Director’s liability in insolvency – Due diligence defence & RVOs

The sheer number of cannabis insolvencies in Canada over the last five years has resulted in a number of unique issues being considered, not least of which is directors’ liability to the Crown for unremitted excise taxes.

Section 295 of the Excise Act, 2001 (Canada) (“Excise Act”) imposes liability on corporate directors for a corporation’s unpaid duties and interest. If a corporation fails to remit required duties or interest, its directors at the time of the failure can be held jointly and severally liable with the corporation for these amounts.

This provision is similar to Section 227.1 of the Income Tax Act (Canada) (“ITA”) and Section 323 of the Excise Tax Act (Canada) (“ETA”). The policy rationale for this approach was recognized by the Federal Court of Appeal (“FCA”) in the leading case of Buckingham v. The Queen, 2011 FCA 142 (“Buckingham”) as follows:

Contrary to the suppliers of a corporation who may limit their financial exposure by requiring cash-in-advance payments, the Crown is an involuntary creditor. The level of the Crown’s exposure to the corporation can thus increase if the corporation continues its operations by paying the net salaries of the employees without effecting employee source deductions remittances or if the corporation decides to collect GST/HST from customers without reporting and remitting these amounts in a timely fashion.

However, the liability of directors for unremitted amounts is not absolute in each case and is subject to certain conditions and a due diligence defence. For example, Subsection 295(2) of the Excise Act specifies that the directors of a corporation are not liable unless and until:

• a certificate for the amount of the corporation’s liability has been registered in the Federal Court under Section 288 of the Excise Act and execution for that amount has been returned unsatisfied in whole or in part;
• the corporation has commenced liquidation or dissolution proceedings or has been dissolved and a claim for the amount of the corporation’s liability has been proved within six months after the earlier of the date of commencement of the proceedings and the date of dissolution; or
• the corporation has made an assignment or a bankruptcy order has been made against it under the Bankruptcy and Insolvency Act (Canada) (the “BIA”) and a claim for the amount of the corporation’s liability has been proved within six months after the date of the assignment or bankruptcy order.

It is notable that directors’ liability for excise tax is not triggered by the commencement of a proposal proceeding under the BIA or commencement of proceedings under the Companies’ Creditors Arrangement Act (Canada) (“CCAA”), only a subsequent bankruptcy event arising out of such proceedings. The Canada Revenue Agency (“CRA”) has also taken the position in a number of insolvency proceedings involving cannabis companies that they are not entitled to assess a debtor corporation while a stay of proceedings is in place, resulting in the CRA usually waiting to submit proofs of claim in the bankruptcy to initiate claims against the applicable directors.

Deemed directors

It is important to note that the Excise Act specifically names directors, not officers, in relation to personal liability for excise debts. However, in certain circumstances, non-director parties (such as officers) can be deemed to be de facto directors where they act in such capacity and may be assessed by the CRA as set out in the CRAs IC89-2R3 “Directors’ Liability.”

Defences

Limitation period

While there are defences to directors’ liability under the Excise Act, they require proactive actions on the part of such directors. The easiest defence to qualify for with respect to a potential assessment relates to the limitation period on claims set out in the legislation. The CRA may not assess a director for amounts payable by a corporation if the individual has ceased to be a director more than two years from the date of the assessment.

Directors sitting on a board of a corporation with significant tax obligations should consider whether remaining on such a board is beneficial in the circumstances or whether resigning to start the limitation clock would be more strategic. Where such resignation occurs, it is critical that it is documented and updated in the appropriate corporate registry to give notice to the public and, importantly, the CRA. A failure to do so can result in an inability to escape liability as considered in Tozer v. The Queen, 2018 TCC 56. Directors also shouldn’t wait to be the last board member to resign unless they intend to guide the company through an insolvency proceeding and seek a release as part of a transaction, proposal or plan, as applicable. Even where the last director of a debtor corporation resigns, they may still be deemed to be a director and be held liable in the circumstances.

Notwithstanding the timing considerations, all directors are jointly and severally liable with each other. While the CRA has typically sought to first enforce against directors with resources (and remember they have access to your tax records), that director can then seek contribution from the other directors who did not contribute pursuant to Section 295(8) of the Excise Act.

