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n the realm of investing, effectively managing risk and capitalising on market trends are vital for meeting financial targets. For this purpose, put options are a key tool that investors often use, to mitigate potential losses and capitalise on market opportunities and while put options are a popular exit option globally, they have faced regulatory challenges in India. It is only in the recent years that the crinkles seem to have been ironed out by the courts and regulators in a significant and meaningful manner.Genesis of the “illegality”
A “put option” is a right (exercisable within a specified duration of time) of the option holder to sell the underlying security to the option debtor at a pre-agreed price. The (‘SCRA’), which was enacted to regulate the securities market and safeguard fair trade practices, viewed such option contracts as problematic and specifically prohibited them to avoid “undesirable speculation in securities”. This blanket prohibition was underscored by a Notification in 1969 which prohibited entering into any contract for the sale or purchase of securities, except “spot delivery” contracts.
With the onset of economic reforms and liberalisation, the regulatory regime was eased by permitting contracts in derivatives to be traded on recognised stock exchanges. So now, even though trading of “options” (being a type of derivative) on recognised stock exchanges was permitted, ambiguity remained over whether the exercise of an option by an option holder — as previously prohibited under the SCRA — had also become permissible.
The Single Judge Bench of the Bombay High Court in 2005 and the Securities Exchange Board of India (‘SEBI’) in 2011 in an informal guidance answered this in the negative. The Bombay High Court observed that a share repurchase/option agreement was invalid under the SCRA since such an agreement did not qualify as a “spot delivery” contract, and the SEBI did not view a put/call option as a valid derivative under the SCRA since they are not contracts traded on recognised stock exchanges, as required under the SCRA.
In a similar rein, the Reserve Bank of India (‘RBI’) did not view option contracts for equity securities favourably, since a fixed price or an assured return for equity instruments at a future date gave such securities the colour of a debt instrument with downside protection.
However, the market participants were not deterred, and it was the norm to have such optionality built into contracts. The investors viewed such contracts as merely contingent contracts, which depended on the realisation of certain trigger events.
Subsequent one-eighty
The enforceability of put options within India’s securities framework came under scrutiny yet again in 2012 in the case of MCX Stock Exchange Ltd. v. SEBI . This case involved an appeal against the SEBI’s order, which classified share buyback agreements (put option agreements) as forward contracts and thus, prohibited them, as they did not qualify to be “spot delivery” contracts. The Division Bench of the Bombay High Court in this case observed that a put option, by nature, is a privilege of one party (option holder) that becomes enforceable only when exercised by such party unlike a standard sale and purchase contract where both parties have enforceable obligations at the outset. The Court further opined that put option agreements should not be classified as forward contracts, since upon exercise of an option, the performance of the contract could not be by any way, other than by a spot delivery, cash or special delivery.
Following this judicial pronouncement, the SEBI pursuant to a Notification dated 3-10-2013 (‘2013 Notification’) decided to further expand the universe of “permitted” contracts. Through the 2013 Notification, the SEBI prospectively blessed the “contracts for the sale or purchase of securities pursuant to the exercise of an option contained in a shareholders’ agreement” with validity, subject to certain conditionalities — the option holder had to hold the underlying securities continuously for a minimum period of one year from the date of entering into the option contract; the consideration for the sale of such securities would need to be in compliance with the extant laws at the time; and the settlement would need to be by way of actual delivery.
Given that the 2013 Notification was prospective in nature, ambiguity existed regarding validity of exercising options for contracts entered between the years 2000 and 2013 , which was finally cleared up in 2019 in the case of Edelweiss Financial Services Ltd. v. Percept Finserve (P) Ltd. (and affirmed by the Divisional Bench of the Bombay High Court in 2023 ). In this case, Edelweiss held a put option to sell shares back to percept if certain pre-agreed post-closing actions were not fulfilled. The Arbitral Tribunal viewed this put option as a forward contract (therefore, a derivative) — which was not traded in accordance with the SCRA (i.e. over a recognised stock exchange) and held it to be invalid. Upon the award being challenged before it, the Bombay High Court determined that the exercise of put option did not amount to “trading” in derivatives, and affirmed that the prohibitions under the SCRA apply solely to derivative contracts — such as publicly traded options — that are bought, sold, or settled on the market and not to private agreements between two shareholders with an option for sale or purchase of their own shares. This decision marked a turning point as it confirmed that the SCRA only regulated the trading of options contracts.
Relying on the abovementioned judgment, the Bombay High Court in the case of Banyan Tree Growth Capital LLC v. Axiom Cordages Ltd. (Banyan Tree) held that the put option in question was not prohibited by the SCRA and that a contract between shareholders containing a put option is not akin to a derivatives/options contract as contemplated by and prohibited under the SCRA.
