End of uncertainty: Options in Indian contracts

On 3 October 2013, the Securities and Exchange Board of India (SEBI) issued a notification permitting put and call options in certain transactions involving public listed companies. The SEBI notification put an end to the debate (that had ensued for the longest time) on whether contracts involving put and call options in a listed company are enforceable.

Despite the SEBI notification, much needed certainty from the Reserve Bank of India (RBI) had been lacking on the issue of put and call options – the RBI had at one point even considered fixed return linked options to be in the nature of debt and disallowed them. In a notification dated 12 November 2013 that was made publicly available only recently, the RBI has permitted non-residents to acquire Indian securities with “optionality”.

Limitations

The RBI notification read with an RBI circular dated 9 January 2014 clarifies the RBI’s stand on call options, put options and other exit-linked terms for both listed and unlisted securities. However, this relaxation comes with certain limitations that are set out in brief below:

Assured returns: Non-residents cannot have assured returns on the securities as part of their exit mechanism. This appears to be the guiding principle.

Lock-in: Non-residents with such securities will be locked in for a period that is higher of: (i) one year from the allotment date; and (ii) sector-specific lock-in applicable under the foreign direct investment (FDI) policy.

Exit pricing: Exit by non-residents cannot be at a price that is higher than: (i) for listed securities, the market price determined on the floor of a recognized stock exchange; (ii) for unlisted securities that are equity shares, at a price to be arrived on the basis of “return on equity” (that is, profit after tax divided by net worth, in each case based on the latest audited balance sheet of the company); (iii) for unlisted securities that are compulsorily convertible preference shares or compulsorily convertible debentures, at a price arrived at by a chartered accountant or a SEBI-registered merchant banker (valuer), based on internationally accepted pricing methodology.

Aakash Choubey is a partner and Mayank Singh is a principal associate at Khaitan & Co. The views of the authors are personal, and should not be considered as those of the firm.