The Law Ministry is reported to have approved a proposal by the Securities and Exchange Board of India (SEBI) to permit the use of put and call options for corporate restructuring and non-speculative purposes. This development should finally bring some clarity over the use of these tools, favoured by those active in the spheres of private equity, and mergers and acquisitions.
Put and call options are widely used around the world in structuring transactions to attain certain objectives. Typically, put options are granted by promoters of companies to investment funds which have a determinate term and require an alternative exit route, should a primary market offering or strategic sale not prove feasible. Call options facilitate an increase in stake at a later date, enabling consolidation by the joint-venture partner or the original promoters.
These options may also be handy in various scenarios, such as events of default, breach of contractual obligations, or even to resolve a deadlock between shareholders and investors. By linking the exercise of options to the achievement of certain milestones, put and call options can also be deployed by parties as positive or negative incentives in the management of a company.
A notification issued by the central government in 1969 under the provisions of the Securities Contracts (Regulation) Act, 1956 (SCRA), forbade parties from entering into securities contracts other than spot delivery contracts (which involve exchange of consideration and delivery of possession of the security on the same or next day as the parties’ execution of the contract for the transaction). The provisions of the 1969 notification were substantially subsumed in a central government notification in 2000, which additionally permitted derivative contracts traded and settled through a recognized stock exchange.
As evident from its stance adopted in informal guidance provided to a listed company in 2011, SEBI was of the opinion that put and call options would continue to be hit by the 2000 notification as they did not fall in either category of permissible securities contracts. Several transactions in the recent past, such as the acquisition of stakes by mining conglomerate Vedanta in Cairn India and by leading spirits multinational Diageo in United Spirits, saw this issue being raked up by SEBI, which forced deal makers to delete references to options in their agreements.
A call for change
Recently, in a dispute between MCX Stock Exchange and SEBI, Bombay High Court made a ruling that favoured the validity of put and call options. In its extensive discussion on the development of the law and judicial precedent on this issue, it rejected SEBI’s contention that such options constituted forward contracts, and were therefore illegal. As options were exercisable at the prerogative of the option holder, they were akin to contingent contracts, which would only be concluded at their exercise. Provided that the exchange of consideration and delivery of securities was made on the same day or the day after the option was exercised, it could be construed as a spot delivery and therefore permissible under law. Unfortunately, SEBI’s second pillar of objection to options – that these were off-market derivatives – was not taken up due to procedural grounds.
However, given that on appeal the Supreme Court permitted the parties to enter into settlement terms and prescribed that the findings of Bombay High Court would not be binding on such settlement, the value of this decision appears to have been diluted. A silver lining from these proceedings was that SEBI appears to have been given impetus to rethink its stance on options. Shortly after the settlement, SEBI was reported to have submitted a proposal to the Law Ministry to rectify the uncertainty surrounding these options, which now appears to have been accepted and is expected to be notified shortly.
While put and call options have been incorporated in investment agreements, there has been no certainty on whether such clauses would be enforceable in the event of a dispute between the parties. Permitting put and call options would significantly boost investor sentiment in India, especially in these choppy markets.
Currently, the fine print of the proposed change is not in the public domain, and there is speculation as to whether it will be implemented through a notification, or require an amendment of the SCRA (which would entail a longer timeline). Questions also abound as to whether the Reserve Bank of India – which has in the past objected to put and call options involving monetary outflows – is on board with this. However, the soundbites emanating from the Law Ministry and industry bodies seem to indicate that investors may finally have some valid grounds for elation.
Siddharth Hariani is a partner and Davis Kanjamala is an associate at the Mumbai office of Phoenix Legal.
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