McArthur T.C.J.:
These appeals, heard together on common evidence, are from assessments made under section 227.1 of the Income Tax Act and subsection 323(1) of the Excise Tax Act for failure of the Appellants to remit to the Receiver General amounts for Canada Pension Plan contributions (CPP), unemployment insurance premiums (UI) and goods and services tax (GST) as well as for interest and penalties. The amounts are: CPP - $7,934.00, UI - $13,463.00 interest and penalty - $15,946.00 and GST - $92,238.00 interest and penalty $4,166.25. The issue is whether the Appellants, within the meaning of the above sections exercised the degree of care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances to prevent Abel Metal Limited (“Abel”) from its failure to make such payments.
The legislation in section 227.1 of the Income Tax Act and subsection 323(1) of the Excise Tax Act provides that where a corporation fails to remit tax, the directors are jointly and severally liable to pay the amount not paid by the corporation together with interest and penalties. These identical sections read:
A director 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.
Mr. Worrell testified on behalf of the three Appellants. Mr. Humphreys, C.A., who was called in to assist the troubled company approximately six months before its bankruptcy, also testified. They were both credible witnesses. I draw no inference from the fact that two of the three Appellants did not appear and the Respondent made no adverse reference to this.
Facts
Abel operated a viable metal construction business primarily in the greater Toronto area for approximately 30 years. It was essentially run by Mr. Lapointe until 1990 when he sold shares to certain employees while remaining a director. It was in the business of manufacturing and installing steel requirements in buildings under construction apart from the structural steel. In 1993, it had approximately 70 employees. The company began experiencing financial difficulties in 1992 after serious losses from projects in Kitchener and Waterloo. As the 1990 recession deepened, it suffered lower profits. Traditionaly, it bid on projects up to $2 million of which 80% of these tenders were over $500,000.00. Contracts in excess of $100,000.00 required bonding. It suffered a serious set back in June 1993 when a request for bonding was refused. Its bank, the Canadian Imperial Bank of Commerce, voiced a concern after reviewing the 1993 financial statement. Mr. Lapointe personally guaranteed the indebtedness to the bank which was in excess of $1,600,000.00.
The company’s struggles continued and in October 1993, it retained the services of Mr. Humphreys, a Chartered Accountant, who has a long and impressive history of assisting financially troubled businesses. Together with the Appellants, Lynda McKinnon, who was the Bookkeeper, and Ronald Lapointe, who was the Chief Executive Officer, Mr. Humphreys met with the bank in an attempt to soothe their continuing concerns. Two days later, on October 18, 1993, the bank unexpectedly dishonoured a cheque in the approximate amount of $46,000.00 payable to the Receiver General for payroll source deductions issued by the company. On October 22, 1993, the bank wrote the company in part as follows:
... ou should therefore exercise caution in not issuing cheques which, when presented for clearing, would increase your liabilities beyond the limits contained herein, as it may be necessary for the Bank to return some or all of such cheques without further notice to you.
Mr. Humphreys was an impressive, informed witness. He was retained to review the situation and advise the company as to the course of action it should take. I have no doubt he is an expert in his field. He concluded in October 1993, that Abel was a viable company and could be rehabilitated with additional capital within the short period and failing an insertion of capital, it required 18 months to recover. He prepared a financial analysis for potential investors.
Through his business contacts he dealt with approximately 12 investors. One in particular appeared prepared to invest but the bank found this investor unsuitable without giving reasons and immediately there after, on April 27, 1994, the bank called its loan requiring the company to file for bankruptcy.
The payroll remittance amounts arise from periods after October 18, 1993 which is the date the bank began exercising control over the payments made by Abel.
The Trustee paid the Receiver General all outstanding employee withholdings. The Trustee did not pay outstanding remittances for the employer portion of Canada Pension Plan contributions and unemployment insurance premiums or the related interest and penalties which are the subject of subsection 227.1(1) assessment. Also, the Trustee did not satisfy the unpaid GST or the interest and penalties of Abel. All but $1,548.77 of GST and related interest and penalties assessed by the Minister relates to remittances due after October 18, 1993.
Appellants’ Position
The primary submission was that the Appellants, as directors of Abel, did not have the freedom of choice to govern the corporation and prevent the failures to remit. Second, the bulk of the GST owing by Abel for which the Minister of National Revenue (the “Minister”) is holding the directors liable was never collected by Abel, never came under the dominion of the directors and never was impressed with a trust. The Appellants submit that it is inappropriate that they be held vicariously liable for these amounts.
