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Options – Not a Part of History Yet
At the time when India is completing two decades of the economic liberalization there are several laurels which the policymakers can boast of. The path-breaking shift from the license-raj to a regime focusing on regulation introduced by the Government of India in the landmark year 1991 have been continued through further economic reforms and the same has also found support from the regulators and the market players.
However, there can be no denial of the fact that in this regard there are lacunas on several front the classic example of which can be found with the treatment of options under the extant regulatory framework.
Putting simply, option is a contractual right but not an obligation of a person to buy or sell an asset (including shares of a company). Options are classified as call option (where the holder has right to buy the underlying asset) and put option (where the holder has the right to sell the underlying asset). The manner of exercise of option is based on the commercial understanding of the parties to contract.
Options in addition to being customary in corporate transactions like joint-venture, private equity investment, venture capital investments are also of deep essence in the contractual arrangements between the transacting parties across the globe.
In India, options are governed by myriad laws which make it difficult to ascertain their status under the law of land. The general aspect of transfer of shares is governed by Companies Act, 1956 (“Companies Act”). Whereas the Securities Contracts (Regulations) Act, 1956 (“SCRA”) specifically governs put and call options aspect of the commercial transactions.
In its original form SCRA, vide Section 20, prohibited options in securities but the said Section was deleted with effect from January 25, 1995. However, under Section 16 of SCRA, the Securities and Exchange Board of India (“SEBI”) came out with a notification (Notification No. S.S. 184(E) of March 1, 2000) by virtue of which any contract in securities will be considered to be void unless they are on spot delivery basis or carried out through stock exchange. Similar stand has been taken by the Reserve Bank of India vide Notification No. 185 (E) dated March 1, 2000. Further, SEBI, through its informal guidance dated May 23, 2011 issued to Vulcan Engineers Ltd., stated that the pre-agreed buyback of shares through put/call option is invalid under SCRA.
The approach of judiciary on the issue of options is also worth discussing. In Nishkalp Investments and Trading Co. Ltd. v. Hinduja TMT Ltd. (2008  Comp. Cas 204 Bom), the parties had entered into an agreement for purchase of shares of a company and the purchaser was provided an exit option in the event seller was unable to get the securities of the company listed on stock exchange, in which case the seller had to buy back shares sold to the purchaser. With respect to the legality of the aforesaid option granted to the purchaser under SCRA, the Hon’ble Bombay High Court held that the said arrangement does not qualify as a spot delivery contract and consequently not permissible under SCRA.
Further, in a recent decision by the division bench of the Hon’ble Bombay High Court in Messers Holdings Limited v. S.M. Ruia & Ors., upheld the pre-emptive rights in contracts as arrangement between shareholders inter-se and not violative of the requirement of free transferability under the Companies Act.
In a situation where the regulatory stance and conflicting judicial pronouncement have created confusion to the issue at hand, the Consolidated FDI Policy (which came into effect from 1st October, 2011) vide its clause 126.96.36.199 provides that equity instruments with any in-built option issued/transferred to a non-resident will lose their equity character and would have to comply with the extant external commercial guidelines. But, this clause has been removed from the FDI Policy vide circular dated October 31, 2011 as it received stiff criticism from global investor community.
While this move from the government has not cleared all the confusion surrounding the options (Companies Act vis-à-vis SCRA), but it certainly has given a breather to the options and it would be interesting to see whether the approach of the Government reflected in the FDI Policy will be extended to the other areas of law governing options in India.
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