Due diligence defence

The second, and more difficult defence to rely on, is the due diligence defence set out in Subsection 295(3) of the Excise Act. This provision states that directors are not liable for a failure of the corporation to remit if 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.

While there is little case law considering the defence available under Subsection 295(3), the equivalent provisions in Subsection 227.1(3) of the ITA and Subsection 323(3) of the ETA have received significant judicial consideration over the past 15 years.

Buckingham is the leading authority regarding the availability of due diligence defences under the ITA and ETA. It was followed by the FCA in Balthazard v. The Queen, 2011 FCA 331 (“Balthazard”) and subsequently in Ahmar v. Canada, 2020 FCA 65 (“Ahmar”).

In Buckingham, the FCA held that the standard of care, skill and diligence required under Subsection 323(3) of the ETA is an objective standard, which provides that every director and officer of a corporation shall, in exercising their powers and discharging their duties, “exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.” This objective standard means that directors may no longer rely on their personal skills, knowledge or capacities, or more importantly, lack thereof, to engage the due diligence defence.

That said, the FCA in Moriyama v. Canada, 2005 FCA 207 recognized that directors are not required to take every conceivable step possible to avoid companies defaulting on their tax obligations. In Balthazard, the FCA held that a director’s due diligence defence is engaged in respect of an obligation to the CRA “that neither the director, nor his corporation, nor the tax authorities could reasonably identify, before the business’s bankruptcy.” The test as set out in Buckingham is as follows:

• The standard of care, skill and diligence required under Subsection 323(3) of the ETA is an objective standard. This objective standard has set aside the common law principle that a director’s management of a corporation is to be judged according to his or her own personal skills, knowledge, abilities and capacities. However, an objective standard does not mean that a director’s particular circumstances are to be ignored. These circumstances must be taken into account, but must be considered against an objective “reasonably prudent person” standard.
• The assessment of the particular director’s conduct, for the purposes of this objective standard, begins when it becomes apparent to the director, acting reasonably and with due care, diligence and skill, that the corporation is entering a period of financial difficulties.
• In circumstances where a corporation is facing financial difficulties, it may be tempting to divert these Crown remittances in order to pay other creditors and thus ensure the continuity of the operations of the corporation. That is precisely the situation which Subsection 323(3) of the ETA seeks to avoid. The defence must not be used to encourage such failures by allowing a care, diligence and skill defence for directors who finance the activities of their corporation with Crown monies, whether or not they expect to make good on these failures to remit at a later date.
• Since the liability of directors in these respects is not absolute, it is possible for a corporation to fail to make remissions to the Crown without the joint and several, or solidary, liability of its directors being engaged.
• What is required is that the directors establish that they were specifically concerned with the tax remittances and that they exercised their duty of care, diligence and skill with a view to preventing a failure by the corporation to remit the amounts at issue.

As noted by the Tax Court in Ayoub v. The King, 2025 TCC 48, the test raises the bar and imposes a higher standard of care where the directors are aware that the corporation is facing financial difficulties. A director who is aware that the corporation is experiencing financial difficulties has an onus to take active steps to prevent the failure of the corporation to remit net tax and such director’s conduct will be evaluated on such basis.

Additionally, the focus of the defence is what the directors did to prevent the failure to remit at the time, not what they did to cure failures after the fact. In Ambs v. The Queen, 2020 TCC 62 (“Ambs”), the Tax Court considered this point citing AG Canada v. Lynda McKinnon, subnom. Worrell v. The Queen, 2000 CanLII 16269 (FCA) for the following proposition:

In my opinion, it is essential to keep in mind the relevant question in this appeal: did the directors exercise due diligence to prevent the company’s failure to remit? This is not necessarily the same as asking whether it was reasonable from a business point of view for the directors to continue to operate the business. 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. The question then is whether what the directors did to prevent the failure meets the standard of the care, diligence and skill that would have been exercised by a reasonably prudent person in comparable circumstances.

