Home » Between The Lines » Bombay High Court: A share purchase agreement containing option to sell the shares does not amount to derivative contract, thereby does not violate provisions of SCRA

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The Hon’ble Bombay High Court (“High Court”) has, by the judgment pronounced on February 2, 2023, in the matter of Percept Finserve Private Limited v. Edelweiss Financial Services Limited [Commercial Appeal (L) No.284 0f 2019 in Commercial Arbitration Petition No. 220 of 2014] (“Impugned Order”), held that a contract containing put option for securities does not amount to derivative contract and hence, not prohibited under the Securities Contracts (Regulation) Act, 1956 (“SCRA”).


Edelweiss Financial Services Limited (“Respondent”) entered into a share purchase agreement dated December 8, 2007 (“SPA”) with Percept Finserve Private Limited (“Appellant 1”) which was subsequently amended via a deed of rectification dated April 21, 2008 (“Deed”) as well as an amendment agreement dated April 23, 2008 (“Amendment Agreement”) through which 2,28,374 shares of Percept Limited (“Appellant 2”) were purchased by the Respondent from Appellant 1 for a total consideration of INR 20 Crore.

The SPA had certain conditions subsequent setout therein, first of which required Appellant 1 to require Appellant 2 to accomplish restructuring of the entire group companies by December 31, 2007 and provide proof of completion of the restructuring to the Respondent.

A dispute was raised by the Respondent on the grounds that there was a failure/negligence on the part of Appellant 1 pertaining to the completion of the restructuring of the group companies within the period stipulated in the SPA, that is, December 31, 2007, and therefore, a breach of the SPA. Owing to the breach of SPA, Respondent was entitled to resell the shares of INR 20 Crore to Appellant 1 for an amount that would yield internal rate of return of 10% of the consideration paid to Appellant 1 under the SPA.

Thereafter, the parties entered into an Amendment Agreement whereby the Respondent extended the timeline for completion of the restructuring to June 30, 2008, failing which the Respondent was entitled to the following remedies as per clause 8.5 of SPA (“Investor Rights Clause”):

“8.5. In the event of non-fulfillment of the first Condition Subsequent, the Investor shall have the right to:
8.5.1. Re-sell the Shares held by it to the Seller or its Affiliates and the Seller is bound to purchase the same, at a price which would give the Investor an internal rate of return of 10% on the Purchase Consideration; or……”

Appellant 1 failed to fulfill the conditions subsequent within the extended time period. Thereafter, the Respondent initiated arbitration proceeding and invoked the Investor Rights Clause and sought the remedies contained therein.

The sole arbitrator by an award dated June 6, 2013 rejected the Respondent’s claim on the ground that transaction (specifically the Investor Rights Clause) was illegal/ unenforceable being in breach of SCRA. This gave an option to the Respondent to demand repurchase of the shares from Appellant 1 as it constituted forward contract which is prohibited under Section 16 (Power to prohibit contracts in certain cases) of SCRA as read with the circular by Securities and Exchange Board of India (“SEBI”) dated March 1, 2000. Further, it was held that Investor Rights Clause was also illegal because it contains an option concerning future purchase of shares, thus a contract in derivatives and not being traded on a recognized stock exchange was illegal under Section 18A (Exclusion of spot delivery contracts from sections 13, 14, 15 and 17) of SCRA.

Aggrieved by the said award, Respondent filed an application under Section 34 (Application for setting aside arbitral awards) of Arbitration and Conciliation Act, 1996 (“Act”). The learned single judge overturned the arbitrator’s conclusion, stating that the aforementioned Investor Rights Clause is entirely legal and does not contravene any of the provisions of SCRA. Hence, this appeal was filed under Section 37 (Appealable orders) of the Act.


Whether the Investor Rights Clause containing option to resell the shares amounts to derivative/future contract and thereby violates the provisions of SCRA.


