SEBI, on 3 October, 2013, by a notification under Sections 16 and 28 of the Securities Contracts (Regulation) Act, 1956, removed the uncertainty over forwards and options contracts in securities. It rescinded a previous SEBI notification dated March 1, 2000, which banned all forwards and options in securities, barring a few exceptions such as spot delivery contracts, contracts traded on exchange, certain pre-emption rights, warrants and convertibles and securities of private limited companies. Although this notification applies prospectively, it brings a cheer to several domestic and foreign private equity and early-stage venture capital investors who were apprehensive about bringing money to India.
The 2000 circular while intending to ban certain kinds of speculative trades ended up with the unintended consequence of banning clauses of pre-emption rights and contracts for preemption, rights of first refusal, or tagalong and drag-along rights contained in shareholders agreements. These would now be valid and enforceable. To validate such clauses in shareholders’ agreements or articles of association of companies SEBI has prescribed three pre-requisites: a) The title and ownership of the underlying securities is held continuously by the selling party for a year; b) the price or consideration must be determined in compliance with all laws, and c) there must be actual delivery of the underlying securities for the settlement of the contract. Subject to the fulfilment of these three conditions, such contracts would be valid and enforceable.
However, there is some ambiguity regarding the applicability of the new law to securities of public unlisted companies. The judiciary has hitherto interpreted the prohibition broadly and thus options even in unlisted shares of a public company have been considered invalid. Extending the prohibition to unlisted securities does not serve any purpose. It would have been a progressive move to restrict the prohibition to only listed securities where there is any public shareholder concern.
Further, prospective operation means that past agreements would still face the challenge of the old and perverse law. Such investors would probably aim to repeal their old agreements and sign new identical ones to protect themselves. This should, ideally have been avoided, as all investors ought to have been allowed the protection of the new law.