Dussault, T.C.C J.:—
The Issue
This is an appeal from an assessment by the respondent dated March 17, 1988, for which the notice bears number 551538, respecting the appellants alleged liability under subsection 227.1(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") and section 68.1 of the Unemployment Insurance Act, 1971, S.C. 1970-71-72, c. 48. The assessment is for a total amount of $6,119.14 representing deductions at source of income tax and unemployment insurance premiums which the company Ferme Jalna Inc. (the company) was required to remit for the months of February to June 1986, as well as T4 differences for 1985, together with penalties and interest. In assessing the appellant, the respondent assumed the following facts, which are found in paragraph 5 of the reply to the notice of appeal:
[Translation] (a) "Ferme L. Rousseau Inc.” is a company incorporated on October 3, 1979 under Part I of the Companies Act of Quebec;
(b) on July 17, 1981, the business name "Ferme L. Rousseau Inc.” was changed to "Ferme Jalna Inc.”;
(c) at the time the assessment which gave rise to this dispute was made, ” Ferme Jalna Inc.” owed the Department of National Revenue the amount of $6,109.14, composed of income tax deductions and unemployment insurance premiums for the months of February to June 1986, and T4 differences for 1985, together with penalties and interest (see the detailed computation in paragraph 2 above);
(d) "Ferme Jalna Inc.” failed to remit the income tax deducted at source and unemployment insurance premiums referred to above to the Receiver General of Canada within the required time;
(e) on January 16, 1987, a receiving order was obtained against" Ferme Jalna Inc.” which was deemed to have made a disposition of its property on December 23, 1986;
(f) on April 15, 1987, the Department of National Revenue filed evidence of its claim totalling the sum of $6,109.14;
(g) the appellant was a director of "Ferme Jalna Inc.” on the dates on which that company was required to pay the moneys in issue to the Receiver General of Canada;
(h) in his capacity as a director of" Ferme Jalna Inc.”, the appellant did not exercise the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances;
(i) in particular, the appellant did not make the necessary arrangements to prevent the failure by "Ferme Jalna Inc."
The appellant contests the assessment, relying on subsection 227.1(3) of the Act, which provides that a director is not liable where'* he exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances”.
The Court heard the testimony of Mr. Laurier Duchesnes of the Royal Bank, Mr. Michel Fontaine, another director of the company at that time, the appellant himself, and Mrs. Aline Chassé, a collection agent with Revenue Canada.
Summary of the Facts
During the years in question, 1985 and 1986, the company operated a business raising hogs.
The Royal Bank (the bank) was a creditor of the company, having granted it a mortgage loan of $300,000 and an operating loan (line of credit) of $40,000. The security held by the bank was a mortgage on a building belonging to the company, a general assignment of debts, and a guaranty on the livestock, under section 178 of the Bank Act, R.S.C. 1985, c. B-1. The line of credit was also personally guaranteed by Mr. Michel Fontaine, the other shareholder and director of the company. A $60,000 line of credit had also been granted by Turcotte et Turmel, a hog slaughtering firm. This line of credit was secured by a second mortgage on the building belonging to the company.
In the fall of 1985, the company started to experience financial difficulties arising, inter alia, from the low market price of pork. As well, the company's inability to obtain payment of $50,000 from the Régie des assurances-agricoles as payment of stabilization insurance relating to the operation of a second hograising site where the company only rented and did not own the building used for that purpose seriously affected its cash flow.
In January 1986 the company's credit was seriously constricted by the cancellation of the line of credit granted by Turcotte et Turmel, the slaughtering firm, following delivery of a notice by the bank to pay moneys owing to the company from the sale and slaughter of hogs directly to the bank.
In April 1986, a following agreement reached between the bank and the principal parties, Mr. Fontaine and the appellant himself, the bank invoked the dation [sic] in payment clause in the mortgage deed. It was also understood that the business would continue to operate with the assistance of two on-site employees in order to facilitate sale of the building by the bank.
According to Mr. Duchesnes, the representative of the bank, the bank began at that point to supervise the company's operations very closely, without, however, taking over management directly.
Mr. Fontaine stated that he no longer went to the farm starting in April or May 1986, since he did not feel welcome because of the bank's role in this matter. However, it seems that he might have signed blank cheques in advance for the purpose of paying the employees.
