'Put' me in trouble and I will 'call' Sebi

The controversy surrounding the enforceability of ‘put’ and ‘call’ options commonly inserted in shareholders’ investment agreements is certainly not unfamiliar to those in the Indian private equity industry. In the view of the Securities and Exchange Board of India (Sebi), and some well-known judicial pronouncements, all transactions in securities unless settled on a ‘spot delivery basis’, that is, where the transfer of securities and payment of consideration take place on the same or the next day, are unenforcable under law. There is a school of thought that views options as contingent contracts that mature into completed contracts only upon the option being exercised. Proponents of this view argue that in case these are settled the same or the next day, these would become enforceable.

However, this argument has not gone down well, either with the market regulator or the Indian courts, and it is now common knowledge that arrangements in the nature of put/call options in securities of listed companies are not enforceable under law. Notably, although Sebi’s jurisdiction should extend only to listed public companies, there exist judicial pronouncements that have extended the scope of the prohibition on the use of options contracts to the shares of unlisted public companies as well.

The only kind of companies (thus far) outside the purview of such a prohibition are private companies, as the shares of these companies are not considered as ‘marketable securities’ under the applicable regulations that prohibit their enforceability. A sub-class of such private companies is the one deemed equated with a public company, better known as a ‘private company which is a subsidiary of a public company’. So far, alluding to a 2006 judgment of the Company Law Board (CLB), legal practitioners would regard such companies as retaining the “basic characteristics of a private company”, and, consequently, such companies were permitted to place share transfer restrictions in their articles, much like any ordinary private company. On a similar note, exercise of put/call options on the shares of such private companies were also considered within the realms of the law.

As if the present conservative approach of Sebi and judiciary was not enough, with a recent judgment of the Bombay High Court, enforceability of put/call options has seemingly suffered — what may be called — another ‘potential’ shot in the arm. In a significant departure from the judgment of the Company Law Board, the Bombay High Court recently remarked that under Indian law, there were only two types of companies — public and private —and that this classification of companies was exhaustive. The Court, therefore, equated a ‘private company which is a subsidiary of a public company’ with a public company itself; and derecognised the long-standing view of such private companies retaining the basic characteristic of a private company. Although this judgment does not expressly discuss the issue of enforceability of call and put options in such companies, it does raise a question mark on whether put/call options with respect to shares of a ‘private company that is a subsidiary of a public company’ would now hold up in a court of law.

The present environment in India is one leaning towards strict scrutiny of put and call options, and scepticism surround their enforceability. With ambiguities surrounding the enforceability of put/call options, it is anybody’s guess how investor-friendly our present investment climate is; and, to this extent, a relaxation in favour of private equity investors will not be completely out of place.

Sidharrth Shankar is a Partner and Vatsal Gaur is an Associate with J. Sagar Associates. The authors are associated with advising clients on this matter. Views of the authors are personal.