Parton v. The Queen, docket 97-659-IT-G

Date: 19990406

Dockets: 97-659-IT-G; 97-669-IT-G

BETWEEN:

RICHARD PARTON, DONALD G. SICKLE,

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent,

Reasons for Judgment

Lamarre Proulx, J.T.C.C.

[1] These appeals were heard together. The Appellants were assessed pursuant to section 227.1 of the Income Tax Act (the "Act"), in their alleged capacity as directors of 605892 Ontario Inc. (the "Corporation") which had failed to remit the source deductions withheld on the salaries of its employees. Although the facts relate to the same Corporation, the Appellants' status was not identical and some part of the evidence was not common to both appellants. Each appellant was represented by different lawyers.

[2] The Amended Notices of Appeal are identical and read as follows:

2. This appeal relates to the period beginning in October 1992 and ending in December 1993 (the "Relevant Period") and to the failure of 605892 Ontario Inc. ("605892") to remit certain employee deductions (income tax, Canada Pension Plan, Unemployment Insurance) ("Withholdings") during the Relevant Period.

3. (-) The Appellant (-) never became a director of 605892, a corporation incorporated pursuant to the laws of Ontario. 605892 carried on a waste oil re-refinery business, and was a wholly-owned subsidiary of Shannon Environmental Ltd. ("Shannon"), a corporation incorporated pursuant to the laws of Alberta.

4. Throughout the Relevant Period, the business and affairs of 605892 were managed by a group of advisors (the "Advisors") representing key investors of 605892 via Shannon. The Appellant and other persons (-) reported to the Advisors, who in turn determined the course of action of 605892.

5. The Appellant was not one of the Advisors.

6. At all times, the Advisors were aware of the financial position of 605892 and of the fact that the Withholdings were not being remitted to Revenue Canada on a timely basis.

7. Throughout the Relevant Period, the Appellant continually raised with the Advisors the issue of the unremitted Withholdings.

8. The Advisors repeatedly assured the Appellant that remittances of the Withholdings would be made.

9. By January 1993, 605892's plant was operating and generating revenue. Furthermore, the Advisors were actively engaged in negotiations with financiers to obtain additional financing for working capital. Accordingly, at all times the Appellant believed that the remittance of the Withholdings to Revenue Canada would be made.

10. Moreover, one of the Advisors, Howard Taylor, F.C.A., who eventually became one of the largest shareholders of Shannon, personally indemnified the Appellant in the event that the Appellant was pursued personally for the unremitted Withholdings. The Appellant has demanded payment pursuant to the indemnity, but Mr. Taylor refuses to honour the indemnity.

11. During the Relevant Period, certain payments were made by 605892 to Revenue Canada on account of the Withholdings.

12. From approximately April 1993 onwards, (-) the Appellant derived no remuneration from 605892 or Shannon.

[3] The Replies to the Amended Notices of Appeal are also almost identical. In the matter of the Appellant Parton, it is the following:

7. In so assessing the Appellant, the Minister relied on, inter alia, the following assumptions:

(a) the Appellant was, at all material times, a director of the Corporation;

(b) the Appellant represented to the Minister that he was a director of the Corporation during the Relevant Period;

(c) the Corporation failed to remit to the Receiver General federal income tax withheld from the wages paid to its employees in the amount of $133,900 as set out in Schedule "A" attached hereto;

(d) the Corporation failed to pay penalties and interest relating to the unremitted Federal tax in the amounts of $6,392.19 and $32,371.61 respectively;

(e) certificates for the amount of the Corporation's liability for Federal income tax, penalties and interest were registered in the Federal Court of Canada under subsection 223(2) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended (the "Act") as follows:

(i) an amount of $100,206.28 was certified on May 14, 1993;

(ii) an additional amount of $215,223.44 was certified on January 22, 1996;

and execution for such amounts was returned wholly unsatisfied on February 20, 1996;

(f) the Appellant did not exercise the degree of care, diligence and skill to prevent the failure to remit the said amount by the Corporation that a reasonably prudent person would have exercised in comparable circumstances;

(g) the Appellant and Donald Sickle were the bank signing officers of the Corporation;

(h) the Appellant was fully cognizant of the Corporation's failure to remit employee withholdings;

(i) the Appellant knowingly attempted to sustain the Corporation's operations by conserving cash to the maximum extent possible, including the deferral of payment of employees source deductions;

(j) the Corporation's corporate charter was cancelled by the Corporations Branch, Ministry of Consumer and Commercial Relations, on October 25, 1995 for default in complying with the Corporations Tax Act.