Decoding enforceability under foreign exchange laws
The RBI followed at the heels of the SEBI and through a series of circulars, permitted sale/purchase of equity instruments pursuant to exercise of option contracts, subject to — compliance with minimum holding period; certain prevailing “fair market” pricing safeguards; and such option not guaranteeing an exit with assured returns for the non-resident investor .
This was followed by a series of judicial pronouncements with respect to the enforceability of put options, particularly in relation to what qualified as “assured returns”. This proposition was scrutinised in the case of Cruz City 1 Mauritius Holdings v. Unitech Ltd. , wherein the parties had a joint venture agreement for a real estate development project pursuant to which Cruz City exercised its put option upon occurrence of the trigger event i.e. project delay, forcing Unitech’s subsidiaries to buy the joint venture’s shares. The Delhi High Court concluded that the put option served not as an unconditional guarantee of returns, but as a mechanism to address contractual breaches. Since the exercise of the put option was contingent on specific breaches rather than fixed returns, the Court upheld its validity.
Subsequent to this ruling, the Delhi High Court faced a similar situation in the case of NTT Docomo Inc. v. Tata Sons Ltd. In this case, the shareholders’ agreement included a provision that mandated Tata Sons to find a buyer for Docomo’s shares or repurchase them at a specified price (sale price) if certain performance indicators were not met. Tata Sons failed to find a buyer and was required to repurchase the shares from Docomo at the sale price, which turned out to be above the permissible fair market value set by Indian Foreign Exchange Control Regulations. Consequently, RBI rejected their plea for the purchase of shares for more than the permissible fair market value, leading to the initiation of arbitration proceedings, where Docomo was awarded $1.17 billion in damages. The Delhi High Court upheld the arbitral award stating that that if Tata Sons was unable to repurchase the shares (as the sale price was more than the permissible limit under the foreign exchange laws) Tata Sons could have found a non-resident buyer, and fulfilled its obligation towards NTT Docomo. The Court also noted that this was a downside protection rather than a guaranteed return, reinforcing the permissibility of put options so long as they do not promise assured returns. However, the absence of clear criteria for defining “downside protection” leaves room for ambiguity and potential misuse.
This aspect of put options was further confirmed in Banyan Tree case where the Bombay High Court reiterated the enforceability of put options that were contingent on specific events and did not guarantee assured returns.
As evident, these cases illustrate a growing trend in favour of the enforcement of put option contracts from a foreign exchange law perspective, provided that they do not assure returns and are contingent upon specific triggers.
Conclusion
While the Indian legal framework has made significant strides in legitimising the enforceability of put options, both in the context of public companies and ones that involve a non-resident, it remains influenced by a dynamic interplay of regulatory requirements, judicial interpretations, and practical challenges. Continued efforts to enhance legal clarity and regulatory processes will be vital in fostering a stable and efficient environment for put options, ensuring their role as a strategic financial instrument in India’s growing market.
*Partner, Shardul Amarchand Mangaldas & Co.
**Senior Associate, Shardul Amarchand Mangaldas & Co.
***Associate, Shardul Amarchand Mangaldas & Co.
Ministry of Finance, Department of Economic Affairs, Restriction on Enter into Contract for Sale or Purchase of Securities, S.O. 2561 (Notified on 27-6-1969)
, Ss. , read with Securities and Exchange Board of India, S.O. 184(E) (F. No. SEBI/LE/3650/2000) (Notified on 1-3-2000). Not Found
, S. , defines “derivatives” to include inter alia, such financial instruments which derive their value from the value of the underlying variables like the share price of a particular scrip in the cash segment of the market or the stock index of a portfolio of stocks.
Niskalp Investments and Trading Co. Ltd. v. Hunduja TMT Ltd., .
Letter No. CFD/DCR/16403/11, Informal guidance provided by SEBI in the reply to Vulcan Engineers Ltd., 23-5-2011, available at: < >
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Securities and Exchange Board of India, LAD-NRO/GN/2013-14/26/6667 (Notified on 3-10-2013).
Securities and Exchange Board of India, LAD-NRO/GN/2013-14/26/6667 (Notified on 3-10-2013).
, Ss. , read with Securities and Exchange Board of India, S.O. 184(E) (F. No. SEBI/LE/3650/2000) (Notified on 1-3-2000). Not Found-
Securities and Exchange Board of India, LAD-NRO/GN/2013-14/26/6667 (Notified on 3-10-2013).
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Percept Finserve (P) Ltd. v. Edelweiss Financial Services Ltd., .
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Foreign Exchange Department, , issued on 9-1-2014.
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