As for the appellant himself, he stated that he was responsible for paying employee's salaries starting in the fall of 1985, and that he made source deductions and corresponding remittances for so long as the bank honoured the cheques. From February to June 1986, he prepared and signed chegues in this way both for employees and suppliers and for source deductions. He stated that starting at the end of May or beginning of June 1986 the cheques for suppliers and employees were prepared by Mrs. Rita Bélanger, a bank employee, and he, himself, went to the bank regularly every week to sign them. Because the company had no more funds, the bank continued in this way to pay suppliers and employees in June and July 1986, as well as other expenses, out of an increase in the company's line of credit, and contrary to the agreement that the $40,000 line of credit initially granted was not to be increased. The bank's expenditures for payment to employees and suppliers in June and July were corroborated by the testimony of Mr. Duchesnes, who supplied details of the payments. As far as what actually happened in respect of the source deductions during the period from February to June 1986, no one was in a position to provide any fuller explanations. The appellant stated, however, that he had himself prepared and sent a cheque dated July 2, 1986, payable to the order of the Receiver General of Canada, in the amount of $901.85 (Exhibit 1-1). According to the appellant, the bank refused to release the funds. In fact, this cheque could not be cashed and was returned for insufficient funds. The appellant maintained, however, that the source deductions were paid normally until this cheque dated July 2, 1986 was dishonoured. On cross-examination, however, he admitted that the first dishonoured cheque relating to source deductions occurred in about April 1986.
However, the appellant stated that during this entire rather disturbed period, for which we have not really been able to determine who did what, he was in weekly contact with Mrs. Rita Bélanger, the bank employee. He also stated that he was never prevented from going to the farm. When asked whether the company could have sold the hogs, given the financial difficulties, he said that this could have been done, because the livestock had not been seized.
Mr. Fontaine testified that during the weekend of July 25, 1986 he and the appellant decided to sell all the hogs on the farm. They therefore proceeded themselves to load the animals for the sale at the slaughterhouse. This decision, it seems, was made without the knowledge of the bank, and because while it had increased the company's line of credit it was then refusing to pay the farm's employees. The sale brought in $70,000, which was entirely recovered by the bank. This sale obviously put an end to the operation. The bank then also collected the $21,000 owing to the company as stabilization insurance. At the bank's initiative, the company was subsequently placed in bankruptcy in February 1987. There were therefore no further assets to be divided among the creditors. The bank, which was already the owner of the farm building by virtue of the dation in payment of April 1986, finally disposed of it in March 1987.
Mr. Fontaine and the appellant testified that during the period in question, that is, from the end of 1985 to July 1986, they were aware of problems concerning source deductions and they discussed these problems between themselves and even with representatives of the bank, as they did the company's other financial difficulties. They stated that, given the bank's refusal to get involved and to honour the cheques, they could do nothing more. Mr. Fontaine further stated that there was an agreement with Revenue Canada for payment of arrears of source deductions for the year 1985.
However, Mrs. Aline Chassé, a collection agent with Revenue Canada, denied that there had been any agreement and maintained that if there had been any agreement or communication it would have been noted on the file, which was not the case. She simply stated that on April 19, 1985 she had received an account for remittance of source deductions owing for the month of March 1986 in the amount of $323.55. She also received three post-dated cheques to cover 1985 arrears, that is, two cheques in the amount of $1,000, dated May 2 and June 2, 1986, respectively, and a third cheque in the amount of $901.95 dated July 2, 1986. These three cheques could not be cashed and were returned after being refused by the bank.
Analysis
Chief Judge Couture of this Court held in Bernard F. Fancy et al v. M.N.R., [1988] 2 C.T.C. 2256, 88 D.T.C. 1641:
The provisions of subsection 227.1(3) are clear that the liability of a director of a company under 227.1(1) is contingent upon his personal conduct as a director in relation to the circumstances that gave rise to the omission by the company to withhold or remit the deductions from employees' salaries. Accordingly, previous decisions rendered by this Court are not of great assistance in arriving at a determination of liability in respect to subsequent appeals unless the Court is dealing with comparable facts.
