Your Put/Call Options Are Approved

The law minister has cleared the use of put and call options in contracts

Samar Srivastava
Updated: May 17, 2013 11:48:59 AM UTC

Within days of being appointed law minister Kapil Sibal has cleared an important piece of investor-friendly legislation. He’s legalized the use of put and call options in contracts. The move is likely to make doing business in India a lot easier for companies and investors alike who’d made use of these options.

Simply put, a call option is an agreement whereby one party agrees to buy securities at a predetermined price at a future date while a put option is where a party agrees to sell securities at a predetermined price at a future date.

The Securities and Exchange Board of India, which regulates Indian capital markets had long maintained that these options run contrary to Securities Contract (Regulations) Act. Its main bone of contention was that any contract that is not a spot contract i.e. where the delivery of shares takes place beyond the day on which the contract was made is a speculative contract. The SCRA prohibits such contracts.

Over the years investors and private equity players have used put and call options while structuring deals. “We use it primarily to safeguard our interests. This is something that is a globally accepted practice and not being able to use it in India has been frustrating for us,” said a principal with a private equity firm. He declined to be named as he is not allowed to speak to the media.

There had been a number of deals that had run afoul of this rule.. Take for instance the recent case of Diageo plc’s share purchase agreement of United Spirits Ltd. which contained a put option. It had to be removed before SEBI granted its clearance. SEBI had also rejected its use in the Cairn Vedanta deal in 2010.

Further adding to the issue was the fact that the Companies Act was silent on the use of such options. A clarification issued by the Department of Industrial Policy and Promotion (DIPP) had said that all such options would be considered debt financing. If a foreign party is involved they’d automatically be treated as an external commercial borrowing.

While investors and private equity players continued to insert these clauses in deals the main issue arose when one party refused to honour its end of the bargain. These contracts couldn’t be enforced in court leaving the aggrieved party fuming but without any legal recourse. In 2009, DE Shaw was prevented by the RBI from exercising a put option. It was to have received a 27 percent return on an investment it made in DLF.

With the change in rules such cases won’t recur and it will open up an internally accepted financing practice to Indian companies.

The thoughts and opinions shared here are of the author.

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