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Validity of Call and Put Options in Private Equity/Shareholding Deals


(a) Call options (since provide a right to acquire more shares) are particularly useful to strategic investors in sectors having sectoral caps. As these venture capitalists put in considerable amount of time and efforts not disputing huge investments in establishing, managing (in case they have nominees appointed on the Board of such investee Companies) the investee companies, they undoubtedly expects returns from such investments by reserving their rights to acquire further shares in the event there is relaxation in sectoral cap thereby enhancing their stake and holding in the said companies.

(b) Put options (since they provide a right to sell their shares) are useful for financial investors who make investments to reap benefits and earn profit from the investment, such investors primarily being private equity and venture capital investors acquire the right to sell shares at a pre-determined price and earn a pre-determined rate of return.


Options are contracts that give the holders the right, but not the obligation to buy or sell a certain number of securities at a set price.

  • Call Option:

A call option allows the holder to buy a security at a predetermined price, usually above the current price, within a limited time period.

  • Put Option:

A put option gives the holder the right to sell securities at a specified price within a limited period. When an option is exercised by the holder, the shareholder will be obligated to buy or sell the shares at the predetermined price.

While a put option provides an investor with an exit route from a company, a call option gives the option to increase the shareholding in the firm.


The Investors may reserve their rights of Put/Call option in investment agreements, shareholders’ agreements and joint-venture agreements. Typically, the exit mechanisms include an initial public offer (IPO), buy back of shares by the investee company and a put option and a call option or tag along / drag along rights.

Put and Call options are helpful in achieving certain objectives such as giving a right to an investor to subscribe and acquire additional shares or to sell shares at a pre-determined price and earn a pre-determined rate of return.

HOW THEY MAY APPEAR IN THE AGREEMENT?- A SAMPLE 1. PUT OPTION TO INVESTOR 1.1 In case, the Company does not come with an IPO within XYZ months from the Commencement Date, the Investor shall have the right but not an obligation to sell (Put option) all or part of the Investor Shares to the Promoters and/or to any other Person designated by the Promoter in installments each vesting on a quarterly/yearly basis starting from the end of the _____ month from the date of the investment exercisable till the end of the ______ month from the Commencement Date. 1.2 In case the Investor opts to exercise the Put Option, the Promoter shall purchase or cause the purchase of the Investor Shares. Subject to the provisions of applicable law, the Promoter shall pay or cause to be paid to the Investor towards consideration of such purchase of Investor Shares a price determined by an independent valuer acceptable to the Investor. 1.3 In connection with the exercise of the Put Option, the Investor shall deliver the Put Notice to the Promoter, calling upon the Promoter to purchase the Investor Shares on the terms and conditions mentioned hereinafter. 1.4 The Put Notice shall specify: o the Put Option amount; o the Settlement Date; o the mode of payment of the Put Option amount; and o location and modalities for the settlement.

The exit provisions particularly hold relevance in cases of foreign investment where the foreign investor seeks to ensure their exit rights. The investors primarily rely on the investee company floating their shares in an IPO, i.e. listing of shares, which provides liquidity and ample exit opportunities to the existing shareholders. However, since listing of a company has various dimensions attached to it which may not make listing a feasible exit mechanism, the investor’s fallback on other options for their exit. For a foreign investor the aforesaid put option and call option hold different significance depending upon the strategy and the kind of investment:



  • Securities With Options Treated As Debt

Vide the FDI Policy (Circular 2 of 2011) dated September 30, 2011, which became effective from October 1, 2011 (the “FDI Circular”), the Department of Industrial Policy and Promotion from the Ministry of Commerce and Industry inserted a new clause which provided that:

“Only equity shares, fully, compulsorily and mandatorily convertible debentures and fully, compulsorily and mandatorily convertible preference shares, with no inbuilt options of any type, would qualify as eligible instruments for FDI. Equity instruments issued/transferred to non-residents having in-built options or supported by options sold by third parties would lose their equity character and such instruments would have to comply with the extant ECB guidelines.”

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The RBI was of the view that fixed return linked options are more in the nature of debt and disallowed them and therefore, made such instruments to comply with the extant ECB guidelines.


As regards recently released notifications dated November 12, 2013 published in the Official Gazette on December 30, 2013 and circular dated January 9, 2014 on this subject matter, it is very much apparent that the securities carrying optionality rights and assured returns are not considered as eligible instruments in hands of foreign investor from FDI viewpoint.

Thus, any foreign investment made in any Equity cannot carry “optionality” and assured returns both. Equity carrying “optionality” but no assured returns is valid and eligible but transfer of such instruments is subject to certain conditions set out in the RBI Circulars.

