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Pao On v Lau Yiu Long

(HPH 180)

The plaintiffs (Pao) owned all the shares in a company (Shing On) which owned a building in Hong Kong (.Wing). The defendants (Lau) were the majority shareholders in a publicly listed company (i.e. it was listed on the stock exchange). The company was called Fu Chip. A company is a legal person having an independent existence from its shareholders. The defendants wanted to acquire the building owned by Shing On and the plaintiffs were willing to sell it to the Fu Chip Co. In order to buy the building, the defendants had to buy the Shing On company. They made an agreement under which the plaintiffs (Pao) would sell all their shares in the Shing On company to Fu Chip Co in exchange for 4.2 m shares in Fu Chip. Now there was a very important clause in this agreement. It was clause 4(k) which you will see on p 181 2nd para. The plaintiffs who were to receive this large parcel of Fu Chip shares promised that they would not sell 60% of the shares for 1 year. The reason for this promise was to ensure that the market would not be flooded with Fu Chip shares which would have the effect of depressing their price. Note that this agreement was between the plaintiffs (Pao) and the Fu Chip Co. In order to persuade the plaintiffs to accept this condition, the defendants had to provide some protection against the possibility that the shares might fall in value during the year the plaintiffs were not permitted to sell them. So there was a subsidiary agreement under which the defendants agreed to buy back 60% of the shares at HK$2.50 in one year's time. Note that this agreement was between the plaintiffs (Pao) and the defendants (Lau). This subsidiary agreement was flawed. It protected the plaintiffs from the possibility of a fall in Fu Chip shares but it it did not allow them to take a profit if Fu Chip shares went up. In other words the price of $2.50 was both a floor and a ceiling. So, soon after entering into the subsidiary agreement, the plaintiffs started to agitate to have it re-cast. They said they would not go ahead with the main agreement unless the subsidiary agreement was re-written in the form of a guarantee or indemnity, that is, it just insured the plaintiffs against a loss but did not impose a ceiling.

The defendants were very anxious that the deal should go ahead. The market had heard about the deal and if it fell through it would probably mean that Fu Chip shares would fall. So the defendants agreed to re-write the subsidary agreement in the form of a guarantee, as the plaintiffs requested. The re-cast subsidiary agreement is described on p 181 4th last para ("The guarantee did not require ..."). Remember that this agreement was between the plaintiffs (Pao) and the defendants (Lau). It is in the form of a guarantee given by the defendants. If the defendants were called on to indemnify the plaintiffs under this agreement, they had the option of buying back 60% of the shares at $2.50 per share. Well. it turned out that Fu Chip shares were not blue chip shares. They fell disasterously. The plaintiffs therefore exercised their rights under the subsidiary agreement. The defendants refused to honour the guarantee. The case ended up in the Privy Council. The case involves an issue of economic duress. It also involved some consideration arguments. We will focus on these. The re-cast subsidiary agreement looked like a one-way promise, namely, a promise by the defendants to the plainitffs. What had the plaintiffs provided in exchange? It was said that the re-cast subsidiary agreement was only supported by a past consideration. This argument is dealt with on pp 181-183 (the "first question"). You will see that this argument was not successful because Lord Scarman used the Re Casey's Patents argument. It worked like this. When, in the original agreement, the plaintiffs were asked not to sell 60% of the shares in Fu Chip for 12 months, it was clear that they would have to be provided with some consideration for this promise. They would not agree to do this unless it was worth their while. Some quid pro quo was obviously contemplated. The subsidiary agreement provided it. It filled in what was obviously missing from the main agreement. But, in any case, there was a consideration in the subsidiary agreement in the form of the defendant having the option of taking back the shares rather than simply indemnifying the plaintiffs. This was a benefit to the defendants because they might then get their money back if the shares went up again. This argument was dealt with on p 184 top para. On p 184 Lord Scarman under the heading "the second question" deals with another argument. It is always possible to find a consideration, which an agreement is apparently lacking, by looking to the surrounding circumstances. Extrinsic evidence may show that there really is a consideration. In this case, Lord Scarman said that the subsidiary agreement really contained an implied promise by the plaintiffs not to sell 60% of their Fu Chip shares for one year. In other words, they were making the self-same promise which was in the main

agreement again in the subsidiary agreement. It is here that the existing duty rule comes in. It could be said that this is not a consideration because the plaintiffs were already bound to this promise under the main agreement. But, the answer to this was that the promise given in the main agreement by the plaintiffs not to sell 60% of the shares for one year was given to Fu Chip, that is, the company. In the subsidiary agreement the promise was given to the defendants, Lau, that is natural persons. So, this is a 3-party existing duty situation. See p 184 half way down. This shows how the existing duty rule in its traditional application is somewhat arbitrary. It is a good consideration in a 3-party situation but not in a 2-party situation (that is before Williams v Roffey came along). In this case it was only a matter of luck that Fu Chip (the company) happened to be a third party, i.e. a different legal entity from the defendants. So, the move to abolish or at least modify the existing duty rule in Williams and in Musumeci may be justified on this basis. "THE THIRD QUESTION". He briefly discussed economic duress and came to the conclusion that in this case, given the rather special facts, the replacement subsidiary agreement was entered into by Lau as a matter of business necessity and to avoid litigation. As Lord Scarman put it on p 187 "...there was commercial pressure, but no coercion." Lord Scarman speaks of "coercion of the will so as to vitiate consent" which might lead one to think that a successful argument based on economic duress would mean that the supposed contract was void. But this would not be correct because the effect of a successful argument based on duress is to render the contract voidable, not void. Lord Scarman has been criticised for this use of language. This case shows how difficult it is to draw the line between acceptable and unacceptable commercial pressure. I repeat that normally threatening to breach a contract will amount to actionable economic duress. But not so in this case. One cannot provide some rule of law on this question. It is a factual question. In the particular circumstances of this case it was not unacceptable to ask for a new agreement when the original agreement was so evidently flawed and probably the other party must have realised that it was flawed.

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