In Indian corporate transactions, especially involving private equity or venture capital investments, put option clauses have gained prominence as strategic tools that provide investors with defined exit rights. A put option allows a shareholder to sell their shares to a designated party—often promoters or the company—at a pre-determined price, irrespective of market conditions. While these clauses are common in shareholders’ agreements (SHAs), their enforceability under Indian law has historically been debated. In this article, we examine the legal framework surrounding such clauses and provide practical insights on their enforcement under Indian company and securities law.
This discussion is especially relevant to businesses and legal professionals across India, particularly in financial and corporate hubs like Ahmedabad. As leading corporate law firms in Ahmedabad increasingly deal with cross-border investments, joint ventures, and foreign exits, clarity on put option enforceability has become critical.
What Is a Put Option Clause?
A put option clause in a shareholders’ agreement grants the investor (the “option holder”) the right, but not the obligation, to sell a certain number of shares to a specified party at a predefined price, usually within a defined time period. This exit mechanism is often triggered by the failure of a company to meet financial or strategic milestones, or at the end of a lock-in period.
These clauses are especially vital for private equity investors who are investing in unlisted companies, as the lack of a vibrant secondary market makes traditional exits like IPOs or third-party sales uncertain or delayed.
Early Legal Roadblocks: SCRA and SEBI Restrictions
Historically, put option clauses faced legal challenges due to restrictions imposed by the Securities Contracts (Regulation) Act, 1956 (SCRA) and SEBI notifications. In 1969, a SEBI notification rendered all forward contracts in securities illegal unless they were spot delivery contracts or executed on a recognized stock exchange.
Though this notification was repealed in 2000, SEBI reimposed similar restrictions through another notification on 1st March 2000, again restricting contracts other than spot delivery unless executed in permitted derivatives. Consequently, put options—which involve future sales at pre-agreed prices—were often treated as prohibited forward contracts. Further, SEBI’s 2011 informal guidance reinforced this interpretation by stating that such clauses fell outside the scope of spot delivery contracts and were, therefore, void.
The Turning Point: SEBI’s 2013 Notification
A much-needed clarification arrived via SEBI’s 3rd October 2013 notification. This superseded prior guidance and provided a framework under which put options could be valid. The key conditions included:
- The securities must have been held by the seller for at least one year.
- The price or consideration must be in compliance with applicable laws.
- The transaction must be settled via actual delivery of the securities.
If these three conditions are satisfied, a put option clause is no longer considered speculative or a forward contract and is thus enforceable.
Many top law firms in Ahmedabad and across India have since advised clients to structure put options in line with the 2013 notification, thereby reducing legal risk and regulatory uncertainty.
Judicial Validation: Edelweiss v. Percept
In Edelweiss Financial Services Ltd. v. Percept Finserv Pvt. Ltd., the Bombay High Court validated the enforceability of put options that complied with the 2013 SEBI notification. The court ruled that:
Put options are not inherently speculative and are not prohibited forward contracts under the SCRA.
Section 18-A of the SCRA, which governs derivatives, does not apply to privately negotiated contracts unless such contracts are traded on a recognized stock exchange.
This decision is particularly relevant for companies headquartered or operating in Maharashtra. However, unless overruled by the Supreme Court, it provides strong persuasive value PAN India, including in regions like Gujarat where legal firms in Ahmedabad routinely handle such corporate contracts.
Considerations for Non-Resident Investors
When a non-resident investor is granted a put option, additional compliance is required under the Foreign Exchange Management Act (FEMA) and RBI guidelines. Earlier, the Reserve Bank of India (RBI) had disallowed assured return instruments to non-residents, interpreting them as debt-like instruments. However, this stance was relaxed through RBI circulars in January and July 2014, which permitted put options for non-residents provided:
- The option does not guarantee an assured exit or fixed return.
- The sale price is in line with valuation norms set out under FEMA regulations.
Thus, when a company or promoter grants a put option to a foreign investor, international law firms in India and experienced law firms in Ahmedabad must ensure the agreement is FEMA-compliant to prevent regulatory hurdles.
Put Options Against the Company: A Special Concern
Occasionally, shareholders may draft put options exercisable not just against other shareholders but against the company itself, effectively making it a buyback obligation. This raises additional complexities:
- Under the Companies Act, 2013, any buyback must comply with sections relating to solvency, permissible limits, and shareholder approvals.
- FEMA restrictions may further apply if the selling shareholder is a non-resident.
Failure to comply with these requirements could render the clause unenforceable. It is crucial that corporate law firms in India, including specialized NCLT lawyers in Ahmedabad, ensure proper structuring and statutory compliance.
Drafting Tips and Recommendations
Clarity of Terms: Define the trigger events, pricing formula, timeframe, and counterparty clearly to avoid ambiguity.
Regulatory Review: Ensure compliance with SEBI, FEMA, Companies Act, and FDI policies—especially when dealing with foreign parties.
Governing Law and Arbitration: Specify jurisdiction and dispute resolution clauses. Engaging an arbitration lawyer in Ahmedabad or PAN India helps enforce such rights smoothly in case of default.
Valuation Standards: Align the exit price mechanism with the fair market value guidelines of RBI to avoid being labeled as an assured return.
Well-drafted agreements, especially when vetted by best law firms in Ahmedabad or corporate law firms in India, provide enforceable protection to investors and reduce litigation risk.
Conclusion
Put option clauses have evolved from being controversial instruments to enforceable rights, provided they are structured correctly and comply with regulatory standards. The legal landscape today supports such investor protections—making them viable and increasingly accepted mechanisms in shareholders’ agreements.
As corporate India continues to attract both domestic and foreign investment, businesses, promoters, and legal advisors must stay abreast of legal developments in this area. Trusted law firms in Ahmedabad and across India play a vital role in helping clients navigate these complexities with foresight and legal precision.
For detailed legal guidance, R&D Law Chambers offers specialized advice tailored to transaction structuring, regulatory compliance, and dispute resolution involving shareholder arrangements.
*The content of this article is intended to provide general information. No reader or user should act or refrain from acting on the basis of the information written above without first seeking legal advice from a qualified law practitioner.