A recent SEBI notification has put to rest the long-standing ambiguity regarding ‘options in securities’. It all started in 1969 when a government of India’s notification provided that contracts for the sale and purchase of securities other than ‘spot delivery contracts’ or contracts settled through stock exchange are void. In addition, Section 20 of Securities Contracts (Regulation) Act, 1956 (SCRA) considered all ‘options in securities’ illegal. This led to endless debates and controversies on the validity of ‘options in securities’. Section 20 and the 1969 notification were repealed in 1995 and 2000, respectively. When that happened, it was thought that dubious provisions being repealed it will bring clarity, but unfortunately, that didn’t happen because SEBI released another notification in 2000 which had similar provision as the 1969 notification, thus nullifying the deletion of 1969 notification.
History is replete with instances that ‘options in securities’ have triggered many controversies and legal battles, including the famous BALCO disinvestment when Sterlite failed to enforce its call option right to increase its stake in BALCO as it was alleged that such options are illegal. Later, deals like the Cairn-Vedanta; the Diageo and UB group for stake sale in United Spirits and some others were also victims and such options in shareholders’ agreement had to be dropped before SEBI gave a green signal to these deals. The last large contest on this issue was between MCX and SEBI which even went upto the Bombay High Court and later in appeal to the Supreme Court.
With this new notification, SEBI has repealed its notification of 2000 and has said that contracts for purchase or sale of securities pursuant to exercise of an option contained therein to buy and sell the securities will be permitted. However, this comes with some conditions, such as, the underlying securities on which such options are exercised will have to be held continuously for at least one year from the date of executing the contract (this aims at validating only genuine call and put options); price or consideration for the sale and purchase of underlying securities has to be in compliance with applicable laws and the contract has to be settled by way of actual delivery of the underlying securities. The relief from notification doesn’t end only with options; it also extends to pre-emption rights such as right of first refusal, tag along right or drag along rights which have also been made valid now.
One notable point is that SEBI has not entered RBI’s zone and has specifically said in the notification that these options and rights will also have to comply with the FEMA Act, 1999 and rules and regulations there under. This is an interesting point and will still keep these options under some cloud of uncertainty for non-resident shareholders. This is because RBI perceives a put option right with a non-resident as a debt instrument, requiring compliance with the ECB guidelines; therefore, till RBI also releases a similar notification (it is high time that it should!) validating these options, they will continue to suffer from ambiguity from FEMA’s perspective. RBI while clarifying could use the same conditions as in SEBI’s notification, which will help align the two sets of regulations and ease deal making.
Not only will M&A deal making become easier and certain now with this notification; PE investors will benefit too from certainty on validity of such options and rights – as these are important options and rights to give them exit. While PE investments in private companies was clear as SCRA and SEBI’s reach did not extend to private companies but when these private companies were taken to public for IPO, SEBI insisted that such options and rights be removed from the agreements. But, now these provisions can stay in the agreement and public company’s articles of association even after IPO listing.
One significant provision in the notification is that contracts entered prior to October 3 will not be affected or validated, thus giving it a prospective effect.
Interestingly, now the newly passed Companies Act, 2013 also recognises contractual restrictions amongst shareholders, such as right of first refusal, tag along right or drag along rights under proviso to Section 58(2) even in public companies, with SEBI now permitting such options and rights in such public companies, this will bring clarity on the validity of such options and rights in M&A and PE deals both from securities law and company law perspective and parties can structure their investments with certainty around enforceability of such options and rights at the time of entering into contract.
This is a major development which is very encouraging; the only piece now left ambiguous is from FEMA’s perspective with respect to such options with non-resident shareholders.
(The author is a partner with J. Sagar Associates. Views are personal).
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