Tax Court of Canada Judgments

Date: 19980824

Docket: 97-100-IT-G

BETWEEN:

RICHARD D. GRIGG,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Rip, J.T.C.C.

[1] The issue in this appeal is whether Richard D. Grigg, the appellant exercised the degree of care, diligence and skill as director of Eastern Abrasive and Coatings Limited ("Company") that a reasonably prudent person would exercised in comparable circumstances to prevent the failure of the Company to remit payroll source deductions during the period December 22, 1992 to November 4, 1993 ("period").[1]

[2] According to section 227.1 of the Income Tax Act ("Act"), section 22.1 of the Canada Pension Plan Act ("CPP") and section 68.1 of the Unemployment Insurance Act ("UI Act"), at the time, where a corporation has failed to remit to the Receiver General for Canada the amounts of statutory deductions withheld from employees' remuneration, the directors of the corporation at the time the corporation was required to deduct, withhold or remit the amount are jointly and severally liable, together with the corporation, to pay that amount and any interest or penalties relating thereto. However, a director is not liable if he or she exercised the degree of care, diligence and skill to prevent the failure that a reasonable prudent person would have exercised in comparable circumstances: subsection 227.1(3) of the Act, for example.

[3] During the period the Company failed to remit to the Receiver General the source deductions withheld from its employees and was assessed for the amount of source deductions, interest and penalties. Revenue Canada assessed Mr. Grigg on May 8, 1996 pursuant to the subsection 227.1(1) of the Act, section 22.1 of the CPP and section 68.1 of the UI Act (as well as section 38 of the Income Tax Act of Ontario) on the basis he did nothing to prevent the Company's failure to remit.

[4] The facts leading to the assessment of Mr. Grigg tell a story of a person who entered into a transaction with a Bank for the purchase of a business and, from the first day the business started, was in over his head, although he did not realize it at the time.

[5] Mr. Grigg has a grade eleven education. He also studied computer and systems analysis at a community college and taught computer. Before incorporating the Company on December 8, 1992 Mr. Grigg had no management experience.

[6] During the summer of 1992 Mr. Grigg worked for Quick-Blast Inc. ("Quick"), a corporation that carried on the business of sandblasting and painting structured steel. Quick employed three people in its shop as well as one person who worked as secretary and bookkeeper. Mr. Grigg was asked by Quick's owners to develop new business, to develop a system of estimating jobs and to manage Quick's day-to-day operations. It appears Mr. Grigg was a minor shareholder of Quick and guaranteed Quick's debts to its Banker. Mr. Grigg worked at Quick for six months, until the second or third week of November 1992, when its principal shareholders declared personal bankruptcy and Quick's banker, The Toronto-Dominion Bank ("Bank"), purported to take over its assets.

[7] Mr. Grigg said he saw a potential for Quick's business since it had contracts in place. Even before the owners of Quick abandoned the business Mr. Grigg discussed the possibility of acquiring the business assets directly from Quick. However, his lawyer cautioned him that this may result in legal problems since, as new owner, he may be liable for the existing debts of the business.

[8] Mr. Grigg attended at the Bank to negotiate the acquisition of Quick's business directly from the Bank. Mr. Grigg's initial discussions were with the manager of the Bank's branch at "Pickering Town Centre", Mr. Murray Yule. The Bank and Mr. Grigg agreed that the Company would acquire Quick's assets from the Bank, the Bank would grant the Company an opening operating line of credit of $20,000 and permit it to borrow an additional $20,000 to purchase equipment.[2] In return the Company would guarantee existing loans to Quick in the amount of $45,000. Mr. Grigg agreed to personally guarantee the Company's debt to the Bank. This arrangement, Mr. Grigg asserted, was made with Mr. Yule and another employee of the branch, later identified in Mr. Yule's evidence as Freda Gauweiler, the branch's Assistant Manager, Credit. The transaction between the Company and the Bank was completed but, insisted Mr. Grigg, not in the manner originally contemplated.

[9] One of the problems was that although the Bank may have had a security interest in Quick's assets, the Bank appears not to have had a record of all the equipment securing Quick's loan.