[4] The Amended Notices of Appeal submitted that the Appellants never became directors of the Corporation but did not relate the facts upon which this proposition was made. The statutory provisions relied upon were sections of the OntarioBusiness Corporations Act, (usually referred to later as the O.B.C.A), that were concerned with the appointment of a director under that Act. At the hearing, it was proposed that the appointment of the Appellants as directors had not been made in accordance with the O.B.C.A.: there was no resolution changing the number of directors for the board of directors from 6 to 2, the board of directors did not have the required quorum when the Appellants were purportedly appointed and there had not been a resolution of the shareholders ratifying the purported change.

[5] The Appellants also submitted that the business and affairs of the Corporation were managed by a group of advisors representing the key investors and that the Appellants reported to these advisors, who in turn determined the course of action of the Corporation. The Appellants claim that, at all times, the advisors were aware that the source deductions were not remitted. The Appellants continually raised with the advisors the issue of the unremitted deductions at source and the advisors assured the Appellants that they would be made. It is the Appellants' position that there was no option given to the Appellants to remit the source deductions. Certain payments were made by the Corporation to Revenue Canada. The Appellants also emphasized the fact that from April 1993, they did not receive any remuneration for their work for the Corporation.

[6] The issues before the Court are essentially threefold: First, it must be determined whether the Appellants were de jure or de facto directors pursuant to the O.B.C.A. Secondly, if it is found that the Appellants were de facto directors, it must be determined whether section 227.1 of the Act applies to de facto directors. Finally, if it is established that section 227.1 applies to the Appellants, the Court must determine whether the Appellants exercised due diligence. The Respondent also raised the question of whether the notion of estoppel applied, preventing the Appellants from contesting their appointment as directors.

[7]Ms. Sandra Cameron-Milkes was the first witness for the Appellants. She had brought with her the minute book of the Corporation. The purpose of her testimony was to show that the minute book had not been tampered with. Ms. Cameron-Milkes is a law clerk for a firm of lawyers. The minute book was produced as Exhibit A-2, which is the original, and Exhibit A-3, which is a photocopy of the minute book. The registration of the Corporation was produced as Exhibit A-1.

[8] Both the Appellants testified. They produced Exhibit A-4, which is a book of documents containing tabs 1 to 74. Further to their testimony, Mr. Robert-David Swim, a tax collector for Revenue Canada, testified at the Respondent's request.

[9] Both Appellants had been senior executives for important corporations. Mr. Parton had lost his job from Shell Oil in 1986. After that he became a business consultant. Mr. Sickle worked 25 years for North American Life as a director of information. He had been a management consultant since October 1990.

[10] The Corporation submitted a tender to purchase the assets of Oil Canada Limited ("OCL"), an oil re-refining operation located at 309 Cherry Street, Toronto, from a trustee in bankruptcy, Coopers and Lybrand Limited. On December 12, 1990, it was ordered that upon payment of the sum of $5.6 million to the receiver, that the land and property be vested in the purchaser. The tender and conditions of sale provided that the closing date would be December 31, 1990. As the purchaser was unable to raise the financing to close the transaction, there were many delays and the date of closing was extended to September 30, 1991. The purchase price for the property was increased to $6.1 million. There was a danger that the purchaser might have to forfeit the $1,348,530.10 deposit to the receiver. The Minutes of Settlement (pages 85 to 101 of Exhibit A-2) were dated August 14, 1991 and amended August 29, 1991. Shannon Energy Limited, the controlling shareholder of the Corporation agreed to cosign the agreement. The Corporation was a subsidiary of Shannon Energy Limited.

[11] The board of directors of the Corporation consisted of six directors (page 9 of Exhibit A-2). On October 29, 1991, at a meeting of the board of directors, four directors tendered their resignation (pages 102 to 120 of Exhibit A-2). Mr. Sickle was appointed a director at that directors' meeting. Mr. John Pozhke and Douglas Hooper remained directors. The board was thus composed of three directors.

[12] On November 25, 1991, a resolution of the board of directors authorized the issuance of a promissory note and debenture to secure the balance of the purchase price owing by the Corporation to the receiver. For this particular resolution, there were three directors who signed, Mr. John Gregory Pozhke, Mr. Douglas Hooper and Mr. Donald G. Sickle. Mr. Pozhke signed the resolution as the President of the Corporation (page 125 of Exhibit A-2). On that same day, there is another resolution of the board of directors to enter into a priority agreement among the Receiver, Shannon Energy Ltd. and Central Guaranty Trust Company (page 124 of Exhibit A-2).

[13] Tab 25 of Exhibit A-4 is a consultancy contract between R.J. Parton Management Services and Shannon Energy Limited. This contract was for a six-month period commencing on the date of closing of the purchase of the assets of Oil Canada Limited from the receiver. The fees were $8,000 per month. This document was accepted on the 27th of November, 1991. Regarding Mr. Sickle, the management agreement appears at Tab 28 of Exhibit A-4. It would appear that management fees in the amount of $8,000 per month were to be retroactive to January 1991.

