Bombay High Court Differentiates Options from Forward Contracts

[Debayan Gangopadhyay is a 3rd year B.A., LL.B. student at ILS Law College, Pune]

An option in securities popularly known in forms such as “call” or “put” option is typically a clause in an agreement for transfer of shares through which the option holder gets the option to sell its shares to or buy additional ones from the transferor on a future date. An “option” is the right or entitlement, but not obligation, of a person to buy or sell an asset (which for our purposes comprises shares in a company).[1] Call options are clauses where the right exists in relation to buying of additional shares and put options are the ones where the option is to transfer the owned shares to a third party or back to the transferor. The put option, when exercised against the counterparty, is generally structured to be exercised when there is a breach of conditions stipulated in the agreement for purposes of return of initial investment. Thus, such option usually contains an internal rate of return (IRR) as an interest towards refund of investment.

The Bombay High Court has recently in Edelweiss Financial Services v. Percept Finserve Pvt Ltd (27 March 2019) allowed enforcing a put option clause exercised by Edelweiss Financial Services Ltd, the appellant, where the shares acquired were to be sold back to the Percept group, the respondent. The nature of such clauses and how they eventually operate are analysed in the judgment and it is held that such option clauses do not conclude that the agreements are in nature of “forward contracts”. Unlike an option contract, a forward contract does not depend upon the exercise of an option by one of the parties. It is a firm contract of sale to begin with, but involves a mere postponement of the transfer to a future date.[2] Such contracts are illegal and not permissible under laws of SEBI.

This post analyses the above judgment along with relevant securities laws. Option clauses are also governed by the Companies Act (both the 1956 and 2013 versions) and the regime overseen by the Reserve Bank of India; however, the judgment and this post are limited to the discussion of such clauses only in context of laws administered by the Securities and Exchange Board of India (SEBI).


Edelweiss entered into a share purchase agreement (SPA) in 2007 with the Percept Group. The SPA contained a put option clause which entitled Edelweiss to exercise the right to sell back the shares purchased to Percept with an IRR of 10%. This option could be exercised in event of a breach of terms and conditions stipulated in the SPA. One of such conditions was that Percept will restructure its entire group within a stipulated time frame. The condition was not met and a subsequent extension was given by Edelweiss. In 2008, after the exhaustion of the extended and amended time frame, the condition was still not met. Edelweiss therefore exercised its right of option to sell back the shares but the same was not complied with by Percept. Thereafter, Edelweiss invoked the arbitration clause in the SPA and a sole arbitrator was appointed to adjudicate the dispute. The arbitrator agreed to the fact that Percept was in breach of the conditions of the SPA, but did not allow exercising the option clause stating that the clause constitutes a forward contract which is prohibited under section 16 of the Securities Contracts (Regulation) Act, 1956 (SCRA) read with SEBI notification dated 1 March, 2000.[3] Aggrieved by the arbitrator’s order, Edelweiss challenged it before the Bombay High Court under section 34 of the Arbitration & Conciliation Act, 1996.

Relevant Laws

Section 2(d) of the SCRA defines “option in securities” as:

(d) “option in securities” means a contract for the purchase or sale of a right to buy or sell, or a right to buy and sell, securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call or a put and call in securities.

Pursuant to the above definition, an option was completely outlawed under section 20 of SCRA until 1995 when an amendment act omitted the section. Thereafter, the March 2000 notification was released by SEBI through the powers conferred upon it under section 16 of SCRA. The said notification replaced an erstwhile 1969 notification which was issued by the Central Government under the same powers. The notification, being very similar to the 1969 notification, had a significant change only in terms of the authority issuing it. Both the notifications declared that any contract of securities other than “spot delivery contracts”, subject to certain exceptions, are illegal. “Spot delivery contracts” as defined under section 2(i) of SCRA are contracts where the transfer of securities and payment of price is completed within the next day of the date of the contract. This makes a forward contract illegal as either the date of transfer or payment or both could be stipulated to occur at a future point of time.

Section 18A of SCRA states that “contracts in derivatives” are legal in certain stipulated situations such as when traded on a recognised stock exchange. Options (both put and call) are treated as a form of “derivatives”, as they derive their value from the underlying shares.[4] The arbitrator in the present case held the put option to be a contract in derivatives and consequently illegal under section 18A.