Submission made by the Appellants:

It was contended by the Appellants that the Investor Rights Clause being contract in derivatives attracted the rigors of Section 18A of SCRA, that is, such an option must be traded on a recognized stock exchange and settlement on the clearing house of the recognized stock exchange. Therefore, the clauses being in breach of Section 18A of SCRA were illegal and unenforceable. The option derived its value from the underlying shares of Appellant 2 and, therefore, was a derivative. A derivative in the present case, being an option attached to the shares of an unlisted public company, was not permitted, and would fall foul of the public policy under Section 18A of SCRA.

Further, the Appellants relied on SEBI notification dated October 3, 2013 issued under Section 16 of SCRA (“Notification”) which inter alia permitted contracts in shareholders agreements or articles of association of group companies, for purchase or sale of securities pursuant to the exercise of an option contained therein to buy or sell the securities, on the terms and conditions set out therein. The Notification clarifies that option contracts as in the present case, entered prior to the date of the Notification attracted the rigors of Section 18A of SCRA and hence were prohibited and contravenes the provisions of SCRA.

Contentions raised by the Respondent:

The Respondent had put forth his contention that contract in derivatives or options contract are distinct from the contract between two shareholders containing an option to buy or sell the shares owned by them. The Respondent substantiated his argument by stating that this distinction between a contract in derivatives and a contract for sale or purchase of Securities, pursuant to the exercise of an option contained in a shareholders agreement, is also apparent from the Notification, according to which the contracts in derivatives are distinct and different from a contract for sale or purchase of securities pursuant to the exercise of an option contained in a shareholders agreement.

Further, the Respondent submitted that Section 18A of SCRA deals only with contracts in derivatives, that is, options contract, which can be traded, bought, sold and settled. Therefore, Section 18A of SCRA would not be applicable to a contract existing between two shareholders containing an option for sale or purchase of their own shares.

The Respondent relied on the judgment of the High Court in the case of Banyan Tree Growth Capital L.L.C. v. Axiom Cordages Limited and Others [2020 SCC Online Bom 781] and another judgement of the Calcutta High Court in the case of EIG (Mauritius) Limited v. McNally Bharat Engineering Company Limited [2021 SCC Online Cal 2915].

Observations of the High Court

The High Court observed that a contract for sale or purchase of shares would come into being only at a future point of time. Further, as per the Investor Rights Clause, it is evident that there was no contract of sale or purchase of shares at a future date as of the day the SPA was signed. A contract that grants the buyer the right to demand that his vendor repurchase securities upon the occurrence of a certain contingency would only indicate that there was no obligation at the time the contract was signed and that the obligation only developed as a result of the occurrence of the contingency. The contract would come into being, if at all, at a future point of time, after the satisfaction of the below mentioned two conditions:

  • failure of condition subsequent attributable to Appellant 1; and
  • exercise of option by the Respondent to require repurchase of shares by Appellant 1 upon such failure.

Entering into a call or a put option for sale is not prohibited under the provisions of Section 18A of SCRA to be read with Section 16 of SCRA. However, it prohibits trading or dealing in such option by treating it as a security.

Decision of the High Court

The High Court while upholding the Impugned Order held that the contract cannot be termed as a trade or contract in derivatives if it merely contains a put in option pertaining to the securities. Therefore, having a put option concerning a security cannot be termed as illegal as per Section 18A of SCRA. The Investor Rights Clause is not contract for sale or purchase of securities, but merely an option which the promisee may exercise and further, such option does not amount to making of a contract in a derivative.

VA View:

The High Court in the instant case interpreted the term “derivative contract” by making it amply clear that each contract/agreement cannot be automatically termed as derivative contract/trade, merely because it contains a put option of securities.

It is pertinent to note that, unless such option is being traded by treating it as a “security” in contravention of Section 18A of SCRA, that is, traded otherwise than on a recognised stock exchange, the same is not in violation of SCRA.

From the above, it may be concluded that there is no bar to enter into shareholders’ agreement which merely provides an option to either of the parties to interse purchase/ sell the shares.

For any query, please write to Mr. Bomi Daruwala at [email protected]