[14] Tabs 23 and 24 of Exhibit A-4 show that the two Appellants had wanted to be insured against their liability as directors. However, they acted as directors without having obtained a formal indemnity.

[15] On November 28, 1991, Mr. Parton accepted to become a director of the Corporation and Mr. Hooper resigned his position as director (pages 126 and 127 of Exhibit A-2).

[16] On December 5, 1991, a memorandum from the Appellants (Tab 26 of Exhibit A-4) to the members of the advisory committee stated that a cash deficiency in the amount of $142,000 was expected for the month of December. The memorandum states that they estimated the fixed costs for the month of January to be in the order of $125,000 and that [t]he above forecasts make no allowance for specific emergency repairs of the physical plant. The Appellants concluded that there is an immediate cash problem that must be dealt with to protect the shareholders' investment. This memorandum also shows that the Appellants knew that the Corporation was already in arrears of tax in the amount of $80,000.

[17]There was a unanimous shareholders agreement dated October 31, 1991. It was amended on September 15, 1992, between all the shareholders of the Corporation, to exchange the shares now held by Shannon Energy Limited for common shares of Shannon on the basis of a total of 16 million common shares of Shannon for the total of 499 shares of the Corporation. This document is reproduced at page 208 of Exhibit A-2. Section 3.03 of this document contained restrictions on the directors of the Corporation. The board of directors did not have power or authority to allot, reserve or issue additional shares in the capital of the Corporation. The amendment to the share exchange agreement is reproduced at page 229 of Exhibit A-2. It is dated September 16, 1992.

[18] On June 19, 1992, Mr. Pozhke tendered his resignation as a director and president (page 133 of Exhibit A-2). On that day, Mr. Parton was elected president and Mr. Sickle secretary of the Corporation (page 135 of Exhibit A-2). The Corporation had from then on two directors: the Appellants. That resolution was signed by Messrs. Parton and Sickle. Thereafter, Messrs. Parton and Sickle held themselves out, respectively, as president and secretary of the Corporation. For example, for the purposes of the Corporation's banking activities at the National Bank as of July 15, 1992, the Appellants listed themselves as directors of the Corporation (Exhibit A-2, page 136).

[19] On March 23, 1993, the first letter was sent by Revenue Canada to the Appellants in their capacity as directors (Tab 11 of Exhibit A-4). This letter explained in comprehensible language the directors' liability. On June 30, 1993, Revenue Canada sent a reminder letter to the Appellants (Tabs 12 and 13 of Exhibit A-4). On July 28, 1993, the Appellant Parton, in his capacity as president, explained in a letter to Revenue Canada that the deficiencies in remitting the source deductions were caused by a difficult start-up period (Tab 14 of Exhibit A-4). Here are some of his words:

... I can assure you that we are operating the company through a very difficult start-up period to enhance the value for all stakeholders. As Mr. Sickle has probably advised, both he and I are significant creditors of the company as we are several months behind in the receipt of our contractual fee income.

At this time, I believe that we are in the process of turning the corner for the Shannon operation. We have established ourselves in the market place, and consequently we are beginning to see a demand level for our lubricating base oils that will be more than sufficient to enable the company to survive.

[20] The Appellants stated that they ceased to draw their fees as of March 15, 1993.

[21] On page 235 of Exhibit A-2, there appears the notice sent by the Appellants pursuant to the Corporations Information Act. It is dated August 10, 1993. On page 236, it shows that Mr. Sickle and Mr. Parton are the two directors of the Corporation. On page 242, it shows that the Corporation carried on business under the name of Shannon Environmental Services.

[22] On January 27, 1994, the Appellant Parton in his capacity as president sent another letter to Revenue Canada (Tab 15 of Exhibit A-4). On February 17, 1994, both Appellants sent a common letter to Revenue Canada (Exhibit A-4, Tab 16). These letters describe avenues of financing that are being negotiated and explain that operations were maintained at the plant in the desire to maintain the maximum value for all stakeholders including Revenue Canada.

[23] Tab 8 of Exhibit A-4 reproduces a report made by Mr. R.D. Swim, dated April 1, 1996. The report states that the account was originally assigned to Collections on December 24, 1992 and that from February 1993 to September 1993, the Corporation made payments in the amount of $65,000 to Revenue Canada. On January 7, 1994, after the Corporation had failed to make its monthly remittances for a number of months, requirements to pay were issued to two bank accounts. These instruments recovered $4,140. The failure to remit deductions were in respect of the period October 1992 to December 1993. The report of the Appeals officer is at Tab 9 of Exhibit A-4.

