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The validity of put options with reference to the FDI Policy has not specifically considered by courts, they are a standard feature in investment agreements by foreigners. However, the wording of the put option clause differs in each investment agreement. Corporate lawyers are also known to structure the option in a crafty way so that it is not in violation of law. The following discussion captures the legal issues surrounding put options:


1) Put options on shares of public companies impose restrictions on the transferability of their shares, by restricting the freedom of the shareholder to sell the share to the person who exercises the option. Under Section 111A of the Companies Act, 1956 shares of a company are freely transferable and restrictions on their transferability cannot be imposed (even in a private contract between shareholders). Hence, put options on shares of public companies were considered to be invalid, from a strict enforcement point of view. However, the Companies Act 2013 contains specifically permits enforcement of contracts for transfer of securities privately amongst shareholders (or between shareholders and third parties).


2) Put options on shares of public companies are violative of the Securities Contracts Regulation Act (SCRA). This is because they are derivative contracts, which, as per the SCRA, are valid only if they are listed on a stock exchange. Second, as per a Central Government notification issued pursuant to the SCRA, only specific contracts where the transfer of shares occurs almost simultaneously (or within a very short time) with the agreement coming into legal effect, and which are executed within the framework prescribed by a stock exchange are valid. These contracts are known as spot delivery contracts or contracts for cash or hand delivery or special delivery. In the case of put options granted to investors, however, the right to purchase is exercised much after the options agreement is legally effective – hence, it is understood to be illegal as it does not meet the above requirements.


The only exception to this is the options that are themselves listed and traded on the exchange.


3) Put options granted to foreigners could be violate Foreign Exchange Management Act (FEMA) - The Foreign Direct Investment Policy circular of the Central Government issued in 2011 had initially contained a clause stating that in-built options in investment transactions are not permitted (which appeared to include put options, as per the view taken by legal experts). However, the clause was later withdrawn through a corrigendum issued by the government – which came as a relief to corporate lawyers.


However, certain put options purport to promise a guaranteed rate of return – e.g. a minimum internal rate of return of 25 percent. It is possible for such options to be considered as similar to debt – in that case, they will constitute external commercial borrowings (ECBs) and will have to comply with the provision of ECB Regulations. ECB Regulations are relatively restrictive and it many investment transactions may be in violation of them if ECB Regulations are attracted.


Those who are interested in further reading can go read the following:

  • MCX Stock Exchange Limited v. Securities & Exchange Board of India & Ors. 2012 (114)  BomLR 1002
  • Naresh K. Agarwalla v. Canbank Financial Services Ltd. (2010) 6 SCC 178
  • SEBI’s letter to Cairn India, available at url: http://www.sebi.gov.in/takeover/cairnlof.pdf, last visited on 3 October 2011.
  • SEBI’s informal guidance to Vulcan Engineers, CFD/DCR/16403/2011.
  • Nishkalp Investments & Trading v. Hinduja TMT Ltd. (2008) 143 CompCas 2004 (BOM)
  • Bhagwati Developers v. Peerless General Finance and Investment Company Limited, http://judis.nic.in/supremecourt/imgs1.aspx?filename=40558


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