the President, CEO and a director of Farms. Although the
Appellant’s wife was also a director, the evidence suggests that her
involvement in the business was limited.
[8] In 1995, Farms
received a significant capital investment from Environmental Research and
Development Capital Corporation (“ERD”). ERD was created to invest large
capital amounts in promising businesses in the environmental and infrastructure
sectors of the Canadian economy. Derrick Rolfe was the managing director and
founder of this venture capital fund. According to Mr. Rolfe, ERD did not run
businesses that it invested in but instead simply monitored those investments
through shareholder agreements. Mr. Rolfe testified that when ERD invested capital
in a business, shareholder agreements were always executed in order to protect ERD’s
involvement where potential adverse events might occur such as corporate
reorganization, issuance of shares or dividend declaration. He stated that this
gave ERD’s investment some protection without involving ERD in the day-to-day
operations of the businesses in which it invested. Mr. Rolfe testified that ERD
wanted to invest in Farms because of the up and coming carbon credit industry
and the fact that Farms was a company that converted carbon dioxide to oxygen
through the growth of trees.
[9] To facilitate ERD’s
investment in Farms, AquaNorth Holdings (“Holdings”) was incorporated with the
Appellant holding 60% of the shares through his corporation, Jocopa Investments,
and ERD holding the remaining 40% of those shares. The Appellant was a director
of Holdings as was Mr. Rolfe, as the representative of ERD.
[10] By 2001, Farms was
in financial difficulties and the relationship between Mr. Rolfe and the
Appellant had become extremely acrimonious. This was self‑evident in the
caustic exchanges which occurred between these two individuals during the
hearing. Backing up to 1998 one of ERD’s major institutional lenders, Philip
Service Board, went bankrupt. Consequently, between 1998 and 2001, Mr. Rolfe
attempted to realize on ERD’s six investments, including Farms. He testified
that ERD decided not to invest further in Farms and in fact discussions
occurred with the Appellant respecting the sale of ERD’s shares in Holdings to
the Appellant. The Appellant testified that Farms needed to refinance as a
result of a number of factors including ERD’s withdrawal of its investment, the
existing debt load of Farms and the state of the Canadian economy after 9/11.
However, according to Mr. Rolfe, during a meeting in the fall of 2001, he
learned that the Appellant had promised the Royal Bank that if Farms could
get further refinancing from this bank ERD would be investing more capital. Mr.
Rolfe testified that, since he was receiving only annual financial statements
from the business, he was unaware, until this meeting, that the Appellant was
attempting to refinance Farms by suggesting ERD would invest more funds. As a
result of his concern over ERD’s investment in Farms, Mr. Rolfe began
attempts to obtain financial information about this business so that he could
make an informed decision concerning the future of ERD’s investment in light of
the bankruptcy of one of its major lenders.
[11] According to Mr.
Rolfe’s testimony, the Appellant frustrated all of his efforts to obtain
financial information. He stated that he wrote letters, sent emails and tried
phoning the Appellant but that the Appellant resisted all of these efforts. It
appears that ERD was entitled to this information pursuant to the shareholder
agreement. When these attempts failed, Mr. Rolfe tried to solicit new investors
and purchasers. According to Mr. Rolfe, the Appellant actively prevented those
potential investors from obtaining access to view the facilities, including
calling the police. The Appellant’s testimony was that none of these potential
investors had signed non-disclosure agreements before viewing the premises.
Following these events, Mr. Rolfe engaged Ernst & Young on December 19,
2001 to act as consultants on ERD’s behalf in a further attempt to obtain
financial information. They were unsuccessful in accessing any information
because the Appellant had apparently removed the pertinent records from the
business premises and as a result Ernst & Young could not determine the
future viability of the business.
[12] On January 17, 2002,
ERD’s solicitors sent correspondence to Holdings formally demanding repayment
of various amounts owing to ERD together with a Notice of Intention to Enforce
Security pursuant to the Bankruptcy and Insolvency Act (Exhibit R-1, Tab
14). Attached to this Notice is an Order of the Ontario Superior Court of
Justice appointing Ernst & Young as interim receiver of Holdings and
allowing Ernst & Young access to the financial information of the business.
Mr. Rolfe’s evidence was that the objective of this Order was to enable Ernst
& Young to ascertain what was going on in the business but that it did not
give Ernst & Young any control over the business operations. Mr. Rolfe
stated that despite this Order, the Appellant continued to control the
operations of Holdings and Farms because, according to Mr. Rolfe, the Appellant
had negotiated and secured additional funding through the senior lender, the
Royal Bank, during December 2001 in which the bank permitted the Appellant to
continue to write cheques and operate the business.