[24] Both Appellants were aware from the start of the directors' liability. The Appellants stated at the hearing that the Corporation had attempted very strenuously to raise financing but most attempts failed. The Appellants referred to some promotional action to raise financing organised jointly with the directors and some advisers that succeeded. But it was far from enough. The Corporation was in financial difficulty from the beginning. The income was never sufficient to meet the operational expenses.

[25] The Appellants stated that the Corporation was managed by a group of advisors representing the key investors in the Corporation to whom the Appellants reported; the advisors determined the course of action of the Corporation; and at all times, the advisors were cognizant of the financial position of the Corporation and of the fact that the deductions at source were not being remitted on a timely basis.

[26] Tab 33 and 47 of Exhibit A-4 are memoranda to the advisors. They are dated January 3, 1993 and September 13, 1993. They discuss the cash needs of the Corporation but there is no mention of a failure to remit source deductions. Tabs 44 and 46 of Exhibit A-4 are notes for comments to the shareholders prepared by Mr. Parton. There is no mention of the deficiencies in remitting source deductions in the comments to the shareholders. Tab 46 also refers among other things to the annual meeting of shareholders held on August 26, 1993.

[27] Tab 69 of Exhibit A-4 is a letter dated October 31, 1994, from Mr. Sickle to the advisors and it says the following:

...

Early this year, when it seemed that 605892 Ontario Inc. would not be rescued by any of the proposed financing deals then being discussed, I wrote a letter to you outlining the urgency of action lest the receiver take action before any financing actually took place. In that letter I requested for Richard Parton and myself an indemnity from liability with regard to our exposure regarding payroll deductions. This request was ignored. I remind you that verbal assurances were made to me that we would not be allowed to suffer personal loss as a result of our efforts to keep the company afloat until financing was completed.

[28] Tab 14 of Exhibit R-1 is a letter addressed to Mr. Swim of Revenue Canada by Mr. Sickle. There is an identical letter at Tab 15 signed by Mr. Parton. They are both dated November 23, 1994. It says the following:

...

2. Relationship of Messrs. Donald G. Sickle and Mr. Richard G. Parton to Company:

Messrs. Sickle and Parton were contracted by Mr. White on behalf of the company during late 1991 to oversee the rehabilitation of the company's waste oil re-refinery and bring the facilities into operation. Due to the undercapitalized nature of the venture, no individuals were prepared to act in the formal position of directors. To facilitate the re-establishment of the environmentally desirable venture, Messrs. Sickle and Parton agreed to act in this position.

...

3. Due Diligence of Messrs. Donald G. Sickle and Richard J. Parton

From the outset, as a result of the absence of a traditional board of directors, an "Advisory Board", comprising Messrs. Howard Taylor, William White and Donald Haldenby was constituted to provide financing and business counsel to Messrs. Sickle and Parton. Regular meetings of this group were held at which financing and operational reports were shared between the parties.

In the summer of 1992, Mr. Haldenby resigned from the Advisory Board, and the Advisory Board was dissolved. However, regular meetings continued to be held by Messrs. Sickle and Parton with Messrs. Taylor and White to facilitate financing activities and to obtain general business perspective and guidance.

...

Messrs. Sickle and Parton were advised that they should attempt to sustain the operations by conserving cash to the maximum extent possible, including the deferral of payment of source deductions, as it would be easier to finance an operating company as contrasted with an inactive company. In response to the question concerning personal liability for the non-remittance of source deductions, Mr. Taylor stated that if that eventuality were to arise, he would assume the liability.

...

[29] The Appellants were assessed in the amount of $288,129.59. Tabs 23 and 24 of Exhibit R-1 show the assessment and the reconciliation of corporate assessments for unremitted source deductions.

Appellants’ arguments

[30] As was mentioned at the beginning, each Appellant had his own counsel. However, for the most part, counsel's arguments were meant for the two Appellants as both counsel agreed on the means of defence. The only point where there was a factual difference was the manner in which each Appellant was purportedly appointed director. In addition, it was agreed by counsel for the Respondent that the Appellants appointment may have been defective. In view of this and to avoid repetition, I will refer to the arguments by both counsel except if necessary.

[31] Counsel for the Appellants submitted that the Appellants were not liable under subsection 227.1(1) of the Act, based on the following:

(a) they never became directors of the Corporation as their appointments were a nullity; and

(b) if they were directors, they exercised due diligence.

[32] Counsel for the Appellants wanted first to put the conduct of the Appellants in the context of the startup of a business. The Appellants believed that the advisors would find the required sources of financing and that a substantial amount of money had been found. The Appellants do not suggest that they did not know about the various directors' liabilities. However, they were under pressure from the advisors and they did the best they could under the circumstances. Counsel's views were that it is simply unjust to impose vicarious liability on the Appellants who acted as dupes or puppets and who had no direct interest in the outcome of the company.

