Gordon Fitzgerald, Gertrude Fitzgerald, Terrence Fitzgerald and Clark Fitzgerald v. Minister of National Revenue, [1991] 2 CTC 2595, 92 DTC 1019

Mogan, T.CJ.:—The appeals of Clark Fitzgerald, Gordon Fitzgerald, Terrence Fitzgerald and Gertrude Fitzgerald were heard together on common evidence. The three male appellants are brothers and they are also the sons of the female appellant, Gertrude Fitzgerald, and her deceased husband, Eugene Fitzgerald. The four appellants were assessed under section 227.1 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") as directors of Eugene Fitzgerald & Sons Ltd. in the circumstances described below.

In the early 1950s, the late Eugene Fitzgerald started the business of making boxes, crates and pallets out of wood. The business was a proprietorship operated in Saint John, New Brunswick out of rented premises. By 1970, the only significant product was pallets. In 1966, Gordon went to work for the father followed by Terrence in 1970 and Clark in 1976. From 1976 to 1985 those actively engaged in the business were the father (Eugene), the three sons (Gordon, Terrence and Clark) and three non-family persons. In 1978, the business moved to Spruce Lake Industrial Park and was incorporated as Eugene Fitzgerald & Sons Ltd. (“the Company"). Upon incorporation, the Company had purchased a site of 1.68 acres in the industrial park and had constructed a new building. In February 1985, a fire destroyed the building and all the contents. Before the fire, the insurance on the building and contents had been reduced and the proceeds from the fire insurance policy were not adequate to cover the full cost of replacing the building and its contents. After the fire, the Company was out of business for a short period and then operated at about one-third the former pace in rented premises.

In June 1986, the business was able to move back to a new plant located on the old premises in the Spruce Lake Industrial Park. In the new plant, the business was never able to operate at its pre-fire capacity for a number of reasons. Some of the old customers had drifted away after the fire and were purchasing pallets from other suppliers. Increased competition had lowered the price of pallets. And there had been a slowdown in the economy around Saint John. The Company was short of cash and closed down the business permanently in October 1986. The land and building at Spruce Lake Park were put up for sale in November 1986.

Eugene Fitzgerald was born in 1908 and was 77 in 1985 when he decided to rebuild after the fire. He was in poor health in the latter part of 1986 and he died in February 1987.

Notices of assessment dated February 5, 1988 were sent to all four appellants assessing them as directors of the Company with respect to payroll source deductions not remitted by the Company. Their common defense is that they were directors in name only. The father was a strong minded individual who by himself ran the business and later the Company. In 1978, the father wanted a limited corporation but nothing else changed. All four appellants testified and described a day in 1978 when they went to a lawyer's office in Saint John to sign some papers; they were told that they were directors of the Company but there were never any meetings of any kind. The father owned all the shares. They were never shown any of the Company's books, records or financial statements. None of the appellants had signing authority on behalf of the Company.

Gordon stated that if he had asked to see the books, the father would have told him to mind his own business. It was Gordon's job to deliver the pallets; and he did this in an old truck but the father went out one day and purchased a new truck without telling anyone. It was not until August 1986 when his paycheque bounced that Gordon realized the Company was in serious financial trouble, and the Company was out of business within two months. Gordon said that he and his brothers could send an army against the father but they would not “get by him". The appellants had nothing to do with the management of the Company and the three brothers were involved only as employees. When the Company went out of business, one went on unemployment insurance, one became a teacher and one went into sales.

There had been a bookkeeper, Mr. Bradley, but he moved to Sussex, New Brunswick around 1983. After that, Mrs. Gertrude Fitzgerald started to do some of the banking for the Company. She deposited cheques from customers and sent out invoices. She also made out payroll cheques and cheques to the Receiver General for source deductions. She was not a bookkeeper, however, and had no independent information concerning any invoice or cheque she would issue. Her husband would tell her the amount of each invoice and the payroll cheque (take-home pay) for each employee and the amount to be sent to the Receiver General for source deductions. She could not make up a financial statement and had no idea as to whether the Company was profitable but she did know when the Company was overdrawn at the bank. It must be remembered that Mrs. Fitzgerald was born in 1911 and was 72 years of age in 1983 when she took on some of Mr. Bradley's former duties and began to make up invoices and cheques. Mrs. Fitzgerald never came to the plant but made out the cheques and invoices at home.

Although the Company appeared to operate as a family business, it was in fact a feudal arrangement with the father as lord of the manor and the other family members as serfs. The fire insurance proceeds were approximately $160,000. This was probably the first time in Eugene Fitzgerald's life when he could actually lay hand on that kind of money and call it his own because the land and plant at Spruce Lake were free and clear at the time of the fire. There was some doubt in the minds of certain family members in 1985 concerning the prudence of rebuilding the plant and trying to retain and continue the business when the father was 77 years of age and none of the sons had been involved in the management of the business. The father was stubborn, however, and absolutely determined to rebuild the plant and retain the business. The sons said that the father would have persevered in this determination even if they had refused to cooperate and had withdrawn their employment from the business.

When the appellants met with Eugene Fitzgerald and his lawyer at the lawyer's office in 1978 to sign certain documents relating to the incorporation of the Company, they were told that they were directors but there was no indication that they had any duties or responsibilities as directors; there were no meetings of any kind; the father kept all the financial information to himself; the father purchased all the supplies and each Friday he would collect the receivables. None of the sons had anything to do with the paper work or administration of the business and they had no idea as to whether it was profitable even though they were all mature adults at the time of the fire.