As well, Addy, J. of the Federal Court of Canada held in Lucette Robitaille v. The Queen, [1990] 1 C.T.C. 121, 90 D.T.C. 6059:
Although, when dealing with “the degree of care, diligence and skill” to be exercised by” "a reasonably prudent person” in "comparable circumstances”, each case must necessarily depend on its particular facts, it appears that the Tax Court in its more recent decisions might have been more lenient towards directors than the previous cases, which seemed to insist on a somewhat higher duty, the duty presumably being an absolute one for the director to take positive action, since he or she must, in all cases, regardless of the situation, prove affirmatively that, both before and after the occurrence, there was on his or her part an exercise of care, skill and diligence in the performance of the duties normally incumbent upon a director. The argument is based on the common law principle that no distinction is to be made between directors whether they are active or purely nominal directors. Although that burden would, in the vast majority of cases, fall upon any director seeking to escape liability under section 227.1(1) by qualifying as an exemption under 227.1(3), I cannot accept that it is an inflexible rule of universal application regardless of the facts of any case. There exists, as was decided by Chief Judge Couture, of the Tax Court of Canada in the reported case of Fancy & Fancy v.
supra, certain exceptional situations where a distinction can and should be made. Be that as it may, the "circumstances" referred to in subsection (3) must be those which, either directly or indirectly, would have an effect on the actions or on the inaction of the person sought to be held liable under subsection (1).
Associate Chief Judge Christie of this Court also held in Denis John Cy- bulskiv. M.N.R., [1988] 2 C.T.C. 2180, 88 D.T.C. 1531:
While at first blush subsection 227.1(3) suggests a requirement for positive assertion on the part of a taxpayer in order to bring himself within its ambit, this is not necessarily so in all situations. It may well be that a taxpayer would not take positive steps in some circumstances and still be correctly regarded as having "exercised" that degree of care, diligence and skill expected of a reasonably prudent person that creates the protection from liability afforded by the subsection.
In the present case, Mr. Michel Fontaine and the appellant Mr. Marc Hamel have described the company's financial difficulties, which started in 1985 and continued throughout 1986, or at least until they decided to cease operations and sell the hogs at the end of July 1986. In April 1986, having made an agreement with the bank, they decided to continue to operate under the bank's supervision. During this entire period, until July 1986, they made arrangements for the employees and suppliers to be paid, despite the company's precarious position with respect to the bank. There is, however, little in the evidence to indicate that the appellant had any concern as to the problems relating to source deductions, except that the company was more or less at the mercy of the bank with respect to the cheques that the bank decided to honour. While the appellant stated that he was in almost weekly contact with the bank, the appellant could not explain any arrangements made with it relating to source deductions, and that, for a period of more than six months.
If one agrees to continue operating a business despite the financial difficulties it is experiencing, and if one accepts to pay employees and suppliers, one must also accept to discharge one's income tax obligations. One must be able to show, if not positive steps, at least concrete facts which may explain one’s inaction during such a long period of time. The decision made jointly with the bank to continue operating for several months when the animals could have been sold earlier implies that the parties had some hope of deriving some benefit from it eventually, if only by limiting their losses. Such a decision, however, implies a responsibility to ensure that the business was not being financed out of what was owed to the government.
We are not dealing here with exceptional circumstances comparable to those described in Robitaille, supra, in which, inter alia, the bank took over effective control of a company without the consent of the directors, and where the director in that case was only vaguely aware of the precarious situation of the company up to that point. This is not the case here. The appellant was one of the directors who participated in the decision to continue the operations, and, from his testimony, he was in frequent contact with the bank. In this case what can be argued against him is that he and the other director continued to pay employees’ salaries for several months, until about the end of May or beginning of June 1986, and then in June continued to sign cheques for salaries, particularly, prepared by a bank employee, that, when he had known for a long time that source deductions had not been made, since he himself was responsible for doing this. He knew or ought to have known since early May 1986 that the cheque for $1,000 to the order of the Receiver General of Canada dated May 1 for 1985 arrears had not been honoured by the bank, and the same subsequently for the cheques dated June 1 and July 2, 1986.
In Robitaille, supra, Cybulski, supra and Fancy, supra it was held particularly that a director may exonorate himself from liability under subsection 227.1(3) of the Act in certain exceptional circumstances without being able to state the specific actions carried out to prevent the failure by a company to make or remit source deductions. If, as in the present case, a director cannot explain the specific steps or action taken to ensure compliance with the Act with respect to source deductions, then his conduct must not be marked by negligence or recklessness to the point that, by his conduct in relation to the situation as a whole, he aggravated it more than he tried to remedy it.
In the case at bar, the whole of the evidence presented does not persuade me that the appellant "exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances".
Accordingly, the appeal of the portion of the assessment established under the Income Tax Act is dismissed.
As for the appeal of the portion of the assessment established under section 68.1 of the Unemployment Insurance Act, 1971 it is dismissed because this Court does not have jurisdiction, as submitted in paragraph 8 of the reply to the notice of appeal.
Appeal dismissed.
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