[13] By early March 2002,
Farms was unable to meet its obligations to either ERD or the Royal Bank and
the latter appointed Deloitte & Touche and forced Farms into receivership
on March 4, 2002. Farms was bankrupt by July 24, 2002.
[14] On March 9, 2004,
the Appellant was assessed for unremitted source deductions, penalties and
interest pursuant to section 227.1 of the Act, section 38 of the Ontario
Tax Act, sections 21 and 21.1 of the CPP and sections 82 and
83 of the EIA. The Appellant was also assessed on March 9, 2004 for
GST deducted at source but not remitted by Farms together with penalties and
interest. According to the evidence of Helene Ciutti, a collections officer
with the insolvency unit of the Canada Revenue Agency (the “CRA”), the
Appellant was assessed for the period October 1, 2001 to December 31, 2001 with
respect to GST and for unremitted source deductions for the month of February
2002.
[15] On August 26, 2002,
Farms was assessed for failure to deduct and remit source deductions, interest
and penalties pursuant to section 153 of the Act. On October 1, 2002,
CRA made a claim for the amount of the corporation’s liability following Farms’
bankruptcy on July 24, 2002. On October 2, 2002, CRA made a claim for unpaid
GST. As a result, the legal prerequisite found in paragraph 227.1(2)(c) of
the Act was satisfied.
Appellant’s Position:
[16] The Appellant
contends that during the relevant period under appeal he was not a director of
Farms and therefore not liable pursuant to section 227.1 of the Act or
subsection 323(1) of the ETA. Although he and his wife are named as
legal directors of Farms on the Corporate Profile Report of the Province of
Ontario during the relevant period and both received salaries as directors, the
Appellant insists that, at the time the corporation was required to remit or
pay the amounts of net tax and source deductions, he was no longer a director.
His argument is that beginning in the fall of 2001 until May/June 2002, two
receivership processes resulted in the removal of his capacity to control the
affairs of the business, thereby effectively removing his authority as a
director. He submits that Mr. Rolfe’s correspondence of December 21, 2001
terminated his duties as director. In the alternative, the Appellant claims
that the Court Order of January 22, 2002 removed him as director prior to
the monies becoming due and payable to CRA.
[17] The Appellant
further submits that, even if he was a director, the due diligence defence is
available to him because he exercised the degree of care, diligence and skill
to prevent the failure to remit that a reasonably prudent person would have
exercised in comparable circumstances pursuant to subsection 227.1(3) of the Act
and subsection 323(3) of the ETA.
The Respondent’s Position:
[18] The Respondent
submits that the Appellant was a director of Farms at all relevant times and
maintained control of the day-to-day business operations of Farms until March
4, 2002, the date that Deloitte & Touche obtained the receivership of
Farms. As the full liability for unremitted GST and payroll deductions were
incurred prior to March 4, 2002, the Appellant is liable as a director of Farms
as he failed to exercise due diligence in preventing this failure of Farms to
remit those amounts. The Respondent argued that the Court Order of January 22,
2002, which ERD obtained to have Ernst & Young act as interim receivers, did
not remove the Appellant as director because the Royal Bank as senior
lender intervened and appointed its own receivers, Deloitte & Touche,
to monitor the company. However, the Royal Bank allowed the Appellant to sign
cheques and continue to operate the company in his role as director. When the
Royal Bank actually obtained its own Court Order and implemented the
receivership of Farms, it was March 4, 2002, which was subsequent to the
relevant periods under appeal and after the amounts in issue were required to
be remitted.
The Issues:
[19] Was the Appellant a
director of Farms during the relevant periods under appeal? If he was not a
director, he will not be liable for the unremitted GST, CPP and EI source
deductions.
[20] If the Appellant was
a director of Farms, did he act with due diligence? If he did, he will not be
liable for these amounts.
Analysis:
(A)
Was
the Appellant a director of Farms?:
[21] The Appellant need
only demonstrate that he was not a director of Farms at the time that Farms was
required to remit the net tax and source deductions. In Robitaille v. The
Queen, 90 D.T.C. 6059, Justice Addy stated that where effective control of
a corporation has been taken over by a bank, without a request by the
directors, and where decisions as to issuing cheques are exclusively made by
the bank, again without consultation with the board of directors, the
corporation’s actions regarding remittances, payments or withholdings will be
essentially those of the bank. Consequently, since subsection 227.1(1)
contemplates that a corporation is acting freely through its board of
directors, in these circumstances there would be no liability on the directors.
