The following article was published in the December 2011 edition of the Canadian Tax Highlights. It is republished here with permission. I thought of this article after conversing with a director who is facing a director liability assessment from Canada Revenue Agency. This director has forgone a salary for years all in the hopes of keeping the corporation functional but as can be seen from what I wrote in December 2011 the courts take a harsh view on the director who uses the Crown monies to keep a corporation afloat in the hopes that matters can be rectified subsequently.
Due Diligence Defence: Objective Standard
The
federal and provincial tax and other statutes administered by the CRA and its
provincial counterparts contain provisions that impose personal liability on a
director of a corporation that fails to remit source deductions or GST, HST, or
PST held in trust. Those statutes also allow the director to escape personal
liability if she can show that she carried out her duties with due diligence to
ensure that remittances would be made to the tax authorities. For years,
uncertainty surrounded the nature of the standard of care: is the director's
personal knowledge and background relevant (a subjective test)? Or is she held
to the same standard as every other director (an objective test)?
In
1997, the jurisprudence on the issue was inconsistent. In Soper (97 DTC
5407), a decision since considered 186 times, the FCA attempted to establish a
standard for the determination of whether a director had acted with due
diligence to ensure that source deductions withheld under subsection 153(1)
would be remitted. The taxpayer accepted a directorship of a company that he
knew was experiencing financial difficulty, but failed to inquire about whether
the tax remittances were being made. Because the taxpayer was an experienced businessman,
he was found not to have carried out his duty with due diligence.
The
FCA said that the standard of care was "objective subjective," and
looked to section 122(1)(b) of the Canada Business Corporations Act (CBCA),
whose language was adopted in ITA subsection 227.1(3).
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
business-persons).
The standard of care set out in subsection 227.1(3)
. . . 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."
In
Peoples Department Stores Inc. (2004 SCC 68), the SCC considered the
CBCA section 122(1)(b) standard of care for a director and said that the Soper
characterization of the standard as "objective subjective" could lead
to confusion. "We prefer to describe it as an objective standard. To say
that the standard is objective makes it clear that the factual aspects of the
circumstances surrounding the actions of the director or officer are important
in the case of the s. 122(1)(b) duty of care, as opposed to the subjective
motivation of the director or officer, which is the central focus of the
statutory fiduciary duty of s. 122(1)(a) of the CBCA." Subsequent TCC
decisions were divided between adherence to the different standards of care
described by the FCA in Soper and by the SCC in Peoples (the
latter decision did not deal directly with tax legislation).
Most
recently in 2011, the FCA dealt with the issue again in Buckingham (2011
FCA 142). The TCC (2010 TCC 247) had concluded that up to February 2003 the
director took reasonable business measures to address the corporation's
financial difficulties and to avoid failures to remit taxes, including work on
a proposed equity issue, attempts to secure a line of credit, reductions in
expenditures, and an attempt to merge with another company. Thereafter,
however, the director focused on curing defaults in remittances rather than
undertaking efforts to avoid further failures to remit. The FCA cited Worrell
([2001] 1 CTC 79 (FCA)), which said that the due diligence defence is not
available if the director's efforts are aimed at remedying defaults after they
have occurred: a director's duty is to prevent the failure to remit, not to
condone it in the hope that matters can be rectified subsequently. The FCA
further emphasized that the interpretation of ITA and ETA defences should not
encourage remittance failures by allowing a due diligence defence to a director
who finances corporate activities with Crown monies in the expectation that the
failures can eventually be cured.
The
FCA agreed "with the trial judge that the 'objective subjective' standard
set out in Soper has been replaced by the objective standard laid down
by the [SCC] in Peoples Department Stores" because of the reference
to a "reasonably prudent person." The similarity of language in the
CBCA, the ITA, and the ETA "is not a mere coincidence, but rather a
further indication that the standard of care, diligence and skill required by
all these provisions is similar. Similar legislative language dealing with
similar matters should be given a similar interpretation unless the legislative
context indicates otherwise." Thus, the common-law principle that a
director's management is to be judged according to her personal skills,
knowledge, abilities, and capacities is set aside: the factual aspects of the
circumstances surrounding the director's actions are stressed, not her
subjective motivations.
The
TCC has since followed the FCA's Buckingham decision in Boles
(2011 TCC 288) and Heaney (2011 TCC 429). In Boles, a de jure
director did not realize that his verbal resignation as a director was
insufficient. He had not been active in the company for more than two years
when he received an assessment under the ETA's directors' liability provision.
The taxpayer unsuccessfully raised the due diligence defence. The TCC cited the
FCA in Buckingham and said that a director must exercise reasonable
care, diligence, and skill and take appropriate steps "to prevent the
failure" to remit and not to cure it thereafter. The court further said
(quoting Buckingham) that the defence was not available to
"inactive directors chosen for show or who fail to discharge their duties
. . . by leaving decisions to the active directors. [Thus] a director must
carry out the duties of that function on an active basis and [cannot rely] on
his or her own inaction."
In
Heaney, the appellants were directors of a corporation, DSL, which ran
into financial difficulty due to the economic times and unforeseeable technical
problems stemming from a contract with Bell. The facts were similar to those in
Buckingham. At a certain point, DSL elected to delay making its
remittances to the CRA; the directors saw this as a temporary measure because
they fully expected to find new financing that would allow DSL to meet its
obligations to the CRA. But throughout 2001 the directors were unsuccessful in
their search for new partnerships, investors, and other ways to recapitalize
the company. Before that time, they took positive actions to cover
remittances--ceasing to advertise, changing product offerings, reducing
customer hours, and focusing on receivables. The directors were not allowed the
due diligence defence in the later period when their focus was on finding
financing to remedy DSL's remittance failures. The TCC emphasized that the use
of an objective standard did not imply that the director's particular
circumstances were to be ignored; quoting Buckingham, the court said
that "[t]hese circumstances must be taken into account, but must be
considered against an objective 'reasonably prudent person' standard."
The
three 2011 decisions indicate that a director who focuses on remedying past-due
remittances rather than on preventing failures to remit cannot rely on the due
diligence defence. Moreover, the FCA has recognized that stricter standards now
apply to directors and that, as the SCC stressed in Peoples, "the
emergence of stricter standards puts pressure on corporations to improve the
quality of board decisions."
Sunita
Doobay
TaxChambers, Toronto
Canadian Tax Highlights
Volume 19, Number 12, December 2011
©2011, Canadian Tax Foundation
A case that caught my interest and that ties into my post on
“Ode to Canada” is the 2011 case that can be found on CanLii namely Fourniev. Cromarty et al., 2011 ONSC 6587 (hereinafter referred to as Cromarty). It triggered my interest because the drafting
of wills is common to the practice of law and wills are essential to the smooth
transition of assets from one generation to another. 