Date: 20010204
Docket: 2000-4637-GST-I
BETWEEN:
PAUL FLEURY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
For the Appellant: The Appellant himself
Counsel for the Respondent: Mark Heseltine
____________________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench on
June 18, 2001, at Yellowknife, Northwest Territories)
Mogan J.
[1] The Appellant was assessed as a director of 923109 N.W.T. Ltd., a company incorporated under the laws of the Northwest Territories which carried on business under the name Orca Interior Systems ("Orca" or "the Company"). It was formed sometime in the early 1990s by Lloyd Whiteford to carry on the business of painting, drywalling, taping and perfecting the drywall interiors of buildings in the construction industry.
[2] From early on, Peter Eccles worked for Orca only as an employee. He was a knowledgeable drywall man and he knew the trades people in and around Yellowknife and was able to get work for Orca. According to the evidence of the Appellant, Orca was reasonably successful in its beginning and was making a profit.
[3] The Appellant purchased Lot 33 in an area of Yellowknife called Trail's End. He registered the lot in his own name with the idea of developing it by constructing a dwelling and then selling the land and building. He did not have the resources to get the building constructed but he knew Orca and some of the people working for it. The Appellant asked Peter Eccles if he would be interested in working with the Appellant to help get the building constructed at Trail's End. Apparently, there was a plan whereby other properties at Trail's End would be consolidated in some kind of joint venture.
[4] At that point, Lloyd Whiteford was finished with Orca and interested in getting out. The Appellant took over Whiteford's shares with the idea that Peter Eccles would also become a shareholder and director and the two of them would own Orca. Exhibit R-2 is a document filed with the Companies Branch in the Northwest Territories showing that the Appellant had become a director of Orca by July 19, 1993. He was the sole director as of that date and continued as the sole director right up until the end of March 1999 when Orca was dissolved by an Order of the Government of the Northwest Territories for failure to file annual documents or some similar reason. In any event, the evidence is that throughout the period from July 19, 1993 until the end of March 1999, the Appellant was the only director of Orca.
[5] Orca needed a line of credit with the bank and, apparently, Eccles was not able to arrange it. The Appellant, being a successful and well-known accountant in the City of Yellowknife, obtained the line of credit for Orca, Eccles then embarked upon more ambitious projects in addition to the construction of a house on Lot 33 which was owned by the Appellant.
[6] Around this time (summer 1993), the Appellant and Eccles brought in Mickey Oakley, another drywaller from British Columbia who put some capital into Orca but did not acquire any shares from the Appellant. The idea was that the Appellant, Mickey Oakley and Peter Eccles, in whatever proportion, would become shareholders and owners of Orca. The Appellant was already on the hook as the sole director, and Oakley put personal money into Orca by mortgaging his house in British Columbia. Eccles did not have any capital in Orca but he expected to become a shareholder if things went successfully.
[7] There were contracts obtained, particularly in the high Arctic, as the Appellant referred to it. These contracts could be very profitable if they were well managed but, some time in 1995-1996, certain supplies were ordered by Orca to be delivered to the high Arctic to satisfy a contracting job. They were the wrong supplies and they could not be used. Apparently, it was Orca's fault, and specifically Peter Eccles' because he was managing the contracts. The wrong supplies had to be replaced by materials delivered by air to the Arctic, a costly way of getting building products up there. By February 1996, Orca had lost about $150,000, mainly attributable to its work in the high Arctic. It was in desperate financial circumstances.
[8] At that time, the Appellant could not persuade either Mickey Oakley or Peter Eccles to become directors or shareholders of Orca because the company was in such a weak financial position in 1995-1996 when these losses were developing. The Appellant could have closed the door on Orca because he owned all the shares and was the sole director. He was, however, reluctant to do so because he thought that the situation could be salvaged. He felt a moral obligation to the people who lived on Trail's End because they had counted on the continuation of the development he had started with Lot 33. He also felt a moral obligation to Mickey Oakley who (although he had not become a shareholder) had mortgaged his home in British Columbia to put capital into Orca in the expectation of becoming a shareholder. Although locking the door on Orca would have been the most rational decision, the Appellant regarded it as a heartless one because he felt an obligation to both Mickey Oakley and the people on Trail's End who were relying on his development to go through. The Appellant kept the Company going.