[33] Counsel for the Appellants points out that the Act does not define the term "director". In order to determine whether or not someone is a director, one must look to the company's incorporating legislation: The Queen v. Kalef, 96 DTC 6132 (F.C.A.). The Corporation was incorporated under the O.B.C.A. This Act defines the term "director" as follows at subsection 1(1):"director" means a person occupying the position of director of a corporation by whatever name called, and "directors" and "board of directors" include a single director. The O.B.C.A. includes a number of provisions which deal with the election and appointment of directors.

[34] There are three ways in which a person can become a de jure director under the O.B.C.A.: (1) a person can be named as a director in the corporation's articles: subsection 119(1) of the O.B.C.A. Counsel for the Appellants submitted that this was not the Appellants’ case; (2) a person can be elected as a director by the shareholders of the corporation at their annual meeting: subsection 119(4) of the O.B.C.A. Article 3.05 of the Corporation's by-laws specifically provides that the directors of the Corporation will be elected at the annual meeting of the shareholders by way of a resolution. Counsel for the Appellants suggest that no evidence has been presented which shows that a meeting of the Corporation's shareholders was ever held during the time the Appellants were involved with the Corporation. (3) a person can be appointed as a director by a corporation's directors in limited circumstances. The O.B.C.A. generally permits the directors of a corporation to fill a vacancy in the board of directors provided that there is a quorum: subsection 124(1) of the O.B.C.A. The O.B.C.A. provides that the majority of the number of directors required by the articles constitutes a quorum. There were articles of amendment dated January 10, 1991, in which the directors were set at six. Therefore a quorum of four was required in order to appoint new directors to fill the vacancies. In addition, the directors had no authority to fill the vacancies on the Corporation's board of directors as article 3.07 of the by-laws provides that the shareholders will fill any vacancies on the board of directors.

[35] According to counsel for the Appellants, the evidence shows that Mr. Parton consented to serve as a director of the Corporation on November 28, 1991. However, the evidence also showed that Mr. Parton was never appointed a director by the board of directors. The Corporation's minute book included no directors resolution or minutes of directors' meetings which appointed Mr. Parton as a director. Even if such a resolution did exist, there were not enough directors on November 21, 1991 or at any later date to fill a vacancy in the board of directors. On October 29, 1991, four of the directors, named in the articles of amendment, resigned and no directors were properly elected by the shareholders to replace them. Therefore, it was not possible for Mr. Parton to have been appointed as a director by the board of directors.

[36] With respect to whether the Appellants were de facto directors of the Corporation, counsel for the Appellants submitted that the common law recognized the concept of the de facto directors in certain circumstances, although there was no concession on this point. These were persons who were considered to be directors by their actions as opposed to by election or appointment. The evidence has shown that the Appellants held themselves out to be directors of the Corporation. They signed a number of documents stating that they were directors of the Corporation. They believed that they were directors of the Corporation, although they were never properly elected or appointed to that position. This does not cause the Appellants to be de facto directors. On the contrary, the evidence has shown that the advisors were the directing minds or de facto directors of the Corporation.

[37] Counsel for the Appellants referred to sections 19 and 128 of the O.B.C.A. Section 128 of the O.B.C.A. reads as follows:

128. Validity of acts of directors and officers. An act done by a director or by an officer is not invalid by reason only of any defect that is thereafter discovered in his or her appointment, election or qualification.

[38] Counsel for the Appellants referred to a decision of this Court in Wheeliker et al. v. The Queen, 98 DTC 1110, at page 1113:

I do not agree that section 97 of the Companies Act and section 132 of the Articles resolve the issue. In my opinion these provisions validate acts of persons who are not de jure directors but who act as directors anyway. The provisions are meant to protect third parties dealing in good faith with such persons by validating their acts. They do not relate to imposing a vicarious tax liability on a person for a failure to act; i.e., a failure to remit source deductions.

Section 97 mentioned in the quotation is a provision of the Nova Scotia Companies Act. It is similar to section 128 of the O.B.C.A.

[39] Counsel for the Appellants also referred to the decision of the House of Lords in Morris v. Kanssen and others, [1946] 1 All E.R. 586 at page 590:

There is, as it appears to me, a vital distinction between (a) an appointment in which there is a defect or, in other words, a defective appointment, and (b) no appointment at all. In the first case, it is implied that some act is done which purports to be an appointment but is by reason of some defect inadequate for the purpose: in the second case, there is not a defect; there is no act at all. ...

...