The Appellants’ Counsel relied on a number of cases including:
1. Beer v. R., [1996] 3 C.T.C. 2628 (T.C.C.)
2. Soper v. R., [1997] 3 C.T.C. 242 (Fed. C.A.)
3. Robitaille v. R. (1989), [1990] 1 C.T.C. 121 (Fed. T.D.)
4. Champeval c. Ministre du Revenu national, [1990] 1 C.T.C. 2385 (T.C.C.)
5. Madsen v. R. (January 4, 1996), Doc. 95-2166(GST)I (T.C.C.) [reported [1996] G.S.T.C. 1 (T.C.C.)
6. Fancy v. Minister of National Revenue, [1988] 2 C.T.C. 2256 (T.C.C.)
He submitted that a number of principles may be derived from these decisions including:
1. Beer (supra), at page 2637:
The business community has to get this message. When money is deducted from an employee for income tax, it is no longer the money of the employer. It was the earned money of the employee and then, in a nanosecond, a goodly portion of it was taken, in compliance with the Act, from the employee and now is held in trust for Her Majesty.
2. Soper (supra), at page 262:
This is a convenient place to summarize my findings in respect of subsection 227.1(3) of the Income Tax Act. The standard of care laid down in subsection 227.1(3) of the Act is inherently flexible. Rather than treating directors as a homogeneous group of professionals whose conduct is governed by a single, unchanging standard, that provision embraces a subjective element which takes into account the personal knowledge and background of the director, as well as his or her corporate circumstances in the form of, inter alia, the company’s organization, resources, customs and conduct. Thus, for example, more is expected of individuals with superior qualifications (e.g. experienced businesspersons).
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”.
3. Robitaille (supra), at page 125:
Furthermore, where the effective control of the corporation has been taken over by a bank such as in the case under appeal, without the bank being requested or invited to do so by the directors, and where the decisions as to what cheques will or will not be issued without consultation with the Board of Directors, are exclusively those of the bank, then from that time the actions of the corporation regarding the payment or withholding of moneys are essentially those of the bank and I would be prepared to hold that, even without considering subsection 227.1(3), there would be no liability on the directors under subsection 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.
4. Champeval (supra), at page 2389:
A director’s responsibility for a company under subsection 227.1(1) is not absolute. It is contingent, that is, a director is relieved of it when he has acted with the degree of care, diligence and skill that a reasonable person would have exercised in comparable circumstances. If one is to be able to determine whether a director exercised the degree of care, diligence or skill required under subsection 227.1(3), that director must have had a free choice before him. If he did not have a free choice in his decisions because of factors completely beyond his control, he cannot be bound by the provisions of subsection 227.1(1), because the provisions of subsection (3) relieve him of all personal liability, since in the circumstances a reasonable person would not have acted otherwise.
5. Madsen (supra), at page 5:
The Appellant was unable to control and direct the payment of Company funds. There was no evidence to indicate a discretion on his part so to do. There was, however, evidence that there was awareness of the GST obligation and, after a visit with their lawyer in November, 1991, awareness of personal liability and of efforts made to direct monies toward the satisfaction of that obligation. On the basis of these facts and on the principles as set forth by Appellant’s counsel, I conclude that the Appellant exercised the degree of care, diligence and skill to prevent failure of payment of tax that would have been exercised in comparable circumstances by a reasonably prudent person.
6. Fancy (supra), at page 2261:
These reasons are not to be construed as suggesting that an employer who assigns his receivables to a third party automatically escapes from the application of subsection 227.1(1). To the contrary they relate to the particular set of facts and the circumstances pertaining to these appeals.
Counsel for the respondent suggested that when the appellants were aware of the company’s serious financial problems around the beginning of August 1982 they should have caused it to cease its operations. By continuing to operate he contended they accepted the risk of becoming personally liable for the company’s debt to the respondent under subsection 227.1(1). I cannot subscribe to such a proposition because it does not reflect the true intent of the legislation. The personal liability of directors created by subsection 227.1(1) is not an absolute liability. It is conditional upon their personal conduct in respect of the circumstances linked to the omission by their company to remit the deductions from its employees’ salary. The exercise of the care, diligence and sill referred to in subsection 227.1(3) exempts them from that personal liability.
Respondent’s Position
In the fall of 1993, the Appellant’s financial situation was critical and it missed its first GST payment. The three Appellant directors were concerned with the deteriorating state of affairs and they engaged Mr. Humphreys upon the insistance of the bank, to deal with the bank, the suppliers and to secure outside financing. The bank commenced lowering their already inadequate line of credit. Notwithstanding, a conscious decision was made by all three directors to stay in business knowing that the bank would not honour payments for GST and source deductions.