[10] In any event the Company took over the business of Quick from the Bank in December 1992. The employees of Quick became the employees of the Company. The employee of Quick who was its secretary and bookkeeper, Ms. Donna Cunningham, was also the Company's secretary and bookkeeper. The business initially was carried on at the same premises.

[11] Mr. Grigg testified that he executed an agreement of purchase and sale with the Bank for the purchase of the business as well as a bill of sale. He has not received any copy of this documentation from the Bank. He stated that Ms. Gauweiler promised him a copy of "everything signed". In the meantime, the Bank moved the "commercial accounts" from its Pickering branch to its branch in Oshawa and in the course of moving documents, Mr. Grigg said, he was told the Bank lost the closing documents. An employee from the Oshawa branch, Mr. Niall MacPhearson, took over the supervision of the Company's account.

[12] Mr. Grigg believed that he had at least three discussions with officials of the Bank in order to obtain the necessary documentation. He said he instructed the Company's bookkeeper, Donna Cunningham, to attend at the Bank to get the documents and she also was unable to do so.

[13] Although she frequently attempted to do so, Ms. Cunningham testified, she confirmed she was unable to get any closing documents from the Bank. First, the Bank told her it would take a "couple of days to draw up" the documents and they could be "picked up" from the Bank soon thereafter. When she went to the Bank, she was told the documents were not ready. Later on, she was told the documents had been shipped to Oshawa, and finally she was told the Bank could not find the documents.

[14] In any event on or about December 17, 1992, the Company and Mr. Grigg executed the usual documentation required by the Bank when a corporation opens an account. Mr. Grigg executed a guarantee in favour of the Bank with respect to the indebtedness of the Company and the Company executed a general security agreement in favour of the Bank. These documents were produced as Exhibits.

[15] Mr. Grigg declared that the Company never received the operating line of credit it was promised. The operating line of credit was to be the Company's working capital. However, the line of credit was "maxed out" immediately, Mr. Grigg stated and Mr. Yule agreed. Indeed both witnesses used the expression "maxed out" to indicate the operating line of credit was used to the maximum amount approved by the Bank. Mr. Yule had "no idea" how or why the Company had used its complete line of credit. The account was managed by Ms. Gauweiler and when the account was transferred to Oshawa in January 1993, Mr. Yule was no longer responsible.

[16] A copy of the Company's General Ledger was produced in Tab 9 of Exhibit A-1, a book of the Appellant's documents. The opening entry in the General Ledger, dated December 22, 1992, is an amount of $21,735.94 "to open account". Opposite the amount of $21,735.94 is the notation "OD". Mr. Grigg stated the initials "OD" indicate an overdraft. At all times when the Company operated its business, the Company was in an overdraft position. Mr. Grigg discussed the problem with Mr. Yule, Ms. Gauweiler and Mr. MacPhearson and "anyone who would listen". Mr. Grigg repeated that the "deal" between him and the Bank was that the Company would have a $20,000 operating line of credit with a zero balance in its account. Instead, the account had a negative balance. Mr. MacPhearson told him, Mr. Grigg recalled, that there was "no way" the Bank could have accommodated a $20,000 line of credit with a zero balance.

[17] As a result, Mr. Grigg recalled, the Company could not purchase product and had to turn down work because the Company could not operate under normal conditions. The Company had no working capital.

[18] Mr. Grigg acknowledged that in December 1992 he knew that the Bank was transferring money from the line of credit to cover previous loans transactions the Bank had with Quick. In the first few months of operation, Mr. Grigg knew of Eastern's financial problems and potential difficulties in carrying on business.

[19] Because the Company was in an overdraft position, the Bank insisted on approving all cheques issued by the Company, according to Mr. Grigg. He explained that the Bank required a list of cheques or photocopies of cheques so it could determine what cheques would be honoured. Mr. MacPhearson approved or disapproved the cheques. Mr. Grigg also stated that Mr. MacPhearson's permission was necessary to bid on jobs. He complained to Mr. MacPhearson personally and by telephone.