... The point may be summed up by saying that the section and the article, being designed as machinery to avoid questions being raised as to the validity of transactions where there has been a slip in the appointment of a director, cannot be utilized for the purpose of ignoring or overriding the substantive provisions relating to such appointment.

[40] Counsel for the Appellants submitted that there was no appointment at all in the case of the Appellants. If, however it were found that the Appellants were de facto directors of the Corporation according to the common law, they argued that statutory exceptions to fundamental principles of law should be strictly construed. In this case, the imposition of vicarious liability on a de facto director for the liabilities of the Corporation constitutes an exception to the common law separation between corporations and directors.

[41] Did the Appellants exercise a degree of care, diligence and skill to prevent the Corporation's failure to remit source deductions that a reasonably prudent person would have exercised in comparable circumstances? Counsel for the Appellants submitted that they should not be found liable under subsection 227.1(1) of the Act for three reasons: (1) remittances were made to the Receiver General when funds were available; (2) they did everything that they could to bring the remittance problem to the attention of the advisors; and (3) the Appellants were precluded from paying the amounts owed to Revenue Canada due to the instructions of the advisors. In other words, they had lost their freedom of choice as directors. Counsel for the Appellant cited Robitaille v. The Queen, 90 DTC 6059 at 6062 (F.C.T.D.):

... I would be prepared to hold that, even without considering section 227.1(3), there would be no liability on the directors under section 227.1(1) because the latter obviously contemplates that the corporation is freely acting through its Board of Directors. The exercise of freedom of choice on the part of the director is essential in order to establish personal liability.

Respondent’s arguments

[42] Counsel for the Respondent referred to a decision of the King's Bench of Manitoba in Northern Trust Co. v. Butchart et al., [1917] 2 W.W.R. 405 (Man. K.B.), to point out that de facto directors are liable for all their acts of omission or commission in the same manner and to the same extent as if they had been de jure directors. She quoted the decision at pages 414 and 415:

... Whatever may be said with respect to his co-defendants, he was an active participant in all the wrongdoing disclosed. The conduct of the defendant Ford after he became a director in June 1913 is but slightly less reprehensible. He was the accountant in charge of the company's books, and must have known not only that the company had no profits, but that its capital was becoming rapidly exhausted. Both he and the defendant Trick set up the defence that they were never legally elected directors, and I think that much must be conceded. There was no shareholders' meeting held in June 1913, although what purports to be the minutes of such a meeting were written up by Ford, and pasted in the minute book. By these minutes both he and Trick are named directors, and they both consented to act as directors. That they had assumed the functions of directors is shown by the protest which they signed in January 1915, if there was no other evidence of their acting. Whether they were legally elected or not makes no difference. They were de facto directors, and for all acts of omission or commission on their part, they are liable in the same manner and to the same extent as if they had been de jure as well as de facto directors, Dixon's Case, 14 Ch. D. 660; Re Owen Sound Lumber Company, 34 O.L.R. 528.

...

... He however, assumed the position of a director and with it the responsibility. It would never do to permit a director who actively participates in the commission of a wrong to excuse himself from liability upon the plea that he was under the control of and acted by direction of somebody else. ...

[43] Counsel for the Respondent also referred to the decision of the Ontario Supreme Court, Appellate Division, in Re Owen Sound Lumber Co., 33 D.L.R. 487. This decision, according to counsel, incorporates the classic statement that has been adopted by courts throughout the country in situations where there had been an improper appointment of a person as a director and that person acts in this capacity. She referred to page 492:

As to the second point, I agree with the view of Middleton, J., that, when the directors assumed the fiduciary office of director, they became liable in all respects as though rightly appointed to that office. To hold otherwise would be to say that a man might do wrongful acts affecting the company's assets, and yet enjoy immunity if he could show some defect in his appointment. If this were the case, it would become fashionable to usurp the office on these terms rather than to accept it in a legitimate but less favoured way.

[44] She also referred to a decision of the Alberta Supreme Court in Oliver et al. v. Elliot et al., (1960) 23 D.L.R. (2d) 486. This decision concerns the curative provision of the AlbertaCompanies Act which is identical to section 128 of the O.B.C.A. She quotes at page 491:

... There can be no doubt that the intention of the meetings of March 20th was to appoint them directors of the two companies. They did not become directors simply because there was a defect in their appointment. That being so, until effective proceedings were taken to prevent them acting as directors, their acts were, in my view, governed by the curative sections of the statute and the articles, and by the principle laid down in Dawson v. African Consolidated (supra). In other words the acts of the directors at the meeting of March 23rd, including the appointment of two new directors, were valid and effective, despite the defects in the appointment of some of the existing directors.

[45] Counsel for the Respondent submitted that without going into the details of the defects in the appointment of the directors in that case, it may be said without doubt, that they were very similar to the defects raised in the present instance.

