Trusts are tricky – they can arise in circumstances where none of the parties involved ever use the word “trust.” There is good reason for this; often the settlor of the trust and the trustee are laypeople who can describe the type of relationship they wish to create, but are unaware of the legal terms to describe it. If a lawyer does become involved, she will likely set the terms of the trust down in writing and will call the relationship a “Trust” to make sure there is no doubt about the parties’ intentions. However, a trust is not created just because a document is titled a “Trust Agreement,” as the Court in Khavari v Mizrahi held.

In that case, Mr. Khavari and Mr. Mizrahi entered into a business agreement to develop certain lands in Toronto. Further to their agreement, Mr. Khavari was to provide the financing and Mr. Mizrahi would oversee the development. Each owned 50% of the shares in the corporations that held title to the development lands.

In 2011, Mr. Khavari experienced legal troubles overseas, which resulted in his Canadian bank accounts being frozen. Although Mr. Khavari had already advanced $14.2 million towards the development project, further funding was needed before the project could be completed. Mr. Khavari and Mr. Mizrahi agreed that the additional funding would have to be obtained from private lenders.

Although not stated explicitly in the court’s decision, it was likely that Mr. Khavari was considered a credit risk to private lenders (it had been alleged that he had participated in one of the largest fraud and embezzlement schemes in Iran, there was an outstanding Interpol warrant for his arrest, and Iran was attempting to have him extradited from Canada). In order to enable them to secure financing for the project, Mr. Khavari and Mr. Mizrahi agreed:

• Khavari would transfer his 50% ownership in the corporations to Mr. Mizrahi, thereby allowing Mr. Mizrahi to have complete control and authority over the development project; and
• Mizrahi would not transfer the shares back to Mr. Khavari until the development project was complete and all debts associated with the project were paid.

Mr. Khavari and Mr. Mizrahi signed a document titled “Trust Agreement” implementing the above terms. They later signed two amendments to the Trust Agreement which, among other things, authorized certain loans that Mr. Mizrahi had arranged.

Unfortunately, the development project faced several delays (bad weather and soil problems among them). In 2015, Mr. Khavari issued a notice of application against Mr. Mizrahi seeking the return of the shares even though the development project had yet to be completed. Mr. Khavari argued that the Trust Agreement created a bare trust, by which Mr. Mizrahi held the shares in trust for him. Mr. Khavari relied on the principle in Saunders v Vautier in support of his request for the return of the shares.

Saunders v. Vautier is an English commonly cited as establishing the common law rule that where beneficial entitlement to trust property has fully vested in the beneficiaries of the trust, but the terms of the trust requires a period of time to pass before the trust property is distributed to them, then the trust may be collapsed and distributed early at the court’s discretion where all the beneficiaries are in agreement and none of the beneficiaries are under legal disability.

Mr. Mizrahi disagreed that the Trust Agreement created a trust. Rather, Mr. Mizrahi argued that the Trust Agreement was simply a contract (meaning trust principles did not apply) and that the terms of the contract should be enforced, namely, no distribution of the shares until the development was complete and all associated liabilities paid.

The Court sided with Mr. Mizrahi. On review, Justice Wilton-Siegel found that there was no intent to create a bare trust (one of the “three certainties” needed when settling a trust, the other two being certainty of subject matter (i.e. trust property) and certainty of objects (i.e. beneficiaries)). Although the “Trust Agreement” appeared to use the language of trusts, it was in substance and effect a contract between two business partners. The agreement made business sense: by transferring the shares, Mr. Mizrahi was able to obtain the necessary funding to continue the development project. The agreement contained mutual covenants and was signed by both parties (which is unusual for a trust agreement). It was later amended in writing and again signed by both parties (once settled, the terms of a trust usually cannot be varied except by court order). The effect of the agreement was to give complete legal and beneficial interest in the shares to Mr. Mizrahi, who was then able to pledge the shares to third parties in order to obtain a loan. The Court held that Mr. Mizrahi’s unfettered ownership rights under the agreement were inconsistent with a trustee relationship. In fact, Mr. Mizrahi’s only obligation under the Trust Agreement was to return the shares to Mr. Khavari upon to occurrence of the triggering events, namely the completion of the development project and payment of all liabilities. Looking at the agreement as a whole and in the context of the business venture, the Court held that the “Trust Agreement” was in fact a contract and it did not give rise to a trust relationship.

The Court also held that Saunders v Vautier would not have applied in these circumstances even if a trust had been created. The principle in Saunders v Vautier applies to circumstances where the beneficiaries have an absolute right to the trust property, the only barrier being the passage of time. While Mr. Khavari argued that the triggering events were analogous to waiting for a deadline to pass, the Court disagreed. It held that there was no certainty that the triggering events would ever occur (namely, that the development would be completed and all liabilities paid). As a result, the Court held that it would not have been appropriate in these circumstances to exercise its discretion and collapse the trust.