Agreement #1 between Pao On and Fu Chip (Main Agreement – Sale of building)

Pao On sell whole building to Fu Chip. In return, it purchase Fu Chip shares (a public co.) : 4.2 million shares at $2.5 per share.

However, Fu Chip don’t want its shares price fall (because even Fu Chip sell this portion of shares to Pao On, they don’t want other major shareholders to suffer should Pao On sell Fu Chip shares in the market all of a sudden which impacts the shares price and in turn impat other major shareholders).  Hence Agreement #2 happens.

Agreement #2 between Pao On and Lau Yiu Long (main shareholder of Fu Chip) à This agreement is a Repurchase Agreement

Pao On agree not to sell 60% of the Fu Chip shares purchased under Agreement #1 within a year (regardless of whether Fu Share shares price rise or fall within the year).

Pao On has concern that he also faces the risk of loss（賬面）by being prohibited from selling 60% of the shares purchased if the shares price fall (because he bought at $2.5 per share, if the shares price for any reason keeps falling, he cannot stop loss by selling the shares). Lau Yiu Long (major shareholder of Fu Chip) promise to repurchase such 60% of shares that Pao On purchased at $2.5 should shares price fall below this price after a year.

Later on, Pao On realized he would lose the chance of gain under Agreement #2, because :

a) if shares price < $2.5 within the year, Lau Yiu Long will repurchase all the 60% of shares at $2.5, then Pao On doesn’t suffer from any loss (he bought at $2.5 and sells at the same price $2.5)

b) But once Pao On sells to Lau Yiu Long (or Lau Yiu Long repurchase from Pao On), Pao On cannot benefit from any subsequent rise of the shares price (should this happen) as 60% the shares were already sold out and Pao On is just left with 40% purchased under Agreement #1 (i.e. Pao On 冇得賺盡).

Hence, Pao On refused to execute Agreement #1 unless Agreement #2 is replaced by Agreement #3 :

Agreement #3 between Pao On and Lau Yiu Long (à This is an Indemnity Agreement)

Pao On request Lau Yiu Long to only compensate any loss to Pao On in cash (instead of repurchase) if shares price fall below $2.5 within the year.  This enables Pao On to continue to hold the shares so that he can benefit from subsequent rise of shares price by selling to the market in due time.

Pao On v Lau Yiu Long [1980] AC 614

Contract; formation; consideration; past and executed consideration; promise to a third party as consideration; avoiding contract; duress.

Facts:

Pao On agreed to sell his private company to the Fu Chip Company, a public company in which Lau Yiu Long was majority shareholder. In return, Pao On was to receive 4.2 million shares in the Fu Chip Company at a price of $2.50 per share. Lau Yiu Long was concerned that if the Fu Chip shares sold to Pao On were immediately placed on the market, this would depress the share price. To meet this concern, Pao On agreed not to sell 60% of his Fu Chip shares for a year. By promising to keep the shares for a year, Pao On ran the risk of a loss if the market price fell below $2.50 per share. To avoid this risk Pao On and Lau Yiu Long entered a second agreement whereby Lau Yiu Long agreed to re-purchase Pao On’s shares, after a year, for $2.50 each.

Having entered this second agreement, Pao On realised that, while it protected him from loss, it also meant he would not make a profit if the price of the shares rose during the year. He therefore refused to proceed with the main agreement (the sale of his company to Fu Chip) unless the contract to resell the shares to Lau Yiu Long after a year at a fixed price of $2.50 was replaced with an agreement whereby Lau Yiu Long would simply compensate Pao On for any fall in the share price below $2.50 (an indemnity agreement).

Lau Yiu Long was reluctant to provide this indemnity but, fearing that a dispute would damage public confidence in the Fu Chip Company, he agreed to give it. The consideration given by Pao On in exchange for the indemnity was said to consist of Pao On’s original agreement to sell his company to the Fu Chip Company and not resell the Fu Chip shares for a year. A year later the share price of the Fu Chip Company had fallen to a price of 36 cents but Lau Yiu Long refused to honor the indemnity, arguing it was not supported by consideration. Pao On sued Lau Yiu Long to enforce the indemnity.

Issue (1): Was there sufficient consideration to make the indemnity legally enforceable?

Decision: Although the main agreement had been entered into before the indemnity agreement, the promises referred to as consideration for the indemnity agreement were not ‘past’ consideration. (Rachel: Promise (or consideration) here refers to Pao On’s promise not to sell 60% of Fu Chip shares in a year)

Reason: Something done before a promise is finally given can be valid consideration for that later promise if:

(1) the initial thing was done at the promisor’s request; and

(Rachel – In the issue brought to the court here, the defendant (Fu Chip) is the Promisor, who promise to re-purchase (hence benefit to Pao On), and in return, Pao On’s consideration is to promise not to re-sell 60% of the shares in the market within a year).  Pao On’s consideration (i.e. the ‘intial thing’ being referred here) was made at Fu Chip’s (the promisor’s) request.

(2) both parties had understood that the thing done would be paid for; and

(Rachel – The ‘paid for’ here refers to Fu Chip’s promise to repurchase)

(3) what is later promised is a benefit that would have been legally enforceable if it had been promised before the thing was done.

(Rachel – The later promise refers to Fu Chip’s promise (or Lau Yiu Long’s promise) to compensate the loss in cash (the indemnity) instead of repurchase the shares.  This means if this promise has been made before Pao On’s promise not to resell 60% of the shares within a year (Pao On’s consideration, or the ‘initial thing’ as being referred here), this Fu Chip’s promise would have been regarded as a benefit to Pao On.

Before the court now, it is the plaintiff (being the promisee who is suing to get the promisor’s promise enforced , hence the plaintiff needs to prove that he has provided consideration.

So,

What is being sued is :

–          Fu Chip need to keep his promise of indemnity (i.e. to compensate Pao On for the loss in $ due to drop of shares price)

Plaintiff : Pao On

Pao On’s consideration : He promise not to resell 60% of Fu Chip shares.  This is to bring benefit to Fu Chip that Fu Chip shares price remain stable.

)

These requirements were satisfied in relation to Lau Yiu Long’s promise of indemnity.

Issue (2): Could the promise that Pao On made to Lau Yiu Long that he (Pao On) would perform his agreement with the Fu Chip Company constitute consideration for Lau Yiu Long’s promise to indemnify Pao On against loss?

Decision: A new promise to perform obligations already owed to a third party can be valid consideration.

(Rachel:
Obligation = not to resell 60% of shares within a year 
This is a contractual duty owed by Pao On to Fu Chip (third party), which is also a valid consideration for the indemnity agreement.)

Reason: Pao On’s promise gave Lau Yiu Long himself the benefit of a legally enforceable right against Pao On if Pao On failed to perform the obligations owed to Fu Chip.

Issue (3): Did the commercial pressure which Pao On exerted on Lau Yiu Long amount to duress so that the indemnity agreement should be set aside as void?

Decision: The circumstances did not amount to duress and the contract remained valid.

Reason: In the circumstances, neither the commercial pressure exerted, nor Pao On’s threat to repudiate否认an existing contractual obligation, amounted to coercion 强迫of Lau Yiu Long’s will sufficient to vitiate his consent. Lau Yiu Long had realistic alternative choices open to him and acted voluntarily in consenting to the indemnity agreement.

Compare North Ocean Shipping Co Ltd v Hyundai Construction Co Ltd [1979] QB 705. [Joe: add URL to the case]