[20] Mr. Grigg testified that he did not retain a lawyer to assist him when he negotiated the transaction for the acquisition of Quick's business or on closing.

[21] Whether the Bank had good title to the assets it purported to sell to the Company is in question. On December 18, 1992, lawyers for PPG Canada Inc. ("PPG") wrote Quick and the Company. PPG's solicitors ignored the position of the Bank. In their view, based on conversation their client had earlier with Mr. Grigg, Quick sold its business to the Company and, if so, that conveyance constituted a transfer of all or substantially all of Quick's assets out of the ordinary course of business. The sale was therefore in contravention of Bulk Sales Act and the Conveyances Act of Ontario. PPG's position was that both Quick and Mr. Grigg were liable to PPG for the value of the assets purported to have been conveyed to the extent of Quick's liability.

[22] Mr. Grigg stated that when he advised Mr. Niall MacPhearson of PPG's reaction to the sale, Mr. MacPhearson told him that "it would blow over because The Toronto-Dominion Bank is a secured creditor".

[23] On March 17, 1993 PPG issued a statement of claim against Mr. Grigg personally and the Company. A statement of defence was filed on behalf of the defendants.

[24] On August 18, 1993, Mr. Grigg wrote to Mr. MacPhearson reviewing a meeting held on August 11 with Mr. Grigg, Mr. MacPhearson and Mr. Grigg's solicitor, Mr. Stewart. In Mr. Grigg's view, once Mr. MacPhearson took charge of the Company's account "all arrangements went bad". In the letter, Mr. Grigg charged that the Bank had "disabled our Company"; the Bank had full control of the Company's direction and daily business needs and obligations.

[25] According to the letter of August 18, Mr. Grigg stated that in his solicitor's view the Bank had failed in its responsibility to notify creditors of Quick when the assets had been seized by the Bank and sold to the Company. This, concluded the solicitor, was a violation of the Bulk Sales Act of Ontario as well as an infringement of the Fraudulent Conveyances Act.

[26] In the letter, Mr. Grigg also referred to lost opportunities by the Company as a result of the Bank's failure to support the Company as originally agreed. Mr. Grigg declared the Company had developed business contacts and had arranged a $3,500,000 contract with Canada Post and a $800,000 contract with Chrysler Corporation in Detroit. In short, Mr. Grigg blamed the Company's inability to secure additional contracts on the Bank's refusal to finance the Company.

[27] At trial, Mr. Grigg insisted that he had discussions with Bank officials to convince them to honour cheques he intended to make in favour of the Receiver General for Canada. However, these officials agreed only to honour those cheques necessary "to keep the Company going". He said he "made every attempt with the Bank to get approval for source deductions". He said he thought that it was important to keep in contact with Revenue Canada.

[28] Mr. Grigg agreed that in fact the Company issued only one cheque to Revenue Canada, a post-dated cheque dated October 19, 1993 in the amount of $2,088 that was not honoured. Mr. Grigg stated that since Mr. MacPhearson had to approve any cheque made by the Company and since Mr. MacPhearson was not interested in having the Company make any payment, he "felt" that there would be no use in preparing cheques for Revenue Canada. The Bank "took upon itself what cheques would be processed".

[29] Mr. Grigg stated that the Bank "basically ran the Company ... I was a telephone reporter to the Bank". When he brought the Canada Post contract to the Bank, he believed that the Bank would have "jumped" to support the Company. Instead, the Bank told him it was not interested in financing the contract.

[30] In order to reduce the Company's expenses, Mr. Grigg acquired new premises for the Company in August 1993. He obtained increased space for the Company at a rent that was 50 per cent of the previous rent.

[31] Mr. Grigg had thought of changing banks and had discussions with the Bank of Montreal. The Bank of Montreal, he said, was prepared to support him but wanted the Company to sue the Bank immediately on the grounds the Bank did not properly transfer assets. He also approached private investors who were initially interested in the Company but were fearful of investing once they learned the bona fides of the purchase of the business was in question.

[32] Mr. Grigg signed all Company's cheques once they were prepared by Ms. Cunningham. However, he stated, it was "the Bank's call what cheques would be approved".