[22] Similarly, in Champeval
et al. v. M.N.R., 90 D.T.C. 1291, Couture C.J. decided that if directors
did not have free choice in the corporate decisions due to factors completely
beyond their control, they cannot be bound by subsection 227.1(1).
However, in White v. M.N.R., 91 D.T.C. 54, a 1990 Tax Court
decision adopted the reasoning in Fraser v. M.N.R., 87 D.T.C. 250,
over more recent jurisprudence and upheld the Minister’s assessment on the
basis that the direct responsibility of a director was to prevent the company’s
failure to deduct or remit.
[23] It is clear from the
evidence that the Appellant and his wife were the legal directors of Farms. The
Appellant, through one of his corporate entities, was also majority shareholder
and a director of Holdings. When the relationship between the Appellant and Mr.
Rolfe became riddled with problems, Mr. Rolfe sent correspondence to Farms to
the attention of the Appellant, dated December 20, 2001 (Exhibit R-1, Tab 12)
advising of various breaches of a Forbearance Agreement (not entered into
evidence) with ERD and requesting access to the premises to show the property
to potential purchasers. The following day, December 21, 2001, Mr. Rolfe,
again on behalf of ERD, forwarded a second letter to Farms requesting that the
Appellant “cease providing authorization over payments from the AquaNorth
accounts”. It went on to state “You are also hereby advised that your duties
and entitlements as a director of AquaNorth are terminated and you will
therefore not attend any Board meetings previously contemplated by you” and “in
the interim you are not required to attend the offices except for management
meetings we schedule”. Therefore, one of the dates on which the Appellant argued
that he lost control as a director over corporate activities was the date of
this last letter, December 21, 2001. However, it is clear from the evidence
that the Appellant ignored this letter and simply filed it under miscellaneous.
He was successful in frustrating any attempt by Mr. Rolfe to access the
premises with potential purchasers or to obtain financial information on behalf
of ERD. In fact, Mr. Rolfe hired Ernst & Young as consultants hoping that
the firm could obtain this financial information but they too failed.
[24] The Appellant
admitted that “From September through to December I was aware of what the
company was doing and the cheques that were being written …” (Transcript, page
123). The evidence supports that the Appellant continued to be in control after
the December 21, 2001 letter. He had been in this business for many years and
was fully aware that the company was in financial difficulty and needed to be
refinanced. He apparently continued to negotiate with the Royal Bank and the
evidence suggests that he secured further advances from the bank. At pages 148
to 150 of the Transcript the following exchange occurred during
cross-examination by Respondent counsel:
Q. He’s calling you saying your answering
machine is off, you’re not returning my calls. Now you’re telling us well, he
could have called any time.
A. There were plenty of instances
where I was not there. I was travelling back and forth down to the St.
Williams nursery. If he was calling -- this is before cell phones, of course
-- if I was travelling down to St. Williams, driving as I typically did, I
wouldn’t have been available.
During that period of time it
was very hectic and chaotic. We were in a financial crisis, at a point in the
year where our operations are at peak. The weeks before Christmas we’re
packaging the trees. They’ve been grown all year and when we hit the December,
January period there’s a huge cashflow requirement and huge labour intensive
seasonal operations.
At that point we would have had
over two hundred employees working in the facilities, three shifts a day.
Management teams going full out, while there’s a financial crisis on.
It’s not surprising at all that
I wasn’t sitting beside my telephone waiting for a call from Mr. Rolfe.
(Transcript, page 148, line 25; page 149, lines 1-25;
page 150, line 1)
[25] It appears that the Appellant was going
full tilt with business operations during peak season, December 2001 to January
2002. The fact that the Appellant ignored this December 21, 2001 letter from
ERD and treated it as ineffectual is supported by the subsequent action of ERD
in engaging legal counsel in January 2002 to apply for an Order of the Court to
have Ernst & Young appointed as interim receivers. If, as the Appellant
contends, Mr. Rolfe, on behalf of ERD, had taken control by virtue of the
December 21, 2001 letter, there would have been no need to hire lawyers to convince
a court to issue an order to AquaNorth for the release of financial information
to Ernst & Young. At one point in the Appellant’s evidence he stated that
he lost control of the company in November 2001 as a result of two receivership
processes. The January 22, 2002 Order was the first receivership order and
therefore the Appellant’s evidence that he lost control in November 2001 is
simply incorrect. At another point in his evidence, the Appellant submitted
that this January 22, 2002 date was the last possible date that he could have
been a director because that Order removed him as a director. Mr. Rolfe’s
evidence is that he obtained this Order with the intention of removing the
Appellant as director and ultimately gaining control of the company so it could
be sold in the hope that ERD could realize on its investment. However, he
testified that he was frustrated again in these efforts because the Appellant
undermined him by negotiating with the main lender, the Royal Bank, without Mr.
