To describe in simple words, the law ministrys very recent proposal to validate the call and put options is an extremely progressive step, and ought to remove the uncertainty around the issue of enforceability of such options in public companies (both in the listed and unlisted space). The timing of the proposal is right too as this will help restore some of the lost investors confidence in the India Inc, especially when the finance minister is also busy attracting international investors back to India and convincing them to believe in governments continued commitment to reforms.
Also, it will provide great exit opportunities to private equity investors who can legally put their shares in favour of the investee company or the promoters of the company, specifically at a time when other modes of exit such as strategic sales and public offer of shares have dried up because of lack of interest in strategic sales and poor capital markets.
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Call and put options are options given to a person to be exercised in future for sale or purchase of shares at a predetermined fixed exercise price within the exercise period. These could be really useful in giving an exit to investors. For example, an investor can agree and exercise a put option on a company or the other shareholders of the company (generally promoters) to sell its shares in return of fixed price which generally carries a component of certain rate of return on investmentthe higher the rate the better it is for the investor. So, these options form a good basis to offer an exit option to the investors.
There could be several other reasons to have such options, for instance, an investor can increase its stake in a company by exercising a call option (i.e. requiring the other shareholder to sell its stake to the investor). For example, a foreign investor by having a call option can reserve its right to increase its stake in cases where FDI limits for foreign investment are subsequently increased in certain restricted sectors like insurance. For the numerous benefits that such options can provide in structuring a deal, surely their recognition and validity is really welcomed.
The uncertainty regarding enforceability of these options had arisen because Sebi believed that call and put options in investment and acquisition agreements are illegal as they do not comply with spot delivery contracts and do not qualify as legal and valid derivative contracts under Securities Contracts Regulations Act. Basis this belief, it had insisted deletion of such options from the agreements which it vetted to clear some recent acquisition deals. But was Sebis thinking on this issue correct Well, not really, and therefore this clarity and validity of options was much needed.
Interestingly, this issue was earlier settled by the Bombay High Court in the dispute between MCX stock exchange and Sebi but it was later appealed in the Supreme Court where in parties reached consent terms. In the consent terms, Sebi said that it would not be bound by the views of the Bombay High Court and thus diluting the decision of the Bombay High Court. Therefore, this proposal will now ensure clarity by amending the relevant Sebi regulations. But there is still time before this becomes a law. The law ministrys proposal will now need to be accepted by the finance ministry before it is notified as amended law by Sebi, although it is very likely that this will happen shortly and without incident.
Now that there is a proposal to validate such options from the Sebi regulations perspective, it will be extremely good if RBI also clarifies its position on put options. RBI believes that shares issued to a non-resident investor with a put option right are no different that debt instruments because the investor has a right to put the shares in favour of the Indian company or any Indian shareholder and repatriate its funds just like a lender, earning the interest on funds invested in the form of rate of return included in the put option exercise price. It is high time (in fact, long overdue) that RBI also should permit genuine transactions of call and put options. Once that is also done, call and put options will be free of any ambiguity and encourage smooth investment and acquisition deals.
The author is a partner with J Sagar Associates. Views are personal. He can be reached at email@example.com