Rejean Deschénes v. Minister of National Revenue, [1990] 1 CTC 2394

Lamarre Proulx, T.C.J.:— The appellant is appealing from an assessment dated January 12, 1987 in the amount of $5,807.57, made pursuant to section 227.1 of the Income Tax Act ("the Act").

The evidence disclosed the following facts.

The appellant is a notary. In 1983, Mr. Mario Roy was his client. From time to time this client bought apartment buildings for which the appellant prepared the necessary legal documents. On one of his visits, he told him of a plan to buy a muffin-selling franchise. The plan interested the appellant. There was a discussion as to terms of participation. The appellant was interested in investing in this project. It was quite clear that under their agreement the notary would invest in the business and Mr. Roy would manage it, that is, he would look after its day-to-day operation. The appellant did not have time to spend on the business. As he was a notary, it was agreed he would be responsible for the legal aspects of creating the business, namely incorporation, negotiating the franchise, the lease, bank loans and sureties. His initial investment was $10,000. To that must be added the value of his professional services rendered without charge. The appellant had to endorse two bank loans. The business started up in August 1983 and was closed in October 1984. Initially the sales outlet was the Place Fleur de Lys shopping centre. The appellant never hired the staff and did not know them. He did not know how many employees the business had. Mr. Roy looked after all that. He hired the staff, paid salaries, made bank deposits and dealt with suppliers.

In 1984, another sales outlet was opened on the Grands Voiliers site.

On March 21, 1984 the appellant’s wife died in tragic circumstances. The appellant had to look after his two children, who were three and seven years old. There were frequent day care problems. There were also difficulties at the office because he had to be absent from work. In April the appellant began operating a franchise at the Galerie de la Capitale alone. The evidence did not disclose the nature of this franchise.

The appellant checked with Mr. Roy from time to time. The latter told him that the business was operating satisfactorily, but it became hard to contact Mr. Roy, especially when the second outlet was opened at the Grands Voiliers site. Mr. Roy, who thought the business was a gold mine, had hired a large number of employees. Like many other businessmen, he was convinced by the organizers of the Grands Voiliers event. This turned out to be a financial disaster, from which the business was not immune. Initially it operated satisfactorily, but after June 24, 1984 the suppliers came down on Mr. Roy. The bankers began calling the appellant. The businesses] principal banker allowed it to continue until October 1984. The appellant's testimony must be cited here, because it indicates the context in which the bank continued advancing money to the business.

(Translation)

Q. Good. O.K. So at what time did that start, did you begin receiving calls from the bank?

A. July, August.

Q. July, August.

A. Yes.

Q. Good. O.K. So I was asking you, what arrangement did you make with the bank at that time?

A. Well, I went to see them and they told me you have endorsements outstanding. The matter was clear and simple. There are those endorsements, and I do not think your friend Mario can pay.

Q. So you paid the bank at that time?

A. No, I did not pay the bank. I made arrangements with the bank. I said, listen, it is Quebec 84, we don't know how this will go. It will be O.K., let the business go on as long as possible so that we can —he said, the money will not be paid —he did not want to pay anything. Agreement had to be reached so that at least certain cheques could be issued to pay wages. Then . . .

Q. Did the agreement also cover the payment of source deductions at that time?

A. That was not negotiated as such at that time.

Q. However, you negotiated the payment of wages.

A. Well, that is. . . if the company was to go on, the employees had to be paid. So the only cheques he allowed to go through —it was not negotiated as such, allowing the wages to go through —he said to me, I will allow the employees' wages to be paid.

Q. Did you formally ask the bank to allow cheques for source deductions to go through?

A. No, I did not ask for that.

Q. As there were problems with wages, did you investigate at that time to see whether there were problems with source deductions?

And then, the bank delayed as much as possible. The bank manager—you will understand there were several people involved—the bank manager, if his loan is not good he has problems, he has to be responsible. He wanted to protect his loan as far as possible. I was trying to protect my endorsement. It was obvious that Mr. Roy was going bankrupt.

I was caught in a situation in which I had some . . . even if I had wanted —I said, what about the source deductions that have not been paid, what could I have done? Not one cheque was going through there. There were no more cheques. The damage was done, it was too late. There was $222,000 in debt.

I had the choice either of making certain arrangements with the people to whom I had given bank endorsements or going into bankruptcy. That is what I did.

Counsel for the appellant maintained that the appellant did not manage the day-to-day operation of the business, did not participate in the business, and his diligence should therefore be judged as that of an investor in a corporation, not as what should be expected of someone handling a corporation's everyday dealings.

Counsel for the appellant also argued that in the event I find that he was in a position to have a share in running the business, in the circumstances described in which the operation of the business was threatened, no diligence could be exercised. Nothing more could be done. The speed with which the business went bad and the appellant's state of nervous exhaustion brought on by his family and business situation have to be considered. In this regard, I quote a passage from the American case John P. Emshwiller, Jr. v. United States of America, 565 Federal Reporter (2d) 1041, which clearly describes the feelings of a person who has to make a decision in such a situation:

We are not insensitive to the dilemma faced by the manager of an insolvent corporation who is making an earnest effort to keep the business on its feet. Should he choose to refrain from paying net wages, he runs the risk of losing employees and with it the business; should he choose to pay net wages, he runs the risk of being unable to pay over those withheld. Despite the difficulty of this choice, there is no basis for allowing a responsible person to choose that course which disables him from meeting his tax obligation by preferring those with wage claims.

However, the testimony of the appellant himself, cited above, indicates that it was he who deliberately chose not to pay the income tax and unemployment insurance deductions. That was a risk the appellant took. It was a risk taken in difficult circumstances, certainly; but it was still a deliberate choice which remained unchanged for a period of several weeks, and was contrary to the duty of the director of a corporation to act with care, diligence and skill in remitting source deductions from employee salaries.

In Merson v. M.N.R., [1989] 1 C.T.C. 2074; 89 D.T.C. 22 at page 2083 (D.T.C. 28), my colleague Rip, J. described as follows 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 decree of prudence required by subsection 227.1(3) leaves no room for risk.

[Emphasis added.]

The appellant is a notary. His practice centres on commercial law. He was a 50 per cent shareholder in the corporation. He must have known that directors have some responsibility in corporate and fiscal law. Even when he was not involved in the day-to-day running of the corporation, he did not in my opinion exercise the necessary degree of care, as he did not encourage the establishment of an adequate payment system. He was the corporation's legal counsel. When he became involved in the corporation's everyday operations— because that is what he did when he conducted negotiations with the banker—he made a conscious and deliberate choice to pay only the employees' net salaries in the hope that the business would get going again and he would not have to repay the bank loans for which he had stood surety. Unfortunately, the business went bankrupt anyway. The circumstances in which he had to make this choice were clearly very unpleasant; but it was still a free choice, a calculated risk which is contrary to the action that should be taken by a diligent director to prevent the failure contemplated by subsection 227.1(1) of the Act.

In these circumstances, therefore, I cannot conclude that the appellant acted with the care, diligence and skill required by subsection 227.1(3) of the Act.

For these reasons, the appeal is dismissed.

Appeal dismissed.