Rolfe’s knowledge. Mr. Rolfe testified that the Royal Bank agreed to lend more
money to the company and to keep the Appellant on to sign cheques and operate
the business with Deloitte & Touche monitoring the activities. During the
direct examination of Mr. Rolfe, Respondent counsel asked (Transcript, pages
253-254):
Q. So on January 22nd, 2002 who was the director of
Farms?
A. Mr. Liddle. We had access to
nothing so, absolutely nothing. No records, no offices, no -- we had nothing,
so he stayed and that was it.
Q. So you tried to remove him?
A. Oh, we tried. Oh, we did try and
he ran to the Royal Bank and, you know, I don’t think the Royal Bank would have
been fond of letting Ernst & Young run something that they were going to
run. I mean, Deloitte & Touche. Deloitte & Touche were already in
with the monitor, I believe, and in the natural progression the bank, as the
senior lender -- if I were senior lender and were in position I’d say yeah,
look, I’m the senior lender I will appoint and –
[26] In late February 2002, the Royal Bank
applied to the Court to have Deloitte & Touche appointed as receivers and
that order was obtained on March 4, 2002 (Exhibit R-1, Tab 17).
[27] There were some
inconsistencies in the Appellant’s recall of events and dates but Mr. Rolfe’s
testimony on the sequence of events was simply more convincing. In all probability
ERD would either have to take a back seat to the actions of the priority lender
or step in pursuant to their receivership order of January 22, 2002 assuming
full responsibility for the Royal Bank debt as well as their own. It seems
logical that, if the priority lender advanced further funds and instilled the
Appellant in the position of operating the business with the authority to sign
cheques, ERD in the month that these events were occurring, subsequent to the
January 22, 2002 order, simply stepped aside and let things play out. The
Appellant admitted to cooperating with Deloitte & Touche, who were
monitoring the business. He could not have done so if he had already lost
control of the business. Any cooperative efforts with Deloitte & Touche
would certainly have occurred after December 2001 and probably after January
22, 2002. Both of these dates were alleged by the Appellant as being potential
dates on which he had been stripped of control and was no longer a director.
Unlike the facts in Robitaille, the Appellant in this appeal was not
stripped of his involvement with the business as he alleges. He never legally
resigned as a director and, according to his evidence, he continued to work
closely with the Royal Bank to obtain further refinancing and to meet
contractual obligations with the customers. He continued to successfully shut
ERD out of the business, to work with the primary lender behind ERD’s back and
to cooperate with Deloitte & Touche in operating the business. All of this
supports that the Appellant was a director for the purposes of
subsection 227.1(1) of the Act and subsection 323(1) of the ETA
during the relevant periods (October 1, 2001 to December 31, 2001 and February
2002).
[28] In summary, neither
ERD’s correspondence of December 21, 2001 nor the Order of January 22, 2002,
effectively removed the Appellant as director of the business during the
relevant periods. The Appellant treated the correspondence as simply a letter
without legal authority and chose to ignore it. ERD decided not to execute the
Order of January 22, 2002 because of on-going actions of the Appellant, the
Royal Bank and Deloitte & Touche. In addition, this Order was aimed
primarily at disclosure of financial information. Until at least March 4, 2002,
the date of the Royal Bank receivership order, the Appellant remained
sufficiently involved in the day-to-day operations, including making decisions
and signing cheques, to support a conclusion that he remained in effective
control as a director during the relevant periods.
(B) As the director
of Farms, during the relevant periods, did the Appellant act with due
diligence?:
[29] Whether the Appellant has exercised due
diligence is essentially a question of fact to be determined within a set of
legal standards. The applicable subsection 227.1(3) of the Act and subsection
323(3) of the ETA, employ almost identical language and provide a
director with a potential defence to liability pursuant to subsection 227.1(1)
of the Act and subsection 323(1) of the ETA. The question
therefore that must be addressed in respect to both of these subsections is
whether the Appellant can escape liability for the company’s failure to remit
net tax and source deductions because he exercised the degree of care,
diligence and skill to prevent this failure that a reasonably prudent person
would have exercised in comparable circumstances.
