Pao On v Lau Yiu Long [1980] AC 614

Key point

  • An act prior to when the the promisor makes his promise can be valid consideration for the promise if the act made at promisor’s request and the parties understood that it will be rewarded by the promisor in the future
  • Commercial pressure, such as a threat to abandon a transaction, does not equate economic duress

Facts

Background

  • In an acquisition deal, Fu Chip, a company owned by Lau (D), agreed to purchase all the shares in Shing On, a company owned by Pao (C)
  • Instead of paying C with cash, Fu Chip paid C using its own shares (as context, in M&A transactions, the acquirer will sometimes pay shareholders of the target company using its own shares instead of cash)
  • Under the share purchase agreement, C gave an undertaking to retain 60% of Fu Chip shares he is allocated for a lockup period of one year so as to stabilise the share price
  • C threatened to walk away unless D entered into a guarantee agreement to provide an indemnity if the share price fell below $2.50 after one year, to which D agreed

Dispute

  • After the acquisition, shares in Fu Chip shares fell below $2.50, D refused to honour the guarantee agreement
  • C sued for breach of contract so as to claim the indemnity
  • D argued that it was not liable on the alternative grounds that:
    1. C did not provide good consideration for the guarantee agreement; or
    2. he entered into the guarantee agreement under duress from C’s threat to walk away

Held (Privy Council)

  • C claim succeeded; D was liable for damages for breach of contract
  • C’s promise to retain the shares for one year was good consideration to the guarantee agreement
  • D had been subject to commercial pressure to enter into the guarantee agreement but that did not amount to duress

Lord Scarman

Validity of consideration

Requirements

  • An act done before the giving of a promise to make a payment or confer a benefit may be considered good consideration
  • For it to do so, three conditions are to be met (at p. 629):
    1. the act must have been done at the promisor’s request;
    2. the parties must have understood that the act was to be remunerated either by payment or conferment of some benefit; and
    3. the payment or conferment of a benefit would have been enforceable had it been promised in advance

Current case

  • C’s promise under the initial agreement to retain the shares for one year was good consideration for the indemnity
  • At the time the main agreement was entered, all were aware that Cs were to have protection from D for the restriction on selling

Duress (at : p. 635)

What amounts to duress?

  • There must be a coercion of will which vitiates consent
  • Mere commercial pressure is not enough

What amounts to coercion of the will?

  • In determining whether there was such a coercion of the will, it is material to inquire:
    1. whether the person allegedly coerced protested;
    2. whether he had an alternative course available to him as a legal remedy
    3. whether he was independently advised; and
    4. whether after entering the contract he took steps to avoid it

Economic duress

  • Their Lordships explicitly recognised the category of economic duress, prior to this case only duress to the person was recognised in English law
  • Economic duress is where commercial pressure amounts to a coercion of the will that vitiates consent, rendering the contract voidable

Current case

  • Although there was commercial pressure, there had not been a coercion of will that vitiated consent
  • D had considered the matter thoroughly, chose to enter into the guarantee agreement to avoid litigation and thought that the risk of the guarantee was low

Commentary

  • This case is an exception to the general rule that past consideration is not good consideration laid down in Eastwood v Kenyon