Counsel referred the Court to Deschénes c, Ministre du Revenu national (1989), [1990] 1 C.T.C. 2394 (T.C.C.), . at page 3 where Lamarre Proulx, J. stated:
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.
...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 contemplated by section 227.1(1) of the Act.
Counsel added that the Appellants were in control of whether or not they would continue paying those employees and not remit those source deductions or if they would stop paying those employees, or in regard to GST, they had the choice of whether they would continue to incur liability for GST and not pay it or whether they would stop incurring that liability for GST. That was their choice. There was absolutely no control reposing elsewhere in regard to that decision.
Counsel referred to Hamel v. Minister of National Revenue (1991), 92 D.T.C. 1288 (Eng.) (T.C.C.) at page 1291 where Dussault, T.C.J. stated:
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...
Analysis
Subsections 323(1) of the Excise Tax Act, 21.1(1) of the Canada Pension Plan and 54(1) of the Unemployment Insurance Act make a director of a corporation jointly and severally liable for GST and the employer portion of CPP and UIC with interest and penalties if the corporation fails to remit these amounts. The vicarious liability of corporate directors is not absolute. Under subsections 323(3) of the Excise Tax Act and 227.1(3) of the Income Tax Act as adopted by subsection 21.1(2) of the Canada Pension Plan and 54(2) of the Unemployment Insurance Act, a director is relieved of liability:
....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.
The facts support the finding that from October 18, 1993 until the bankruptcy on April 28, 1994, it was the bank, and not the directors, that controlled the finances of Abel. This restriction on the directors’ freedom of choice is sufficient to relieve the Appellants of personal liability for both the payroll assessment and the GST assessment. The Appellants did not have the freedom of choice to govern the corporation and prevent the failures to remit, in respect of both the payroll assessments and GST assessments.
The Federal Court of Appeal has recently examined the nature of the due diligence defence in Soper (supra). A necessary pre-condition for imposition of personal liability is that the directors must have the necessary freedom of choice such that the corporation is freely acting through its board of directors. In Champeval (supra), under circumstances similar to those of the Appellants, Couture, C.J.T.C. found that where the failure of the corporation results from factors outside the control of the director, the director is relieved of personal liability. Madsen (supra) is another case where a bank dictated which cheques would be honoured and which would not. Bell, J. held in favour of the Appellant.
In Soper, Robertson, J. concluded that the standard of care in subsection 227.1(3) is flexible and can be described as “objective subjective”. He then commences his analysis by characterising the nature of the Appellants’ di-
rectorship. In the present case the Appellants did not have de jure control over finances after the bank imposed terms on October 18, 1993. The Respondent correctly concluded that the Appellants had the choice, prior to October 18, of either going along with the bank’s terms or shutting the business down, and although a very harsh decision, the Respondent concluded that they should have closed the business down, against the advice of the consultant and leaving 70 employees without work. Is this due diligence? Given all of the circumstances, I think not. The Appellants were in a cyclical business having been through recessions successfully in the past. Up until September 30, 1993, when the bank returned a cheque for non sufficient funds, bills had been always paid. They had retained a professional, highly qualified in dealing with troubled companies. He concluded that Abel was viable and advised the Appellants to continue operations. He looked actively for a new investor and had found one who was not approved by the bank for reasons unknown to the Appellants. It would appear that a monitor for the proposed investor, who was in the same business as Abel, concluded that the corporation should not be shut down. Mr. Humphreys concluded that even without a new investor, Abel could have been turned around in eighteen months.
The Appellants had an obligation to its employees not to shut down without satisfactory evidence that the business was not viable. The reasonable person test must be applied. The Appellants took a common sense approach. They had proven history of surviving business down turns, their bank appeared to support their continuation, they had the positive advice of Mr. Humphreys and Mr. Lapointe had given the bank his personal guarantee in mid 1993.
The Appellants made efforts to have the bank pay remittances. The payroll remittances withheld from the employees were paid, it is the employer portion that is at issue and GST, most of which was never paid to Abel and its directors.
In Fancy (supra) at page 2261, Couture, C.J. was faced with a somewhat similar situation and found in favour of the taxpayers. He stated that subsection 227.1(1) does not create an absolute liability but is conditional upon the conduct of the directors given all of the circumstances. After October 18, 1993, Abel was not freely acting through the Appellants with respect to its finances. The exercise of freedom of choice on the part of the directors is essential in order to establish personal liability, as stated in Robitaille(supra).
The Appellants did not have the freedom of choice to prevent the failures to remit in respect to both the income tax and GST assessments.
The appeals are allowed with one set of costs to the Appellants.
Appeal allowed.
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