[9] Orca obtained an additional $50,000 from the bank and the Appellant immediately committed $25,000 to paying down the goods and services tax liability. This was confirmed by an accounting statement from Revenue Canada which specifically showed the payments of $10,000 on February 21, 1995 and $15,000 on June 12, 1995. There is no question that the Appellant was conscious of the GST liability and taking steps in June at least to reduce it by committing those two payments of $10,000 and $15,000.
[10] The fact remains that Orca struggled and, in February 1997, Eccles who was a strong-minded person would not permit the Appellant to take control of the Company, even though the Appellant was the sole shareholder and director. If the Appellant had attempted to take control, Eccles would have quit. In that scenario, the Appellant acknowledged that he did not have the business connections and goodwill in the construction industry to obtain contracts and get the work done. Ultimately, Eccles left the job in the Arctic and the Company, in the words of the Appellant, simply came apart after February 1997. It was not able to operate and another person had to be hired to help finish the Trail's End job. That other person insisted upon getting a piece of the action and so, when the house was completed on Lot 33 and sold, most of the proceeds of disposition went to that other person. All Orca got was an opportunity to pay down some of its debts. There was no profit available for Orca, no profit available for the Appellant as the sole shareholder, and he lost money personally on the Trail's End project. Orca became insolvent and its Charter was canceled by the Government of the Northwest Territories in March 1999.
[11] The Company had been assessed for GST and it was unable to pay. Therefore, the Appellant was assessed within the two-year period as the sole director of Orca. He faces a significant vicarious liability for GST under section 323 of the Excise Tax Act in his position as the sole director. The question is whether the Company's liability on which the Appellant has been assessed as a director will be upheld or whether he can be excused from that liability under subsection 323(3) which is commonly referred to as the due diligence provision. Subsection 323(1) is the charging section which makes all the directors of a company jointly and severally liable for the company's failure to remit certain amounts. Subsection 323(3) is an escape clause which permits a director to be excused if he has exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.
323(1) Where a corporation fails to remit an amount of net tax as required under subsection 228(2) or (2.3), the directors of the corporation at the time the corporation was required to remit the amount are jointly and severally liable, together with the corporation, to pay that amount and any interest thereon or penalties relating thereto.
323(3) A director of a corporation 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.
[12] There are significant facts running against the Appellant in this case. He is the only director of the Company. Where there are a number of directors, some may be "inside directors" intimately connected with the management of the company; and some may be "outside directors" not connected with day-to-day management. The cases decided under this area of the law indicate that an inside director is more vulnerable than an outside director. When there is only one director, however, he has to be the inside director. There is no buffer or shield or protection to the Appellant. He stands as the only director and, therefore, he is an inside director.
[13] More is expected of a sophisticated business person than of a person who has no business skills. In a particular case, a woman was excused because she became a director only as the wife of one of the other directors and she had no business experience. In this appeal, the Appellant not only was the sole director, but he has been a certified general accountant for approximately 30 years. He has a successful accounting practice in Yellowknife with distinguished clients. Exhibit R-1 is an annual report of a particular client of the Appellant where the financial statements are a matter of public record. Therefore, the Appellant must be regarded as a man with business smarts. He is not an innocent in the world of business. He is a knowledgeable, sophisticated, intelligent businessman.
[14] The above two facts run against the Appellant. He cannot plead innocence or ignorance of business matters because of his business background. Nor can he claim that he assumed some other director was looking after the Company because he was the only director. I refer briefly to the Federal Court of Appeal decision of Soper v. The Queen, 97 DTC 5407, cited by counsel for the Respondent wherein Robertson J.A, referred to the character of certain directors and stated at page 5416:
... more is expected of individuals with superior qualifications (e.g. experienced business-persons).
and further at page 5417:
... inside directors will face a significant hurdle when arguing that the subjective element of the standard of care should predominate over its objective aspect.