[33] Mr. Grigg agreed that he was aware of the Company's obligations under the various statutes to remit source deductions to the Receiver General for Canada. He stated that "initially" he was not aware the source deductions had not been remitted. He was concerned with the difficulties he was having with the Bank and the difficulty in getting supplies from suppliers. Creditors were threatening to sue and, he said, "probably Diane was trying to protect me at first ...". He believed he first became aware of the Company's failure to remit source deductions in February or March 1993 when Ms. Cunnigham first informed him of the default. He insisted he immediately telephoned Revenue Canada and explained the reason the Company had failed to remit the source deductions. Revenue Canada officials informed him that another employee of Revenue Canada would contact him later.

[34] Eventually, in June 1993, a Ms. Sabrina James of Revenue Canada telephoned Mr. Grigg to arrange a meeting at her office in Scarborough, Ontario. Ms. James asked Mr. Grigg several questions on the telephone and asked him to bring the Company's books to the meeting, which was scheduled in July 1993.

[35] At the meeting with Revenue Canada, Mr. Grigg recalled, he explained the problems the Company was experiencing, including the PPG lawsuit and the Bank problems and gave Revenue Canada all the information it required. He added that besides PPG, at least six other suppliers were threatening to sue. He described this as a "daily battle".

[36] Mr. Grigg told Ms. James that employees' pay cheques were paid out of the operating line of credit. The Company did not have a separate payroll account or a separate account for source deductions.

[37] Mr. Grigg conceded that Company payroll cheques to him were honoured by the Bank. However, he stated, the majority of the cheques paid to him were for reimbursement for supplies. For the eleven months he worked for the Company he was paid $10,000.

[38] During their meeting, Ms. James asked Mr. Grigg for monthly post-dated cheques of $4,000 each to satisfy the outstanding debt and a commitment by the Company that it stay current. Mr. Grigg said that he offered Revenue Canada $2,000 monthly "because we did not have sufficient funds". Revenue Canada refused the counter offer. Mr. Grigg stated that he intended to discuss the matter with Mr. MacPhearson but Mr. MacPhearson "was not too concerned". He said Mr. MacPhearson did not offer to honour any cheques payable to Revenue Canada.

[39] A second meeting was held with Revenue Canada. Mr. Grigg hired a "consultant" to advise him at this meeting. However the consultant told Revenue Canada that if the government did not want to accept Mr. Grigg's offer of monthly post-dated cheques of $2,000, Mr. Grigg would file for bankruptcy. Mr. Grigg said it was never his intention to file for bankruptcy and immediately dismissed the consultant.

[40] Mr. Grigg did deliver to Revenue Canada post-dated cheques for $2,000 but Revenue Canada refused to accept the payments. Apparently, according to Mr. Grigg, Ms. James told him that if the Company did not pay as required, Revenue Canada would garnish all the Company's receivables. Mr. Grigg discussed Ms. James' reaction with Mr. MacPhearson who told him "to tell him what Revenue Canada wanted and he would let it clear".

[41] Ms. James attended at the Company's offices in mid-September 1993 to review the books and review contracts and the lawsuit with PPG. She asked for a cheque in the amount of approximately $2,088 and Mr. Grigg accommodated her. Since the Company did not have funds to "cover" the cheques, Mr. Grigg telephoned the Bank for approval and the Bank agreed to honour the cheque. The cheque was post-dated to October 19, 1993. However, when the cheque was submitted for payment the Bank "bounced the cheque". Mr. Grigg said he learned that the cheque was not honoured by the Bank on or about October 28, 1993 when Mr. MacPhearson faxed Ms. Cunningham with the information. When Mr. Grigg telephoned Mr. MacPhearson to learn the reason the cheque had not been honoured, Mr. MacPhearson told him "he was tied up or busy that day and could not approve the cheque".

[42] At that point Mr. Grigg began to "examine our options, including not challenging Revenue Canada's right to garnish the Company's receivables and to pay PPG". The Company could not get any money from the Bank. Since there was no viable alternative, Mr. Grigg decided in November to do what the Bank had recommended on several occasions: close down the business. He gave the keys to the business to Mr. MacPhearson.

