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High Court on the enforceability of Option Contracts

Finsec Law Advisors

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The High Court of Bombay, in the matter of Edelweiss Financial Services v. Percept Finserve Pvt. Ltd. decided on March 27, 2019, has upheld that agreements containing clauses related with exercise of call/put options may not be in the nature of ‘forward contract’ which were prohibited under the Securities Contracts (Regulation) Act, 1956 (SCRA) before the 2013 amendment.

In the instant matter, the parties had entered into a share purchase agreement wherein one of the conditions required the promoters of the Percept group (Promoters) to restructure its company through an IPO within a stipulated period of time, failing which Edelweiss had an option to re-sell their shares in the company to the Promoters at a pre-determined price. On failing to restructure the company, Edelweiss exercised its option; however, the Promoters refused to purchase the shares arguing that the option clause was illegal and contrary to Section 18-A of SCRA. The arbitral tribunal concurred with the Promoters.

On appeal the High Court held that option contracts are not in the nature of forward contracts. While the former refers to an obligation which would only arise in future on happening of certain contingent events (failure to restructure the company, in the present matter), the latter refers to a contract which confers present obligation that is to be performed in future. On this issue, the Court has reiterated its order in MCX Stock Exchange Ltd. v. SEBI (2012).

The Court further discussed the legality of the option contracts in terms of Section 18-A of SCRA, which provides that contracts in derivatives shall be legal if they are traded on a recognized exchange and settled on a recognized clearing corporation, as provided in the said provision. While holding that Section 18-A is not restrictive provision but merely an enabling one, the Court stated that by virtue of Section 18-A option contracts are not prohibited per se, but trading / dealing in option contracts and treating them as a security is prohibited. Such trading or dealing makes them a derivative product and attracts the restrictions provided in Section 18-A.

This opinion of the Court has brought much needed relief to the corporate world, wherein contracts containing such option clauses which are to be enforced only on fulfilment or non-fulfilment of certain conditions are common; but the legality of which was always a point of discussion.