[46] Regarding the due diligence aspect, counsel for the Respondent submitted that the diligence that is required is one that has put in place the means to prevent the non remittances. The Appellants did not set up such a system, they have done exactly the opposite. They did nothing to prevent the failure. In fact they caused the failure. They chose to pay other suppliers to keep the business active.

Conclusion

[47] My analysis of the evidence leads me to conclude that the Appellants’ appointment as directors was not a nullity as was suggested by their counsel on the basis of the decision in Morris, supra, a quotation of which is found at paragraph 39 of these Reasons. This decision distinguishes between defective appointment and no appointment. There is a defective appointment where the acts purporting to appoint come from the directors or the shareholders but are not in conformity with the statutory act or the charter or the by-laws of the corporation. There is no appointment where there is usurpation of the function of directors. In this instance, the appointments were defective but it was not a case where there was no appointment at all. Some acts were done which purported to be appointments. There was no usurpation of the function of directors by the Appellants.

[48] Besides, these appointments appear to have been acquiesced to by the totality of the shareholders. Contrary to what counsel for the Appellants has submitted, there were general meetings of the shareholders. That can be seen at paragraph 17 of these Reasons referring to a unanimous shareholders agreement, at Tab 27 of Exhibit A-4, which is a 1991 Annual Report to the Shareholders, signed by the Appellants as directors, at Tab 46 of the same Exhibit, stating that an annual meeting was held on August 26, 1993 and at Tabs 44 and 46 of the same Exhibit showing the comments to the shareholders prepared by Mr. Parton for the shareholders annual meeting. Therefore, it was known by the totality of the shareholders that the Appellants were the directors and that the number of directors was two. No objection has ever been raised by the shareholders. The shareholders, by their acquiescence, could be considered to have cured the irregularity regarding the number of directors on the board and their appointment: see in this respect pages 234 and 235 in the chapter entitled "Irregularities" in F.W. Wegenast, The Law of Canadian Companies (Toronto: Carswell, 1979). It would appear that the Appellants could be considered de jure directors. They surely were de facto directors.

[49] Court decisions are to the effect that de facto directors bear the same liability as de jure directors regarding outsiders. I will quote from The Law of Canadian Companies, supra, at pages 408 to 411 as to whom are de facto directors and what is their responsibility:

De Facto Directors.

If a person not duly elected nevertheless acts as a director he may under certain circumstances be regarded as a de facto director. Persons assuming to act as directors of a company without having been properly elected, or a board not duly constituted, because too many or too few were elected or remained in office, or consisting of directors who, or some of whom have held on after the expiry of their term of office, ...

... outsiders, at all events, are entitled to assume that the internal proceedings of a company have been regular and that those who purport to speak and act for the company have been duly authorized.

... Between the company and persons having no notice to the contrary, directors de facto are as good as directors de jure, ...

...

The objection to de facto directors cannot, of course, be invoked by an unauthorized director himself, as for example to escape liability for payment of dividends out of capital, or for other misfeasance, or to escape a statutory liability for wages of workmen, or for failure to make government returns, ...

[50] As stated above, counsel for the Appellants relied on a decision of this Court in Wheeliker, supra, that says at page 1114 that although they may have been de facto directors at common law, they were not under the Companies Act and should not be held vicariously liable under section 227.1 of the Act.

[51] It is difficult for me to understand where this finding comes from that directors are de facto directors at common law and not under the statutory acts. If I look at the sources of Company law set out by Wegenast in The Law of Canadian Companies, supra, at page 53, I see that the sources are to be found:

Sources of Company Law.

Generally speaking the law and rules governing an ordinary commercial company are to be found in (a) the statutory provisions under which the company was incorporated and legislation in pari materia with it, (b) the charter, or other constating instrument under which the company is incorporated, (c) the by-laws of the company, or in the case of a registered company its articles of association, and (d) general principles of company law as embodied in decisions of the courts.

[52] Judicial interpretation cannot be dissociated from the statutory acts it interprets. Caselaw or jurisprudence is a source of company law, it is not distinct from it. At any rate, there is no doubt that the notion of de facto directors is specifically contemplated in section 128 of the O.B.C.A. Indeed that section speaks of nothing else than de facto directors. Section 97 of the Nova ScotiaCompanies Act is similar to section 128 of the O.B.C.A. There are many other provisions regarding de facto directors in the O.B.C.A. I therefore cannot follow that part of the decision of this Court in Wheeliker, supra, and I must conclude that the term "director" in the O.B.C.A. includes de facto directors insofar as their liability to outsiders is concerned.

