Subject â€“ Company law 1 Option Contracts -An analysis of position in India Background Put and call options are one of the preferred mechanisms for investors in India, both foreign and domestic, and in different type of transactions like joint venture, stock market, etc. In lay manâ€™s term a put option enjoyed by A against B gives A an option to sell certain securities at a future date at some specified price. Whereas a call option enjoyed by A against B gives A an option to compel B to sell the specified securities at a specified date and for a specified price.
Don’t waste time! Our writers will create an original "Option Contracts" essay for youCreate order
These options are founded in commercial practicalities. In some cases the promoter has call options by which he can buy out the investors. The investment carries certain pre emptive rights as well like Right to First Refusal, Drag Along Rights, etc. This is a standard that is practiced internationally, even in India though not expressly. The recent changes by regularity authorities like RBI, SEBI and Judiciary has made the position of investors very turbulent in India. Section 2(d) of the Securities Contract (Regulation) Act, 1956 defines â€œoptions in securitiesâ€ as a purchase or sell of a right to buy or sell securities in the future. The judiciary has upheld that options are not obligation but a right. Section 20 of the Securities Contract (Regulation) Act, 1956 (SCRA) had prohibited options upon securities. A 1995 amendment had deleted the concerned provision, but still the air of ambiguity regarding option contracts wasnâ€™t clear as a March 1, 2000 circular of SEBI had prohibited the use of option contracts. If both the amendment and circular is read together it is logically deducible that option contracts are only valid till they are (a) spot delivery contracts; (b) hand delivery; (c) contracts for cash; (d) special delivery and (e) contracts for derivatives permissible under the SCRA or the SEBI 1992 rules. Since the Amendment is still in force along with the circular by SEBI in 2000 that clarified itâ€™s position related to prohibition on option contracts, there exists an contradiction between the 1995 amendment of SCRA and 2000 circular of SEBI. CURRENT SITUATION The SEBI by a recent 2013 circular has agreed to include clauses related to pre emptive rights, right of first offer, tag-along right, drag-along right and call and put options, when contained in shareholders’ agreements, as valid contracts, for the purpose of the SCRA. Some judicial decisions that lead to the strategic acceptance of option contracts by SEBI has been enumerated below : In 2005 the Bombay High Court dealing with the buy-back clause in a share agreement held that such a contract would not be valid under SCRA as it is not a spot delivery contract. In 2011, SEBI issued an informal guidance that an agreed purchase of shares of a listed company through call or put options of a listed company is invalid, since it does not constitute a spot delivery. The contract was held not to be a derivative under SCRA as it was not a contract traded in stock exchange but settled on clearing house of a stock exchange. In 2012 Bombay High Court, dealing with the options of purchase or sell between parties, held that the options are mere privileges of option holder and a concluded contract would only come into existence when an option holder actually enforces the option. The appeal filed by SEBI was disposed off by the Supreme Court on grounds of mutual consent filed by parties. All this led to a deadlock which was cleared atlast by SEBI which by its 2013 circular enhanced the scope of option contracts under the SCRA. The notification clarifies that the contracts now included under SCRA shall be in accordance with the extant exchange control laws of India and that the changes shall not affect the validity of any contract entered prior to the notification. ANALYSIS
Prior to the notification there was a lot of ambiguity related to the validity of option contracts. Two views existed, with one advocating that they were invalid as they were neither spot delivery contracts nor were they derivatives traded in the stock market as enumerated in Vulcan Engineers Case and the other view advocating the validity of option contracts based on MCX case judgement that advocated that such contracts were rights vested in the option holder and not a concluded contract. By including contracts for purchase or sale of securities pursuant to exercise of an option, SEBI has put to rest a long standing debate.