[43] The Bank informed Mr. Grigg that if he did not return to the premises of the Company or take anything with him they would not pursue any action against him on his guarantee to the Bank. The Bank did not pursue action against Mr. Grigg. Several months before the appeal at bar was heard, Mr. Grigg settled the action with PPG.

[44] Ms. Cunningham testified she had worked for Quick for two years before joining the Company. She had previously taken a bookkeeper course. At Quick, she answered the telephone, prepared correspondence, accepted the mail, acted as bookkeeper and dealt with the Bank. She continued performing the same duties with the Company.

[45] Ms. Cunningham declared that Mr. Grigg had numerous meetings with Bank officials and that she attended most of the meetings. She confirmed Mr. Grigg's understanding that one of the agreements with the Bank was that on the day the Company opened for business the Company would have a $20,000 line of credit and not an overdraft.

[46] As a result of the operating line of credit never being put in place, Ms. Cunningham testified, the Company had many problems, two of which were that the Company could not collect its receivables because the Bank seized them and Revenue Canada could not be paid. She confirmed that Mr. MacPhearson determined which of the Company's creditors would be paid. Ms. Cunningham recalled that she would send him a list of payable and receivables and he would determine what cheques would go through. Originally she sent the list to Mr. MacPhearson on a monthly basis and then on a weekly basis.

[47] Ms. Cunningham said if she was not sure when she advised Mr. Grigg that no amounts of source deductions had been paid to Revenue Canada; it was either in January or February 1993. She said she spoke to Mr. MacPhearson and he told her "Revenue Canada could wait". Ms. Cunningham said that any meeting she attended at the Bank with Mr. MacPhearson was "useless". She described him as "arrogant". She conceded that the first time she requested a cheque payable to Revenue Canada for source deductions was in March 1993 and the Bank refused to approve the request. Before March she "only asked [Mr. MacPhearson] what cheques they could write and what he would allow".

[48] Ms. Cunningham recalled that when PPG sued Mr. Grigg and the Company, the Bank itself said it was not sure who owned the assets at the time of the purchase and sale of the assets to the Company and "things started going down the drain".

[49] Mr. Yule agreed that the arrangements with Mr. Grigg were that when the Company took over Quick's business it would have an operating line of credit of $20,000 and it also receive a term loan. The Company would also enter into a general security agreement with he Bank for all of its receivables, assets and undertakings.

[50] Mr. Yule recalled that although Mr. MacPhearson was employed by the Oshawa branch, he maintained an office in Mr. Yule's branch in Pickering. Mr. MacPhearson did not report to Mr. Yule but to the Oshawa branch.

[51] Mr. Yule agreed he was involved in the negotiations for the sale of Quick's assets of Quick to the Company but only to a "small degree". Mr. Yule's evidence did not enlighten me or clarify the terms of the agreement between the Bank and Mr. Grigg. He did reveal that Mr. MacPhearson is now working for the Bank in Thunder Bay.

[52] Based on the above facts, I must determine whether Mr. Grigg exercised the degree of care, diligence and skill as a director of the Company to prevent the failures of the Company to remit source deductions to the Receive General during the relevant period. There have been many reported cases dealing with this matter and the latest pronunciation on this issue from the Federal Court of Appeal is set forth in the reasons of Robertson J.A. in Soper v. R.[3]:

... The standard of care laid down in subsection 227.1(3) of the Act is inherently flexible. Rather than treating directors as a homogenous 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) 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”.

[53] Robertson J.A. categorized the reported cases into two categories: those that deal with "inside directors" and those that deal with "outside directors" At page 263 (5416-17), he states:

[...] it is difficult to deny that inside directors, meaning those involved in the day-to-day management of the company and who influence the conduct of its business affairs, will have the most difficulty in establishing the due diligence defence. For such individuals, it will be a challenge to argue convincingly that, despite their daily role in corporate management, they lacked business acumen to the extent that that factor should overtake the assumption that they did know, or ought to have known, of both remittance requirements and any problem in this regard. In short, inside directors will face a significant hurdle when arguing that the subjective element of the standard of care should predominate over its objective aspect.[4]

[54] There is no question that Mr. Grigg was an inside director of the Company. Indeed, he was the only director of that Company.

