On February 02, 2023, the Division Bench of the Bombay High Court (‘Bombay HC’) rendered its judgment in the case of Percept Finserve Pvt. Ltd. v. Edelweiss Financial Services Ltd.^[1] inter alia holding that a put option clause contained in share purchase agreements is legally valid under the provisions of the Securities Contracts (Regulation) Act, 1956 (‘SCRA’) and the notifications issued thereunder (‘Judgment’).

Background of Dispute

The put option clause in question was contained in a share purchase agreement dated December 07, 2008 (amended on April 23, 2008) (‘SPA’), whereby Edelweiss Financial Services Ltd. (‘Edelweiss’) purchased the shares of Percept Limited from Percept Finserve Pvt. Ltd. (‘Percept Finserve’) (collectively, along with Percept Ltd. is referred to as ‘Percept’) for INR 20 crores. The SPA gave an option to Edelweiss to re-sell the shares of Percept Ltd. to Percept Finserve for a purchase consideration of INR 20 crores along with 10% of internal return of rate, if Percept failed to fulfil certain conditions subsequent as per the SPA.

When Percept failed to comply with the conditions subsequent, Edelweiss exercised its option under the SPA. As Percept failed to act in terms of the put option, Edelweiss invoked arbitration against Percept.

The arbitral tribunal in its award dated June 06, 2016 (‘Award’) held that a put option is a forward contract and, in any event, a derivative contract and, therefore, illegal under the notifications issued under Sections 16 and 18A of the SCRA. The Award was challenged by Edelweiss under Section 34 of the Arbitration and Conciliation Act, 1996 (‘Act’) and was set aside by the Bombay HC on March 27, 2019.^[2] The issue of whether the put option clause contained in the SPA was valid and enforceable under the provisions of the SCRA came before the Division Bench in an appeal filed by Percept under Section 37 of the Act against the order of the Bombay HC.

The exercise of the put option in question was challenged in view of the Notification of the Securities and Exchange Board of India (‘SEBI’) bearing no. S.O. 184(E) dated March 01, 2000 (‘SEBI 2000 Notification’) which prohibited all contracts for the sale or purchase of securities, except spot delivery contracts or the contracts in derivatives that are permissible under the law. The SEBI 2000 Notification was rescinded by SEBI’s Notification No. LAD-NRO/GN/2013-14/26/6667 dated October 03, 2013 (‘SEBI 2013 Notification’). The SEBI 2013 Notification inter alia specifically exempts contracts contained in shareholders’ agreements for sale or purchase of securities pursuant to exercise of a put / call option from prohibition under the SCRA. A proviso in the SEBI 2013 Notification states that it shall not ‘affect or validate any contract which has been entered into prior to the date of this notification’. Since the SPA in question was entered into and the put option clause contained therein was exercised before October 03, 2013, the Division Bench considered the effect of the SEBI 2000 Notification.

Judgment

Certain key observations in the Judgment include:

1. As regards the scope of an appeal under Section 37 of the Act, the Judgment held that an appellate court’s jurisdiction to examine an order setting aside or refusing to set aside an arbitral award in an appeal under Section 37 of the Act is more circumscribed in comparison to the court’s fairly narrow jurisdiction under Section 34 of the Act.^[3]

2. The Division Bench held that a put option is not a forward contract. The contract would come into being, if at all, at a future point in time, upon the happening of an event or contingency and the consequent exercise of the option by a party upon the occurrence of that event or contingency. As such, the put option is not prohibited under Section 16 of the SCRA read with the SEBI 2000 Notification.

3. The Division Bench further held that the contract for repurchase upon the exercise of the option is nothing other than a spot delivery contract. The original vendor being given an option to repurchase the securities by a particular date cannot lead to a conclusion that the contract contemplates such repurchase on any basis other than spot delivery. Hence, it would not attract the prohibitions under the notifications issued under Section 16 of the SCRA.

4. The Division Bench also considered whether a put option contained in the SPA would amount to making of a ‘contract in derivatives’ and attract the embargo of Section 18A of the SCRA. It held that a put option is not a ‘contract in derivatives’ and that Section 18A of the SCRA does not, by itself, make any particular contract illegal or invalid. What the law prohibits under Sections 18A and 16 of the SCRA read with the SEBI 2000 Notification is not entering into a call or a put option for sale or purchase of securities, but trading or dealing in such options treating it as a security. Only when such option is traded (not in accordance with Section 18A) would it attract the embargo of law as a ‘contract in derivatives’.

 AZB & Partners successfully represented our client, Edelweiss in relation to the validity of a put option under Indian law.

[1]   Percept Finserve (P) Ltd. v. Edelweiss Financial Services Ltd., 2023 SCC OnLine Bom 319. The Divsiion Bench of the Bombay HC comprised of Hon’ble K.R. Sriram and Hon’ble S. Patil, JJ.

[2]   Edelweiss Financial Services Ltd. v. Percept Finserve Pvt. Ltd., 2019 SCC OnLine Bom 732. This decision has been relied upon in Banyan Tree Growth Capital L.L.C. v. Axiom Cordages Ltd., 2020 SCC OnLine Bom 781, para. 84.

[3]   Relying on UHL Power Co. Ltd. v. State of Himachal Pradesh, (2022) 4 SCC 116, para. 16.