While the validity of such contracts is settled by the circular, more confusion seems to be have had been added with respect to the enforcement of such contracts. As per the MCX judgement the option contract would become a contract only on exercise, hence to be settled as a spot delivery contract. However by including spot delivery and pre emptive contracts as a different class of contracts, the settlement of contracts is under ambiguity. Also as the above two contracts have been included in class of permitted contracts, there is ambiguity whether they can be traded as market securities. For example if a shareholderâ€™s agreement contains mere call option, could the right be traded by option holder.
By legalising the concept of option contract, for the validity and enforceability of contracts the selling party is required to own the securities for a minimum period of one year. Also, the contract for such sale and purchase pursuant to the exercise of an option must be by actual delivery of the underlying securities. The intent behind this clause was to prevent any speculative transactions among the parties, which was the intent behind the introduction of SCRA.
The circular of 2013 expressly states that the contracts entered before the circular will not be affected by the change, hence the validity and enforceability of such contracts still remains questionable. The only option the affected parties are left with in order to continue their contract is by re entering the contract on a date after the circular came into force.
Though SEBI has permitted options in shareholders’ agreements, the same have been subjected to the extant exchange control regulations. RBI has often been uncomfortable with such contracts in shareholders’ agreements since it views these contracts as more in the nature of debt as opposed to equity, thereby defeating the spirit of the foreign direct investment policy. The RBI has even issued various show cause notices for removal of such provisions. Unless RBI issues a notification permitting options in shareholders’ agreements, these options in cross border deals might still remain questionable. CONCLUSION The issue of the validity of call and put options has been debated frequently. SEBI has earlier held options to be invalid in Vulcan Engineering, and recently, has even asked parties to remove put options from their agreements, as in the recent case of Vedanta Resources Plc’s acquisition of Cairn India Limited. Hence the Notification is a welcome move and will bring great relief – to the domestic investors, at least. Having said that, the call and put options are subject to extant exchange control regulations. RBI has been holding such options invalid on 2 counts. First, that they were not valid contracts under SCRA, and second, that they were in the nature of debt. By way of the Notification, the first of the two issues have been addressed. To that extent, since put options is more pertinent to the second objection- it remains to be seen whether call option would now be permitted. It seems that SEBI may have consulted with the RBI before coming out with the Notification, and it is expected that RBI may soon permit options and preemptive rights from an exchange control perspective, thereby clarifying the issue in relation to these contracts. Therefore to conclude we can say that the recent circular has on one hand cleared years long ambiguity in one hand by expressly validating option contracts but on the other hand has also created confusion over validity of such contracts entered earlier than the circular. This leaves interested latter parties with the only option of re entering contracts.
 Available at https://www.sebi.gov.in/acts/contractact.pdf  Notification S.O. 184 (E) dated March 1, 2000  Ankit Guha, Are Option Contracts Enforceable, available at https://www.legallyindia.com/20090831159/Legal-opinions/are-option-clauses-actually-enforcable.  The Notification No. LAD-NRO/GN/2013-14/26/6667 dated October 3, 2013 availableat www.sebi.gov.in  Niskalp Investments and Trading Co. Ltd. vs. Hinduja TMT Ltd. [ 143 Comp Cas 204 (Bom)]  SEBI Informal Guidance in the matter of Vulcan Engineers Limited dated May 23, 2011 availablehere https://www.sebi.gov.in/takeover/vulcanlof.pdf  MCX Stock Exchange Limited vs. SEBI, 2012 (114) BomLR 1002  in the matter of Vulcan Engineers Limited dated May 23, 2011 availablehere https://www.sebi.gov.in/takeover/vulcanlof.pdf  MCX Stock Exchange Limited vs. SEBI, 2012 (114) BomLR 1002  Nishith Desai Associates, SEBI Permits options and Pre emptive Agreements, available at https://www.mondaq.com/india/x/270684/Shareholders/SEBI+Permits+Options+And+Preemptive+Rights+Arrangements
We will send an essay sample to you in 2 Hours. If you need help faster you can always use our custom writing service.Get help with my paper