Call and Put Options Allowed By SEBI

Another breather for Corporate India after the passage of the Companies Act, 2013 is that SEBI has allowed companies to include call and put options in the M&A and Private Equity Agreements.[1] Companies can now enter contracts for pre-emption including right of first refusal, or tag-along or drag-along rights contained in shareholders agreements or articles of association of companies or other corporate bodies, SEBI said on 3rd October 2013.[2] Companies can also transact in spot delivery and derivatives contracts.

The said move is anticipated to render peace of mind to the foreign investors looking for such options in their transactions and it is also expected to encourage the foreign investors to enter in India and seek the agreeable returns. In fact, the order has been passed in lieu of removing an obstacle that had delayed several large transactions including that of Diageo Plc™s purchase of a stake in United Spirits Ltd.

One of the major reasons why PE firms feared investing in India was the invalidity of call options. Under Indian laws an option has to be a spot delivery contract or it has to be listed on a recognized stock exchange. In devoid of such a situation, the option not only runs afoul of section 18A of the SCRA but also SEBI Notification No. S.O184 (E).[3] Furthermore, the call option is also in contravention of the free transferability of shares as embodied in sections 82 and 111A of the Companies Act, 1956 (Companies Act).

Option contracts have been an integral part of the Mergers, Private Equity (PE) Deals in India. Indian corporate have been using options to structure their deals, raising finances from the foreign lenders. The foreign lenders entering in India want to secure their interest in the Company. In order to secure the interest, the common features which are seen in the Agreements and contracts are the pre-emption rights for the investor in the form of Right of First Refusal, Tag Along Rights, Drag Along Rights, etc.

Options (both call and put) are treated as a form of derivatives, as they derive their value from the underlying shares.[4] Stated differently, an options contract is a derivative contract between a buyer and a seller where the seller gives a right but not an obligation to buy from or sell to the seller the underlying asset on or before a specific date at an agreed price.[5]

The SEBI in its informal guidance note given to Vulcan Engineers Ltd[6] relating to the purchase and sale of shares of the company at a pre agreed price under the PUT/Call Options stated that: ‘As [this] (call and put) option would be exercised in a future date…the transaction would not qualify as a spot delivery contract under SCRA S. 2(i), nor as a legal and valid derivative contract in terms of S. 18A.’

Also, in the Cairn-Vedanta deal[7] SEBI was of the view that put option and call option arrangements and the Right of First Refusal do not conform to the requirements of a spot delivery contract nor with that of a contract of Derivatives as provided under section 18A of the Securities Contracts (Regulation) Act, 1956. Also, put option and call option arrangement along with the right of first refusal are in violation of Notification No. SO 184(E) dated March 1, 2000 issued by SEBI. SEBI in its view clearly provided that the Options not being the spot delivery contracts are prohibited in terms of SEBI Notification No. SO 184(E) dated March 1, 2000.

In the light of this recent development, it is clear now that the matter of CALL and PUT options under M&A and PE Deals will be free from judicial controversy. Never the less, the foreign investor will gain much confidence when it comes to investment in India.

[2] Ibid

[4] Rajshree Sugar and Chemicals Ltd v Axis Bank Ltd, 2009 (1) CTC 227

[5] Rakhi Trading Private Ltd v SEBI, 2010 Indlaw SAT 58; Indiabulls Securities Ltd v SEBI, 2010 Indlaw SAT 57.

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