[53] The Appellants have tried to exculpate their liability in putting it to what appears to be known in English law as "shadow directors", although this notion does not relieve the de facto directors from their liability, because by assuming the position of directors they have assumed the obligations and duties coming with this function. The notion of shadow directors would only add to the number of directors. I refer to Gower's Principles of Modern Company Law, 5th ed., (Sweet & Maxwell, 1992) at pages 143 and 144:

De Factoand Shadow Directors

While, de jure, people cannot be directors unless they have been properly appointed, they may, as we shall see later, be able to bind the company although they have not. Moreover, they may be subject to liability as if they were directors because they have assumed that position, or because an increasing number of legislative provisions expressly apply not only to directors, but also to "shadow directors", i.e. persons "in accordance with whose directions or instructions the directors of the company are accustomed to act" otherwise than only because "the directors act on advice given ... in a professional capacity."

[54] Counsel for the Appellants suggested that the Appellants were dupes or puppets and that no vicarious liability should be imposed on them. With hindsight, that may be how the Appellants' behaviour may appear. However, when they chose the course of action that has brought this unfortunate assessment this is not what they thought of themselves and it is not an accurate description of their role in the management of the company. The Appellants were intelligent persons and had active and important roles in the Company. There is no evidence that they acted under forcible threat. They are accountable for their own actions.

[55] The documentary evidence shows that the Appellants' memoranda to the advisors were in the nature of those of executive directors. In Gower's, supra, at page 158, I find of interest the distinction made between the executive director and the non-executive director as follows:

Executive and Non-Executive Directors

It will have been apparent from the foregoing that directors may be either non-executive or executive. The former are directors expected to do little or nothing other than to attend a reasonable number of board meetings and, perhaps, some of the committees that the board may establish. As such they will be modestly rewarded by directors' fees resolved upon by the company in general meeting. Executive directors are those who, in addition to their roles as directors hold some executive or managerial position to which, as we have seen, they are appointed by the board, which will determine their emoluments and "perks". ...

[56] The notion of an executive director is not different from that one of an inside director as analyzed in Soper v. The Queen, 97 DTC, 5407 at page 5417:

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. For such individuals, it will be a challenge to argue convincingly that, despite their daily role in corporate management, they lacked business acumen to the extent that that factor should overtake the assumption that they did know, or ought to have known, of both remittance requirements and any problem in this regard. In short, inside directors will face a significant hurdle when arguing that the subjective element of the standard of care should predominate over its objective aspect.

[57] In Merson v. M.N.R., 89 DTC 22, Rip J. described at page 28 the standard of reasonable care which a diligent administrator should exercise to comply with the requirements of subsection 227.1(3) of the Act:

... The prudence required by subsection 227.1(3) in the exercise of care, diligence and skill is different from that required by a director performing his duties, under corporate law, notwithstanding that subsection 227.1(3) and subsection 122(1)(b) of the Canada Business Corporation Act, for example, both use identical words. The exercise of care, diligence and skill by the director contemplated by subsection 227.1(3) is not founded on the director's obligations to the corporation; it is based on one of the corporation's obligations under the Act and the failure of the corporation to fulfil such obligation. A director who manages a business is expected to take risks to increase the profitability of the business and the duties of care, diligence and skill are measured by this expectation. The degree of prudence required by subsection 227.1(3) leaves no room for risk.

[58] The Appellants were two persons who had been at the executive level in business before. They accepted the position of director, with a substantial remuneration (the remuneration ceased as of March 15, 1993), of a corporation whose business was being implemented, a business that required a great deal of financial resources and had experienced cash flow difficulties from the start. They knew of the obligations of a company's director. They asked to be insured against them. However, they accepted the function of directors without any written indemnification. They were taking risks but they thought that these risks were surmountable. It is evident that knowing what they know now, they would not have taken them. The risks that they took were among others not to pay the entire salary of the workers. They paid the net salary to the employees and did not remit the other portion to the fiscal authorities. They did that on purpose.

[59] They were honest persons who acted in the interest of the corporation. Sadly, most cases, if not all, of directors' liability who come before this Court concern honest persons who thought that they could overcome the financial difficulties they were encountering by making the minimum disbursements of cash they could to maintain the business afloat, hoping that they would be able to remit the source deductions at a later time when quietness would have resurfaced. This Court's jurisprudence is that this does not prevent the directors to be exculpated from liabilities under paragraph 227.1(1) of the Act. It is a provision that is based on the deliberate intention of not remitting the source deductions while continuing to pay the net portion of the salaries. The evidence in these appeals did not reveal anything else.

[60] Due to the conclusions that I have set out above, I do not see the need to deal with the issue of estoppel. The appeals are dismissed with costs to the Respondent.

Signed at Ottawa, Canada, this 6th day of April, 1999.

"Louise Lamarre Proulx"

J.T.C.C.