[30] Generally, directors must take every
reasonable effort to ensure that corporate deductions and other amounts owing
in respect to tax are collected, withheld and then properly remitted. Directors
will be expected to show the specific steps and actions that were taken to
prevent this failure. Various methods may be implemented, depending on the circumstances,
to achieve this end, including establishing separate accounts for such
withholdings, regular communication and reporting between directors and the
corporate accountants, financial officers and lending institutions and
monitoring by obtaining periodic confirmation that remittances are current.
However, there is no legal requirement that any of these methods or systems are
utilized but they will go a long way to preventing such a failure in the first
place and assisting a director in avoiding potential liability by supporting
the argument that the director has exercised the diligence that a reasonably
prudent person would have.
[31] So, is the legal test to be applied in
measuring a director's behaviour and actions in the circumstances of each case
an objective test or a subjective/objective test? The Federal Court of Appeal
decision in Soper v. The Queen, 97 D.T.C. 5407 at page 5416, referred to
the standard of care as a combination of subjective/objective components:
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".
[32] This decision maintains that the standard
of care in respect to the subjective test requires that a Court looks at the
director's particular background, knowledge, skills and experience in
determining if the director exercised due diligence. The objective test will
then be applied to determine whether the director, measured against his or her
personal background, acted reasonably.
[33] After the 2004 Supreme Court of Canada
decision in Peoples Department Stores v. Wise, [2004] 3 S.C.R. 461,
many have questioned whether the test in Soper has been overruled. At page
491, the Supreme Court stated the following:
63 … We prefer to describe it as an
objective standard. To say that the standard is objective makes it clear that
the factual aspects of the circumstances surrounding the
actions of the director or officer are important in the case of the s. 122(1)(b) duty of care, as
opposed to the subjective motivation of the director or
officer, which is the central focus of the statutory fiduciary
duty of s. 122(1)(a) of the CBCA.
[34] It appears that the Federal Court of Appeal
has not treated the decision in Peoples as changing significantly the
test as it is set out in Soper. In Hartrell v.The Queen, 2008
D.T.C. 6173, at paragraph 12, the Court stated:
[12] The appellant argued that
the decision of the Supreme Court of Canada in Peoples Department Stores
Inc. (Trustees of) v. Wise 2004 SCC 68 changed the
test with respect to the due diligence defence from the "objective
subjective" test, in Soper, to simply an "objective"
test. Whether Peoples Department Stores can be said to have eliminated
the subjective aspects of the due diligence defence in subsection 227.1(3) of
the ITA is not entirely clear since that the decision dealt with a provision of
the Canada Business Corporation Act R.S.C. 1985, c. B-3. In that regard,
the Supreme Court of Canada, in paragraph 63 of the decision, stated that:
With respect, we feel that
Robertson J.A.'s characterization of the standard as an "objective
subjective" one could lead to confusion. We prefer to describe it as an
objective standard. To say that the standard is objective makes it clear that the
factual aspects of the circumstances surrounding the actions of the director or
of the officer are important in the case of the s. 122(1)(b) duty
of care, as opposed to the subjective motivation of the director or officer,
which is the central focus of the statutory fiduciary duty of s. 122(1)(a)
of the CBCA.
If Peoples Department Stores did change the test to be
applied under subsection 227.1(3) of the ITA to one that requires due
diligence to be demonstrated on a purely objective standard, such a new test would
be more difficult to meet than a test that contains some elements of
subjectivity. As such, we are unable to see how the potential application of Peoples
Department Stores could be helpful to the appellant.
Again at paragraph [14], the Court made reference
to the Soper decision and affirmed the application of the due diligence
defence according to Soper:
[14] Based
upon the evidence before the TCC, we are of the view that it was open to the
TCC to make these factual findings. Accordingly, we are not persuaded that the
TCC made any palpable and overriding error in applying due diligence defence in
Soper to these factual findings and in reaching the conclusion that Mr.
Hartrell had failed to exercise the degree of care, diligence and skill that a
reasonably prudent person would have exercised in comparable circumstances to
prevent the source deduction remittance shortfalls that occurred in 1998.