... the purpose of subsection 227.1(3) is to prevent failure to make remittances and not to cure the default after the fact ...
[15] Counsel for the Respondent relied on the above statements because the Appellant made it clear that he was conscious of his obligations under the GST legislation. He stated that he would take one-half of the capital raised from the bank and commit it to paying down the goods and services tax. He was acting in good faith. He was doing this, however, at the same time that liabilities were occurring because Orca was billing its customers and collecting GST but not remitting the GST collected. The Appellant was aware of this fact as confirmed by correspondence in Exhibits R-4 and R-5. Revenue Canada wrote to Orca at the end of December 1994 and in early January 1995 pointing out that about 12 quarterly returns had not been filed. The Appellant replied to the letters stating that the situation was referred to him and that all attempts were being made to comply within a deadline.
[16] Within that deadline, a number of returns were filed by Orca (Exhibit R-6), signed by the Appellant himself. Again, the Appellant had applied himself to the task because he showed precise computations of the GST collected by Orca, the input tax credits that it was entitled to claim on the basis of GST paid to suppliers, and a net tax payable or a net refund depending on the circumstances. The Appellant took seriously the warning from Revenue Canada in its letter of December 1994 and his response of January 1995. Notwithstanding the seriousness of the situation and that 12 quarterly returns were filed in January 1995, the company continued to operate for a further 24 months. It moved forward building up a continuing GST liability until it went out of business in February 1997.
[17] To demonstrate how conscious the Appellant was of the problem, he was asked about Peter Eccles' employment by Orca and explained that when cash got tight and the Company could not remit the source deductions from payroll, it simply eliminated the payroll. Eccles was effectively the only person on salary. His salary arrangement was cancelled and he became a consultant to the Company. He was paid a gross amount and was personally responsible for any tax on that amount. The Company got rid of its payroll to avoid the problem of unremitted source deductions. That was a prudent thing to do but the astuteness and prudence demonstrated in taking that step when applied to the failure to remit the ongoing GST obligation makes the GST obligation stand out in sharper contrast. It is difficult for me to find that a director has satisfied the due diligence test for GST when he could make such a decision with respect to payroll source deduction and, at the same time, permit the Company to fail to remit for nine or ten quarterly periods knowing that GST was being collected from clients to whom Orca was sending out bills.
[18] There are four individuals involved in this case. There is the Appellant who was the sole shareholder and director of Orca since 1993. Peter Eccles was the rainmaker for Orca, someone who could get the work, manage it, and provide the standing in the construction business to be able to operate. Mickey Oakley who was hired because he was a drywaller and he believed in the Company. He mortgaged his own home in British Columbia and contributed the proceeds to Orca and lost it. The uncontradicted evidence of the Appellant is that Mickey Oakley lost his house which was the family home for him and his wife and children; a very dramatic event for Oakley. And the fourth person was Jim Corbett who was the office administrator under Eccles.
[19] The Appellant, of course, was busy running an active accounting practice in Yellowknife. He was asked in cross-examination if he was ever threatened physically when he went to the offices of Orca and indicated he wanted to take over the books. He said that there was no such threat. Eccles was a strong-minded man; he had the goodwill of the construction industry; he was the person who could win the contracts which permitted the company to survive. Because Eccles was strong-minded and important and stubborn, the Appellant had to handle him with kid gloves. The Appellant could not afford to fire Eccles. Although the Appellant was the sole director and shareholder, he was really in the hands of and at the mercy of the most important employee of the Company. Not an enviable position.
[20] The Appellant had knowledge week by week and month by month that the GST returns were not being filed; GST was not being remitted; and that a failure was taking place. The burden was on the Appellant, as the only director, to do something about that. In the more recent decision of the Federal Court of Appeal in Worrell v. The Queen, 2000 DTC 6593, referred to by counsel for the Respondent, the directors' appeals were allowed. The appeals of Mr. Worrell and the other two directors were allowed but, notwithstanding that, Evans J.A., writing for the majority stated in paragraph 68 on page 6603:
... In order to avail themselves of the defence provided by subsection 227.1(3) directors must normally have taken positive steps which, if successful, could have prevented the company's failure to remit from occurring. ...
