A recent judgement by a division bench of the Bombay High Court may well be the game changer required as regards legal certainty on enforceability of options in India. The judgment itself deals with a challenge to the actions of the regulator in refusing recognition to a new stock exchange. A key aspect was the validity and impact of buy back arrangement.
In the case of MCX Stock Exchange v Securities and Exchange Board of India (W.P. No. 213 of 2011), the court ruling means that options, whether put or call, in securities of public companies are valid and enforceable. This finally brings much needed clarity on the issue of enforceability of options given that such arrangements find place not just in investments by financial investors, but also almost all joint venture or strategic investments.
Until now, the validity and enforceability of options has been a subject of a considerable amount of debate. The Securities and Exchange Board of India (Sebi), the Indian capital market regulator, has in two other recent instances struck down such arrangements by holding them to be prohibited by provisions of the Securities Contracts (Regulation) Act, 1956. This Act does invalidate all forward contracts.
Forward contracts are those contracts for sale or purchase of securities which are settled other than on a spot delivery basis. Spot delivery contracts are transactions where the transfer of securities and payment of consideration for such securities takes place on the same or the next day. As options oblige one of the parties to sell its shareholding at a future date, Sebi has time and again viewed them as forward contracts.
The Bombay High Court has, however, disagreed with Sebi's views in the MCX judgment. It has held that an option agreement constitutes merely a privilege, the exercise of which depends on unilateral volition of the party exercising the option. In such an event, a concluded contract of sale comes into existence only at a future date when such option is exercised. Once exercised, the contract would be settled on a spot delivery basis. Therefore, the court reasoned that the options are not forward contracts and hence, not hit by the Securities Contracts (Regulation) Act restrictions.
It is interesting to note that one of the judges of the division bench which has passed the MCX, had in another matter taken a view which was seen as a narrow one. In that case the issue before the single bench was whether pre-emption rights (restrictions on transferability of shares) are enforceable in case of a public company. This is in view of the provisions of the Companies Act, 1956 which stipulate that the shares of a public company are freely transferable.
The single bench had held that such pre-emption rights are against the provisions of the Companies Act. Thankfully, this ruling was explicitly overruled in Messers Holdings v Shyam Madan Mohan Ruia, by another division bench of the Bombay High Court. The court validated pre-emption rights in the case of public companies. It needs to be pointed out that the Messers Holdings judgment is pending in appeal before the Supreme Court of India.
Unless the Supreme Court negates interpretation as put forward in Messers Holdings (and for that matter, the MCX judgment if Sebi were to appeal against it), investors should get considerable comfort as regards the enforceability of options in relation to investment in Indian companies. This will only benefit the Indian economy in the long run.
Nitu Agarwal and Shuchita Bhushan