A notification issued by SEBI in October 2013 replacing the erstwhile March 2000 notification allowed pre-emption rights such as option clauses in contracts subject to certain conditions. However, this notification could not have helped Edelweiss as it was issued only in 2013 and does not have any retrospective effect.


The Bombay High Court observed the reasoning of the order by the arbitrator and contentions made by Percept. The said order agreed to the breach caused by Percept but found clauses of put option in the SPA to be illegal. The rationale given behind was that March 2000 notification read with section 16 of the SCRA declared only spot delivery contracts to be valid. It held the SPA to be in the nature of a forward contract and not that of a spot delivery because of the option clause. Further, as also contended by Percept, it was concluded by the order that, as the put option amounted to a contract in derivatives and the transaction did not fall under section 18A of the SCRA, it was illegal.

The judgment divided the issues along the sections involved. Firstly, in terms of section 16 read with the March 2000 notification, the Court observed the case of MCX Stock Exchange Ltd. v. SEBI which dealt with a purchase option clause similar to the option in the SPA. The Court observed the above judgment, distinguishing forward contracts from option clauses. It was observed that in case of forward contracts the obligation exists at the time of signing the contract, but performance is stipulated at a later point. However, the obligation under an option occurs at a later point if and when an option clause is exercised out of a future occurrence. The latter kind of contracts cannot be said to have the nature of future contracts as the contract to repurchase shares out of an option arises when such option is exercised and not before that. The Court stated:

The contract would come into being, if at all, at a future point of time, when two conditions are satisfied, namely, (i) failure of condition subsequent attributable to Respondent No. 1 and (ii) exercise by the Petitioner of its option to require repurchase of shares by Respondent No. 1 upon such failure. It is only after the Petitioner exercises such option that the contract is complete. The arbitrator has committed a clear error in reading the judgment of MCX Stock Exchange Ltd. The law stated in it is plain and clear, and having regard to it, the arbitrator’s view that the contract in the present case was a forward contract, can certainly be described as an impossible view; it is a view arrived at by practically disregarding the law stated by our Court in MCX Stock Exchange Ltd.

The Court then went on to examine the applicability of section 18A of the SCRA to the present case. Section 18A, as mentioned above, declares certain kinds of contracts in derivatives to be legal. It was contended that as the put option does not come under the ambit of this section, it is not permitted and is hence illegal. The Court, after observing the contents of the section, pointed out that it does not per se prohibit any of kind of contract but only validates the contracts given in its contents. It was held that the section does not by its own force invalidate any contract. It is not fair to assume that the types of contracts in derivatives which are not mentioned in the section should directly be considered as illegal. The Court also went on to observe that the arbitrator’s order classified the contract as a contract in derivatives merely because of the put option clause to deal with securities which, as already discussed, is not the case here. The option to re-sell the shares purchased is just an option and not a contract in itself.

The Court has also ruled that the cross objections filed by a respondent in a petition under section 34 of the Arbitration and Conciliation Act are not maintainable, since the provisions of Civil Procedure Code, 1908 are not applicable to proceedings under section 34 as the Arbitration and Conciliation Act is a code in itself and section 34 does not make any provision for filing of cross objections.


Put and call options (and their variants in terms of tag-along and drag-along rights respectively) are not merely customary in equity investment transactions, but they also form the core of the contractual arrangements between the parties. The Bombay High Court provides relief by distinguishing option clauses which are beneficial for investors from forward contracts. Exit options are essential for the flexibility of the investors and many investors prefer to have options in case circumstances the singing of an agreement change over time. Even though put option clauses are now expressly legal after SEBI’s October 2013 notification, they are subject to conditions. As the courts have differentiated option clauses from forward contracts in their very essence and nature, they should be allowed as long as the clause only gives a right and not an obligation at the time of signing of the contract. The obligation must arise when the right in terms of the option is exercised.

Debayan Gangopadhyay

[1] Norman Menachem Feder, “Deconstructing Over-The-Counter Derivatives”, 2002 Colum. Bus. L. Rev. 677, 692 (2002).

[2] Umakanth Varottil, “Investment Agreements in India: Is There an ‘Option’?”. 4 NUJS Law Review 467 (2011).

[3] Securities and Exchange Board of India, Notification No. S.O. 184(E) (March 1, 2000)

[4] John D. Finnerty & Kishlaya Pathak, “A Review of Recent Derivatives Litigation”, 16 Fordham J. Corp. & Fin. L. 73, 79 (2011).


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