Those are the magic words from subsection 323(1). A director is not liable for a "failure to remit" under subsection 323(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. To prevent the failure, action has to be taken. The Federal Court of Appeal in Worrell, asked whether what the directors did to prevent the failure met that standard of care, diligence and skill.
[21] In my view, the Appellant has not met that standard. He knows too much as a sophisticated businessman. He was the only director but he permitted compassion to outweigh business judgment. He knew the default was continuing weekly and monthly and he could have locked the Company's door. He did not, however, because he wanted to see if he could salvage the capital that Oakley had put into the business. He wanted to keep the Company going to permit this development on Trail's End because he felt a moral obligation to people who lived there. Those are compassionate reasons, but a person who is the director of a corporation cannot take funds that belong to the Crown and permit them to be used for corporate purposes in the hope and expectation that things will turn around and that, one day, the unremitted tax will be paid.
[22] The Federal Court of Appeal also stated in Worrell at paragraph 73 on page 6604:
... if directors decide to continue the business in the expectation that the company will turn around and will be able to make good its remittance defaults after they have occurred, if the company nonetheless fails without paying its tax debts, it is no defence for the directors to say that the risk that they took would have been taken by a reasonable person. The subsection 227.1(3) defence only applies if it can be demonstrated that the directors exercised the care, diligence and skill that a reasonably prudent business person in comparable circumstances would have exercised to prevent a future default.
When the business does not turn around and the Company cannot remit the delinquent amounts, the directors have not done anything to prevent the failure. They have consciously permitted the failure to happen, and all they have done is hope that it will be remedied at a later date.
[23] In these circumstances, I am obliged to dismiss the appeal. I do this reluctantly because the Appellant is obviously an honourable person. He kept this Company going for what I would call compassionate reasons. He knew that other people were counting on it, primarily Mr. Oakley who lost his house in the long run, and the people at Trail's End who were dependent in part upon this development going through at Lot 33. The fact that the Company went down the drain and the Appellant lost money along with others is a sad fact, particularly in a remote city of Canada without the support of adjoining communities. There are times, however, when a director has to make the hard and necessary decision to lock the door to prevent continuing failures to remit amounts to the various taxing authorities like Revenue Canada for GST.
[24] I recently allowed a GST appeal for director's liability but, in that case (Gryschuk and Quon) the directors were assessed for a quarterly payment of $20,000 (the first and only quarterly which the company had failed to remit). That circumstance was close to absolute liability but I allowed their appeals for other collateral circumstances as well. In this appeal, the liability accumulated over many, many quarters in an ongoing manner, when the liability could be seen to be growing. The two situations are so different that, while I allowed the appeal of the two directors just referred to, I am obliged to dismiss this appeal and uphold the assessment.
[25] On closing, I would recommend that the Appellant ask Revenue Canada to grant him some relief from interest and penalties which the Minister has discretion to grant. The Appellant should inform the Minister of any extenuating circumstances which he thinks would help him.
Signed at Ottawa, Canada, this 4th day of February, 2002.
|
"M.A. Mogan" |
J.T.C.C.
COURT FILE NO.: 2000-4637(GST)I
STYLE OF CAUSE: Paul Fleury and Her Majesty the Queen
PLACE OF HEARING: Yellowknife, Northwest Territories
DATE OF HEARING: June 18, 2001
REASONS FOR JUDGMENT BY: The Honourable Judge M.A. Mogan
DATE OF JUDGMENT: July 3. 2001
APPEARANCES:
For the Appellant: The Appellant himself
Counsel for the Respondent: Mark Heseltine
COUNSEL OF RECORD:
For the Appellant:
Name: N/A
Firm:
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada