Legal Development
Pursuant to a notification issued by the Securities and Exchange Board of India on October 4, 2013, (“2013 notification”) the following arrangements / contracts which were earlier not legally enforceable or allowed to be entered into by listed public companies and unlisted public companies(issuing marketable securities) (collectively referred to as “said companies”) are now permitted, as follows:-
Contracts for pre-emption including right of first refusal, or tag-along or drag- along rights; and Contracts for purchase or sale of securities pursuant to exercise of a call or a put option (viz. Call & Put Options).
Conditions for entering into put and call options
(i) the title and ownership of the underlying securities is held continuously by the seller for a minimum period of 1 (one) year from the date of entering into the contract;
(ii). the contract is settled by way of actual delivery of the underlying securities; and
(iii). the price or consideration payable for the sale or purchase of the underlying securities pursuant to exercise of an option, is in compliance with all the applicable laws.
Brief Legal History & Position before the 2013 notification
Under the regulatory framework of Securities Contract (Regulation) Act, 1956 and particularly in light of a notification issued by SEBI in 2000, only spot delivery contracts 3 and contracts in derivatives were permitted to be entered into and enforceable for the said companies. Typically shareholders agreements amongst other things contain clauses relating to preemptive rights such as RoFO, RoFR, Drag Along and Tag Along and option contracts (put and call). When the articles of association of the said companies were consequentially amended to incorporate such clauses for make it legally binding, not only the legal enforceability, but even the capacity of such companies to enter into and agree upon such arrangements was uncertain. [Note: For details relating to preemption clauses, call and put options and its legal validity, the reader can refer to our research update titled ―Typical Clauses of an Investment Agreement‖].
In 2012, Bombay High Court had passed a judgment in which it held that if the parties merely entered into option arrangements, the same would not ipso facto cause violation of provisions of SCRA, as it was as the privilege of the option holder whether or not to exercise the options. If the privilege is not exercised then, there would not be any concluded contract. However, if the option is exercised then the same would have to be effectuated by way of a spot delivery contract, which would be in conformity with the provisions of SCRA. In the said judgment, the Court distinguished between a forward contract which was already a concluded contract for the purchase or sale of securities in future at a determined price and an ‗option‘ (which was not yet a concluded contract but only an agreement to contract at a future time) [Note: For a detailed analysis of the said judgment and the regulatory framework governing spot delivery contracts, the reader can refer to our research update titled ―MCX Case: Validity of options under SCRA]
Analysis & Comments
The 2013 Notification comes a relief for listed public companies and unlisted public companies issuing marketable securities as such companies can now enter into contracts containing such preemptive clauses and option contracts and can also incorporate the same in their articles of association. It also brings finality to the issue relating to capacity of said companies to enter into such arrangements. However, it needs to be noted that section 194 of the Companies Act, 2013 prohibits forward dealings in securities by a company by a whole time director and key managerial personnel for not only the company whose securities are dealt as per options but also for its holding, subsidiary or associate company.
About Bulwark Solicitors
Bulwark Solicitors is a law firm pioneered by Solicitor Chirag Sancheti and Advocate Deep Shridharani. The firm has expertise in the areas of both Litigation and non-Litigation. Under the non-litigation Law practice, the firm practices in the areas of Corporate Law, Intellectual Property Law, Bankruptcy & Insolvency Law, Competition Law, Real Estate and Conveyancing and DTAA Advisory. Further, under Corporate Law area, we practice Company Law, Securities Law, Mergers and Amalgamations, Private Equity and Venture Capital Investment Transactions, Legal Due Diligence and Foreign Exchange Management Law.