PaO On v Lau Yiu [1980] AC 614

KEY POINTS

• Contracts require an exchange of value—consideration—to be valid. This can be goods, services, or promises, ensuring each party gains something from the deal.

• Promising to do something you're already obligated to do generally doesn't count as consideration. For new contracts, additional obligations or benefits are needed to create valid consideration.

• When a company buys a business and uses its own shares as payment, conditions may include deferring the sale of shares. This can affect stock stability and raise questions about market impact and fairness.

• Vendors seeking protection against potential losses when selling company shares can ask for indemnity from third parties. These agreements must have valid consideration and align with public policy.

• If a party agrees to indemnify another under threat of repudiation, it raises concerns of economic duress. This occurs when pressure is used to force agreement, potentially invalidating the contract.

• Contracts that violate public policy—like those encouraging unfair practices—are invalid. Agreements must align with legal and ethical standards to ensure fairness and protect societal values.

FACTS

• Pao On, Ho Mei Chun, and Pao Lap Chung (“Plaintiffs”) owned the issued share capital of a private company whose main asset was a building under construction.

  • Lau Yi Long, and Benjamin Lau Kam Ching (“Defendants”) were majority shareholders of a public company interested in acquiring the aforementioned building.

  • In February 1973, the Plaintiffs agreed in writing with the public company to sell their shares in the private company, with the understanding that the price would be satisfied by an issue of shares in the public company.

  • To prevent market depression for the public company's shares, the Plaintiffs agreed, at the Defendants' request, to retain 60% of their newly acquired shares until after April 30, 1974.

  • Both parties orally agreed that the Plaintiffs would be protected against potential losses from a decline in share value until April 30, 1974, leading to the creation of a subsidiary agreement.

    • Under this agreement, the Plaintiffs would sell and the Defendants would buy 60% of the allotted shares at $2.50 per share by April 30, 1974.

  • In April 1973, the Plaintiffs sought to replace a prior agreement with a guarantee of indemnity from the Defendants, fearing potential losses. 

  • The Defendants, concerned about litigation delays and public confidence, agreed and signed a contract to indemnify the Plaintiffs if share prices fell below $2.50 by April 30, 1974. 

• Despite retaining 60% of their shares, the Plaintiffs faced losses when share prices dropped. They sued the Defendants, initially winning in the High Court but losing on appeal.

• The Plaintiffs then appealed to the Judicial Committee, questioning consideration for the indemnity contract and potential duress affecting the Defendants' consent.

JUDGEMENT

• The Court reversed the Hong Kong Court of Appeal's decision, holding that the Defendants were bound by the contract of guarantee, validating the Plaintiffs' claim for indemnity.

  • The Court reasoned that a prior act can be valid consideration if it was performed at the promisor's request, expecting compensation.

  • In this case, the Plaintiffs' earlier promise not to sell shares before April 30, 1974, established the required consideration for the Defendants' promise of indemnity.

• Extrinsic evidence confirmed that the real consideration for the indemnity was the Plaintiffs' commitment to retain 60% of their shares until after April 30, 1974.

  • The Court found no evidence of coercion or duress, even though the Defendants experienced commercial pressure.

  • Contracts negotiated at arm's length remain valid, even with unequal bargaining positions.

  • The Defendants' contract of guarantee was neither invalid nor voidable.

COMMENTARY

• Contracts require "consideration," which is an exchange of value, to be valid.

  • This exchange can be goods, services, or promises, ensuring both parties benefit.

  • A promise to do something you're already obligated to do generally isn't valid consideration—new contracts need fresh obligations or benefits.

• The court found no evidence of coercion or duress in the agreement.

  • Even though the defendants faced commercial pressure, contracts negotiated at arm's length remain valid, even with unequal bargaining positions.

  • The court reversed a previous decision, upholding the validity of the contract of guarantee, validating the plaintiffs' claim for indemnity.

ORIGINAL ANALYSIS

• Plaintiffs had a company which they agreed to sell to Defendant’s company, in return for shares in Defendant's company rather than money.

• To protect Defendants’ share price, a subsidiary agreement was made that Plaintiffs would keep 60% of their shares until after April 30, 1974, and to protect Plaintiffs against a possible drop in share price, Defendants agreed to buy 60 per cent of the allotted shares on or before April 30, 1974, at $2.50 a share.

• Defendants later (when Plaintiffs refused to move forward with the deal since they wanted a more lucrative agreement for themselves) agreed to provide a guarantee of indemnity (i.e. that they would only pay $2.50 per share if the shares fell below that price, but would pay the asking price otherwise). This was due to Defendants’ fear of costs of litigation + falling confidence in Defendants’ company if the deal was delayed.

• Plaintiffs’ shares collapsed in price and Defendants refused to honour the subsidiary agreement since they said it was non-existant, while the indemnity agreement was invalid due to duress and past (i.e. invalid) - consideration.  

HL

• Held that:

  1. There was no duress, merely commercial pressure, and the coercion of the weaker bargaining party by the stronger one was not duress;

  2. The promise not to sell shares by Plaintiffs WAS valid consideration, despite being given before the indemnity arrangement, since it was made at Defendants’ request with the understanding that Ss would be rewarded in some way for this conduct (even though the specific reward was only established later) i.e. resurrection of the Lampleigh rules.

• This understanding “survived through” the cancellation of the subsidiary agreement in favour of the indemnity one. 

Lord Scarman

• For past-consideration to be valid:

  1. It had to have been performed at the other party’s request;

  2. The parties must have understood that the act was to be remunerated either by a payment or the conferment of some other benefit (why is this test subjective when normally the objective test is used for explaining the content of a contract?);

  3. The payment/benefit would have to have been legally enforceable if it had been given in advance of the consideration.

• These are present here.  The promise not to sell the shares before a certain date was consideration for the subsequent guarantee i.e. an act/promise made before the actual agreement could suffice as consideration for the later promise. 

RELATED CASES

• Barton v Armstrong

• Lampleigh v Braithwaite