[35] Clearly the Soper test has been
applied by this Court since the Peoples decision and endorsed by the Federal
Court of Appeal. It would appear to be the appropriate and preferable test to
apply in this appeal. The Appellant testified that the standard is not
perfection and that he did his best. He claimed that he acted responsibly and
that there was nothing he could have done. He testified that GST was charged to
customers on the invoices and on progress payments. These amounts were entered
on the corporate books as accounts receivable. The customers paid the GST.
Farms collected this money and deposited it to a bank account. In the normal
course of business, Farms was subject to audit standards through KPMG,
according to the Appellant's evidence. He did not want to wind the business
down or let it go bankrupt. To prevent the demise of his company, he was busy travelling
to secure new customers and contacts and attempting to secure additional
financing.
[36] Did all of this amount to positive action
by the Appellant to ensure that these amounts, which were charged to customers
and then collected and deposited, were being remitted to the Receiver General?
What were the reasonable steps, if any, that he took to prevent this failure by
Farms to remit these amounts, before that failure occurred? Based on the facts,
I must conclude that the Appellant has failed to adduce sufficient evidence to
establish the defence of due diligence.
[37] While the Appellant made a number of
assertions that he acted reasonably and did everything he could do, they were
simply assertions. The Appellant failed to support these assertions with
evidence of the proactive steps which he took and of the installation of reliable
corporate systems and controls that were not only in place, within the
corporate entity, but were actually being followed during the period when these
amounts were to be remitted to the Receiver General. According to the
Appellant's evidence, deductions were taken and GST collected but these amounts
were not remitted. As of September 2001, the Appellant was aware that
Farms was experiencing financial difficulties. In fact, he testified that he
anticipated these difficulties one year prior to this when one of ERD'S major
investors was unable to fulfil its loan obligations. This means that the
Appellant had knowledge of financial difficulties prior to the commencement of
the relevant periods in these appeals, being October 1, 2001, and that he
was probably aware of the potential for difficulties one year prior to
October 1, 2001. The case law supports that, when a company is
experiencing financial hardship, a director has a higher duty to ensure that
remittances are being properly made. Therefore, the Appellant may well be held
to an even higher standard of care because he admitted that he was aware of
these financial problems prior to the periods under appeal. Without proper
systems and controls in place, such as a tracking system by way of a separate
bank account for these remittances, it is the lure of available cash that
entices so many companies, when financially strapped, to dip into funds that
should be earmarked for source deductions and GST remittances. That appears to
be what occurred with Farms. There was no evidence of sufficient safeguards in
place to prevent the failure to remit these amounts. Although there was
evidence that some measures had been set up such as audits by KPMG, I had no
evidence of how this system may have been working or if it was being followed
in the period when Farms was experiencing difficulties. In fact, Mr. Rolfe
testified that KPMG's figures were inaccurate because some cash was not being
deposited to the corporate account. Also according to Mr. Rolfe, financial
information was removed from the premises and that Deloitte & Touche could
not complete historical financial records.
[38] The Appellant admitted that from September
2001 to December 2001, he was aware of what the company was doing and the
cheques that were being written. He also admitted that he was aware of late
payments to the Receiver General but he believed that "it would sort
itself out". It is apparent that the Appellant was busy during the period,
prior to and subsequent to October 1, 2001, actively securing financing
and ensuring completion of contracts, in an effort to salvage his
company — his "baby", as he referred to it in his evidence.
However, hoping remittances will eventually sort themselves out in the midst of
this flurry of activity is choosing to stick one’s head in the sand. At some
point, the tide is going to come in.
[39] The Appellant has been involved in the
forestry business for many years. He has a business degree and has been
conducting business since 1983. Farms was one of the largest suppliers of
seedling trees to the forest industry. Against the background of the
Appellant's education, his many years in this industry, his experience with
lending institutions and business practice, and his admission that he was aware
of corporate actions, aware of the cheques being written and aware that
remittances were late, I must conclude that the Appellant failed to act
prudently in making reasonable efforts to ensure these remittances were made to
the Receiver General. The Appellant took no concrete actions to prevent the
shortfall in these remittances and, consequently, failed to exercise the degree
of care, diligence and skill that a reasonably prudent person would have
exercised in comparable circumstances to prevent such failure.
[40] For these reasons, the appeals are
dismissed with costs.
Signed at Summerside, Prince Edward Island, this 11th day of September 2009.
Campbell J.
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