[55] Each case has to be decided on its own facts. As outlined by Bowman T.C.J. in Cloutier v. M.N.R.[5] the analysis of the due diligence defence is a question of fact:

The question therefore becomes one of fact and the court must to the extent possible attempt to determine what a reasonably prudent person ought to have done and could have done at the time in comparable circumstances. Attempts by courts to conjure up the hypothetical reasonable person have not always been an unqualified success. Tests have been developed, refined and repeated in order to give the process the appearance of rationality and objectivity but ultimately the judge deciding the matter must apply his own concepts of common sense and fairness.

[56] There is no question in my mind that a person more sophisticated in business practices than Mr. Grigg would not have entered into transaction with the Bank in the manner Mr. Grigg did. From the first day the Company commenced to carry on the business it believed it had acquired from the Bank, the Company was in an intolerable financial position. However, Mr. Grigg was not a sophisticated businessman. This appears to have been his first venture in the commercial world as an investor/manager. I am not surprised that he spent most of his time during the Company's operations struggling to keep the Company afloat.

[57] According to Mr. Grigg and Ms. Cunningham, from the outset of the Company's operations, the Bank dictated which of its creditors would be paid. Mr. Grigg was concerned with trying to ameliorate the Company's situation with the Bank and to ensure its suppliers would continue to supply the Company. Although Mr. Grigg was aware that the Company had a statutory obligation to remit source deductions, he did not address his mind to this issue until sometime in February or March when Ms. Cunningham informed him that the Company had failed to remit the sources deductions to the Receiver General. It was only when Mr. Grigg learned of the failures to remit that he immediately contacted Revenue Canada with an attempt to resolve the matter of delinquent payments and to put the Company on a firm basis with Revenue Canada. It was also in March 1993 that Ms. Cunningham first formerly asked Mr. MacPhearson to issue cheques in favour of he Receiver General and was refused. There had been no system to excuse the Company's timely payroll remittances to the Receiver General in which Mr. Grigg may have some semblance of confidence.

[58] Up to and including the end of February 1993 Mr. Grigg did nothing to prevent the Company's failures to remit. That the Company was in an intolerable relationship with its banker is not by itself a valid due diligence defence. It is only when Mr. Grigg learned of the failures and got in touch with Revenue Canada in an attempt to right the failures and Ms. Cunningham requested the Bank's approval of cheques to Revenue Canada did Mr. Grigg start to exercise a degree of care, diligence and skill to prevent future failures. It is obvious that due to the Bank's overwhelming presence in the affairs of the Company, no cheques payable to Revenue Canada would be approved or honoured by the Bank.[6]

[59] Therefore, in my view, up to and including the time Mr. Grigg got in touch with Revenue Canada and Ms. Cunningham requested the Bank to honour a cheque to the Receiver General, which appears to have been sometime in March 1993, nothing was done by anyone employed by the Company, including Mr. Grigg, to prevent the failures to remit. Once the Bank rejected the request for the approval of the cheque to the Receiver General Mr. Grigg knew with certainty that the Bank would refuse all future requests. No matter what he did from that point on he could not compel the Company to issue cheques to the Receiver General without the approval of the Bank. Before he was advised of the Company's failures to remit, Mr. Grigg was ignorant of the failures. Hence, he could not have prevented what he did not know was occurring.

[60] Mr. Grigg is liable, therefore, as director for the amounts the Company has failed to remit to the Receiver General for Canada up to and including March 15, 1993, but not subsequently.

[61] The appeal will be allowed with costs and the assessment will be referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the appellant exercised the degree of care, diligence and skill to prevent the Company's failures to remit source deductions after March 15, 1993 that a reasonable prudent person would have exercised in comparable circumstances.

Signed at Ottawa, Canada, this 24th day of August 1998.

"Gerald J. Rip"

J.T.C.C.

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