It will normally not be sufficient for the directors simply to have carried on the business, knowing that a failure to remit was likely but hoping that the company’s fortunes would revive with an upturn in the economy or in their market position. In such circumstances, directors will generally be held to have assumed the risk that the company will subsequently be able to make its remittances. Taxpayers are not required involuntarily to underwrite this risk, no matter how reasonable it may have been from a business perspective for the directors to have continued the business without doing anything to prevent future failures to remit.

The liability of the directors under Subsection 227.1(1) is not conditional on the existence of sufficient cash in the corporation to pay the remittances of employee source deductions. In Balthazard, the FCA stated that it is important for directors to act quickly in order to avail themselves of a due diligence defence, as the farther a business falls behind in its taxes, the more difficult it becomes to argue that the business is not using Crown remittances to operate.

Furthermore, the following justifications have also been rejected by Courts:

• Reliance on professional accounting advice relating to remittance obligations where the directors are involved in the operation of the business. The Tax Court in Newhook v. The Queen, 2021 TCC 1, held that the director in that instance managed the business and therefore had an obligation to oversee, review and consider the accounting advice they were getting and could not completely allocate blame to their accountant. However, the reverse has been true where an auditor of a public corporation missed falsified financial statements provided to the board showing no amounts due to the CRA.
• Mental health impairment except in extreme circumstances. In Hirjee v. The King, 2023 TCC 4, the Tax Court found that, with specific reference to a director’s duties to remit tax and mental illness, the test becomes whether the director can establish, on a balance of probabilities, that because of mental illness (a) he or she was incapable of understanding or appreciating the duty to prevent a failure of the corporation to remit or, (b) (even if this was understood) he or she was unable to discharge that duty.

In the event of an appeal of a determination by the Tax Court, the Federal Court of Appeal noted in Ahmar that the application of the legal test in evaluating the director’s conduct is a question of law that is reviewable on the correctness standard. In contrast, the Tax Court’s consideration and weighing of the evidence in determining whether a corporate director has exercised due diligence is subject to review on the palpable and overriding error standard.

Mitigating circumstances

While efforts to rectify failures to remit after the fact have not usually been basis to allow directors to rely on the due diligence defence, the Tax Court in Ambs did take notice of the efforts of the directors to liquidate their personal assets and loan the proceeds to the corporation to enable it to pay its creditors. While the directors were still found liable, the Tax Court recommended that the CRA consider waiving interest and penalties given the circumstances by exercising the discretion granted by Subsection 220(3.1) of the ITA and Section 281.1 of the ETA.

The CRA position on RVOs

Another avenue open to directors to mitigate personal liability through an insolvency proceeding is seeking a personal release either in the plan of arrangement or compromise or in the reverse vesting order (“RVO”) granted in respect of a transaction. The current legal test for qualifying for those releases was set out by Justice Marion in Delta 9 Cannabis Inc (Re), 2025 ABKB 52 (“Delta 9”).

While the CRA originally did not object to such releases being included in RVOs, and in some cases consented to them being granted, the CRA has taken much more aggressive positions in proceeding since the release of Delta 9. For example, they have taken positions on the record in the BIA proposal proceedings of Tricanna Industries Inc. (“Tricanna”) and the CCAA proceedings of Freedom Cannabis Inc. that may complicate their ability to enforce against directors where an RVO has been granted, even if a release is not included in the RVO.

The CRAs position in both proceedings has been that the directors of the debtor corporation are not directors of the residual corporation (“ResidualCo”) that is usually bankrupted at the end of the proceedings. Therefore, the directors of the debtor corporation are not liable for the excise obligations that are transferred to ResidualCo. In the Tricanna proceedings, this position was maintained by the CRA, who continued to object to issuance of the RVO, even where a deeming provision was included in the RVO confirming that the directors of Tricanna were deemed to be directors of ResidualCo for the purposes of liability allocation. It remains to be seen how the Tax Court will deal with these positions where the CRA subsequently seeks to go after unreleased directors.

If you have any questions regarding directors’ liability, or wish to discuss any potential proceedings, please contact the author or any member of MLT Aikins restructuring and insolvency group.

Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.

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