The RBI Circulars have provided that Equity Securities which:

  1. contain an optionality clause; and
  2. which provides a foreign investor with a right to exit at an assured price, will not be regarded as an eligible security and cannot be subscribed to by foreign investors. The guiding principle that RBI has set forth, is that foreign investors should not be guaranteed any assured exit price at the time of making the investment.

“Assured Return”?

A “price assured” may be intended to mean a price which is, subject to it being in compliance with the pricing requirements under the law, ought to be treated as a return which is contingent, rather than assured i.e. foreign investors can have “optionality” attached to Equity Securities so long as such option / right does not assure them of a fixed exit price.

Therefore what is permitted is “put” right which does not result in an Indian resident providing an assured return to foreign investors. This is however, subject to the following conditions:

  1. Such Equity Securities will be locked in for a minimum period of one year, unless a higher lock-in is prescribed by the exchange control regulations and
  2. Such exit will be subject to pricing guidelines discussed below.


Exit by non-residents cannot be at a price that is higher than:

(i) for listed securities, the market price determined on the floor of a recognized stock exchange;

(ii) for unlisted securities that are equity shares, at a price to be arrived on the basis of “return on equity” (that is, profit after tax divided by net worth, in each case based on the latest audited balance sheet of the company);

(iii) for unlisted securities that are compulsorily convertible preference shares or compulsorily convertible debentures, at a price arrived at by a chartered accountant or a SEBI-registered merchant banker (valuer), based on internationally accepted pricing methodology.

RBI has further stipulated that all existing contracts will have to comply with the above lock in and pricing conditions to qualify as compliant with exchange control laws. It, therefore, needs to be assessed if any “put” options with an assured return (issued before the date of the RBI Circulars) can be regarded as eligible securities under the exchange control regulations and lock-in conditions will have to be suitably imposed.


  • “Options in securities” were considered illegal as they were prohibited by SCRA until 1956.
  • In June, 1969- Notification issued to the effect that all contracts for the sale and purchase of securities other than ‘spot delivery contracts’ or contracts settled through stock exchange are void.
  • In 1995, Section 20 of SCRA which said all options are void was omitted.
  • However, in the year 2000, the 1969 notification was repealed.
  • In the same year, notification was released to the effect that “no person can enter into any contract for sale or purchase of securities other than spot delivery contract or contract for cash or hand delivery or special delivery of permissible contracts in derivatives.”

Therefore, as per SEBI, until recent, the enforceability of put and calls neither qualified as spot delivery contracts u/s 18 of SCRA nor qualified as derivative contracts in terms of section 18A of SCRA as they are entered between private parties and are not contracts traded on stock exchanges and settled on the clearing house of the recognized stock exchange.

This issue took another leap when it was contested between MCX and SEBI which even went to the Bombay High Court and later in appeal to the Supreme Court, where no clarity could be achieved on the decision pronounces as it was held by the Bombay High Court that such contracts do not violate “spot delivery contracts” (u/s 18 of SCRA), however, how valid are they in terms of derivatives (u/s 18A of SCRA) was left unsolved.


With this new notification, SEBI has repealed its notification of 2000 and validated the sale/purchase transactions exercised pursuant to options. However, noteworthy are the conditions underlying such right of options which are:

ü Lock in period of one year

ü Price payable on sale/purchase of underlying securities pursuant to exercise of option is in accordance with applicable laws

ü Contract to be settled by actual delivery of security/ies.

The relief from notification also extends to pre-emption rights such as right of first refusal, tag along right or drag along rights which also have a locus standi now. This notification has come into play with prospective effect.



Prior to the enactment of Companies Act, 2013, issue was unclear as regards free transferability of shares. It remained a matter of dispute, where in the case of Messer Holdings Limited v. Shyam Madanmohan Ruia, it was held that any private arrangement between shareholders of a public company on a voluntary basis relating to the share transfer restrictions is not violative of Section 111A of the Companies Act, 1956 and also suggested that it is not mandatory for the companies to incorporate such restrictions in the articles of the Company.

In Private Company, there were restrictive provisions in the act of 1956 which restricted the right of private companies to transfer its shares. However, it was pertinent to note the Supreme Court ruling in V.B. Rangaraj v. V.B. Gopalakrishnan which held that to ensure enforceability of clause pertaining to ‘restriction on transferability of shares’ on the private company and its shareholders, the same must be contained in the articles of the company.


The enactment of Companies Act, 2013 recognizes the enforceability of 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 which provides that the securities or other interest of any member in a public company shall be freely transferable; provided that any contract or arrangement between two or more persons in respect of transfer of securities shall be enforceable as a contract.

These changes in Securities laws, RBI and companies act brings in more clarity on the validity of such options and rights in M&A and PE and parties can therefore structure their deals with more certainty, protecting their rights under the new regulatory regime.


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