After the business was closed down in the fall of 1986, one of the major suppliers was owed $55,000 for raw materials. The father had been told that the land and building should sell for $140,000 and so he thought that all creditors (including Revenue Canada, Taxation for payroll source deductions) would be paid from the proceeds. When the building did not sell immediately, this supplier came to the Fitzgeralds' home with a lawyer and, on January 20, 1987, a month before the father died, Mrs. Gertrude Fitzgerald (then in her 76th year) signed a collateral mortgage granting the supplier a form of security for its claim. She knew at the time that the land and building were free and clear; that the supplier was owed $55,000; and that Revenue Canada, Taxation was owed about $14,000 for source deductions. She did not appear to recognize the significance of granting a collateral mortgage to the supplier and stated that the supplier would not wait and she felt pressured into signing. She did not consult her sons and she did not know that the supplier would come out ahead of other creditors but she did know that the collateral mortgage would put the supplier in an advantageous position. Mrs. Gertrude Fitzgerald was a very unsophisticated woman who had lived in the same house in Saint John for 45 years. Similarly the sons were unsophisticated in commercial matters.

The land and building were offered for sale in September 1987 under a power of sale clause in the collateral mortgages and, when no purchaser came forward, the property was taken by the supplier in satisfaction of its claim. Other creditors including Revenue Canada, Taxation were left empty-handed. There was entered in evidence a copy of the collateral mortgage signed only by Gertrude P. Fitzgerald. Any creditor with a substantial claim against the Company should have at least considered challenging the validity of the collateral mortgage on the basis of whether Mrs. Gertrude Fitzgerald had authority to sign it alone on behalf of the Company.

It appears to me that the appellants were directors in law (i.e., their names appear in the Company's minute book as directors) but they were not in fact directors. They never met as directors. They never acted alone or in concert as directors. They had no knowledge of the management or administration of the Company's business. They had no equity in the Company. They had no way of compelling the fifth director (Eugene Fitzgerald, the sole shareholder) to disclose any information concerning the Company's financial affairs. They were directors in law only because of their family connection to Eugene Fitzgerald. Although any one of them could have resigned as a director if he or she had thought of it, such resignation would have been a source of family friction and, from the viewpoint of the male appellants (the three sons), the idea of resigning as a director would not have occurred to them before the idea of quitting their employment.

I would not hold as a general rule that a passive or inactive director is free from liability under subsection 227.1(1) of the Income Tax Act. For example, a person who consents to being a director of a corporation in order to accommodate a friend or client and then fails to participate as a director in the affairs of the corporation is still very much at risk under subsection 227.1(1). The passive or inactive director is not, per se, free from liability under subsection 227.1(1). But when the passive or inactive director has become a director in the context of a family business operated by a corporation which is dominated by an uncompromising patriarch, the domestic responsibility for maintaining harmony within the family becomes interwoven with the legal responsibility to third parties and, in these circumstances, I think that it is not reasonable to impose the same standard of care, diligence and skill on the passive "family director" as on the person who is truly free to become a director and does so outside a family context.

Applying the above proposition to the facts of this case, I hold that the appellants satisfy the test in subsection 227.1(3) because they exercised the degree of care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances. I emphasize "in comparable circumstances" because a reasonably prudent person would, in this feudal family, maintain family harmony by serving as a director in name only and by leaving the management of the business in the hands of the strong-minded patriarch who ha managed it successfully for 30 years. If Eugene Fitzgerald were still alive, he would be liable under subsection 227.1(1) for the amount of $14,588.88 which has been assessed against each of the appellants herein. After the fire, the late Eugene Fitzgerald, as the only de facto director, made certain imprudent decisions which resulted in the loss of the family business and any equity therein. Without considering any further argument, I would be content to allow the appeals for the reasons set out above. There is, however, a further argument.

The appellants have a second defence which was not pleaded (they acted on their own behalf without the benefit of legal counsel) but which has come to light following the recent decision of this Court in Leung v. M.N.R., [1991] 2 C.T.C. 2268; 91 D.T.C. 1020. Each appellant received a notice of assessment dated February 5, 1988 showing a balance of $14,588.88 with the following endorsement typed on the face of the document:

Liability under Subsection 227.1(1) of the Federal Income Tax Act, and section 36.1 of the New Brunswick Income Tax Act, Section 22.1 of the Canada Pension Plan, and Section 68.1 of the Unemployment Insurance Act, 1971, for $14,588.88 being the amount of the unpaid Payroll Deductions payable by Eugene Fitzgerald & Sons Ltd. in respect of Notices of Assessment dated July 28, 1986, December 8, 1986, and December 12, 1986.

There was nothing in any one of the four notices of asessment under appeal which indicated what particular amount was assessed under the federal Income Tax Act, the New Brunswick Income Tax Act, the Canada Pension Plan or the Unemployment Insurance Act. Also, there was no information to indicate the particular payroll periods when the Company had failed to remit all or part of the source deductions. I adopt the following statements by Rip, J. at page 2277 (D.T.C. 1027) in the Leung case:

An assessment, therefore, is not complete unless the notice is given in such manner that the taxpayer knows the amount of tax assessed under the appropriate statute.

Notification of the aggregate of amounts assessed under four statutes, in my view, does not inform a taxpayer of a particular amount assessed under one of the statutes. The assessment is incomplete.

Applying the decision in Leung to the appeals herein, I conclude that each purported notice of assessment dated February 5, 1988 is not complete. Relying on either one of the arguments discussed above, I would allow the appeals and vacate the four assessments made on February 5, 1988.

Appeals allowed.