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SEBI's rejection of call and put options will hit these instruments hard
August, 20th 2011

The debate on the validity of call and put options is not a new one. Although this debate was dormant for some time, the securities market regulator's recent view on the issue has forced it back into news. Recently, Sebi, in its informal guidance in Vulcan Engineers matter, has reiterated the stand it took in the case of Vedanta-Cairn deal that put and call options are not valid and had directed the parties to drop the call and put option arrangement from the share acquisition agreement.

Sebi's view is that any pre-agreed buyback of shares through call and put options is not valid under the Securities Contracts (Regulation) Act, 1956. This is a sudden move. These share options had always existed and Sebi had knowledge of them, but it never approached them the way it has started doing now.

Naturally, this has not been well accepted by the legal and industry circles. Itis viewed as a retrograde step good enough to wary the investors. This will now add more uncertainty to the already-unsettled issue of enforceability of put and call options.

In spite of Sebi's view, private companies can still breathe easy, although securities of unlisted public companies may fall in this trap. Courtesy for this goes to some judicial precedents where ithas been held that provisions of Securities Contracts (Regulation) Act are not applicable to private companies but are applicable to unlisted securities of public companies. Nonetheless, it has opened the debate on the enforceability ofcall and put options.

Examining this issue from the Companies Act, 1956, perspective, there is a strong argument that these options are not really a restriction imposed by one shareholder on the other on transfer of shares. In fact, these options are mere private arrangements between two shareholders agreeing to buy or sell shares from each other, generally at a pre-determined price, on the happening of certain events.

Therefore, these options should not be treated as, and equated to, restriction on transfer of shares. The rule that an owner of a property is freely allowed to buy or sell his property should also apply with no exception to the buying or selling of shares as long as all other compliances of law are followed. Notably, the Companies Act does not prohibit and restrict shareholders from agreeing to call and put options.

Let us assume that these options are considered as restriction on transferability of shares. Even then, in a private limited company, these can still be enforced against the shareholders inter se and the company, provided they are incorporated in the articles of association (incorporation in articles is required because of the Supreme Court judgment in Rangaraj's case). The reason that these options can be enforced in a private limited company is that the Companies Act permits providing restriction on transferability of shares in a private limited company. However, the position is slightly different in the case of a public company.

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