Bombay High Court Reiterates Distinction Between Forward Contracts and Options in Securities

The distinction between a forward contract for sale and purchase of securities in a company on the one hand and the creation of an option in relation to such securities on the other hand bears considerable relevance when it comes to their enforceability. While the Securities Contracts (Regulations) Act, 1956 (SCRA) and various notifications issued therein by the Central Government as well as the Securities and Exchange Board of India (SEBI) proscribed forward contracts, they had (at least implicitly) been somewhat lenient towards options, although the erstwhile legal position had been somewhat fragmented and ambiguous. It is only in 2013 that SEBI clarified matters and shone the green light to options contained in shareholders’ agreements or articles of association of companies.

Forward Contract or Option? Relevance of the Distinction

I had the opportunity to analyze the pre-2013 legal position in the following excerpts from an article published in the NUJS Law Review in 2011:

Forward contracts are firm arrangements for purchase and sale of securities at a future date at a predetermined price. In such contracts, the seller is bound to sell and the purchaser is bound to purchase, with the only condition being the lapse of time. Neither party is entitled to make any decision whether to perform the contract (or not), and hence a “contract for the purchase and sale of securities” can be said to have come into existence at the time of execution of the contract itself. On the other hand, an option is a different type of contract. An option only provides an entitlement to purchase or sell securities. An option holder may either exercise the option, or allow it to lapse, depending on the circumstances. A firm contract for purchase and sale, which creates a legally binding purchase and sale obligation, arises only when the option is exercised in accordance with the terms of the contract. The obligation to purchase and sell comes into existence upon the occurrence of a contingency, which is the exercise of the option; an option can at best be a contingent contract. Hence, in this case, a “contract for the purchase and sale of securities” can be said to come into existence only upon the exercise of the option, and not prior to that when the option contract itself is entered into. So long as the transfer is com­pleted (through actual delivery of securities and payment of price) either on the day the option is exercised or the following day, it should qualify as a “spot delivery contract”, and therefore permissible within §16 of the SCRA and the SEBI notification. According to this analysis, a forward contract will fall within the proscription of §16 of the SCRA and the SEBI notification, while an option should stay outside their scope.” [footnotes omitted]

This same issue involving a pre-2013 scenario came up in a decision of the division bench of the Bombay High Court in Percept Finserve Private Limited v. Edelweiss Financial Services Limited (2 February 2023). Under a share purchase agreement dated 8 December 2007 (SPA), Edelweiss purchased shares held by Percept Finserve in Percept Limited. The bone of contention related to the following clauses in the SPA:

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 share 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

8.5.2.   Continue as a Shareholder of the Company, subject to the following undertaking from the Seller: xxxxxxxxxxxxxxxxxx

Effectively, the aforesaid clauses were put in place to ensure that Percept Finserve performed certain conditions subsequent that were imposed on it in the SPA. The failure on the part of Percept Finserve would give Edelweiss two options, either to (i) sell the shares it purchased back to Percept Finserve at an internal rate of return of 10%, or (ii) to retain the shareholding in the company. If Edelweiss exercised the first option, it would create a binding obligation on Percept Finserve to purchase those shares at the agreed price.

On the facts, since Percept Finserve failed to satisfy the conditions subsequent in the SPA, Edelweiss exercised the option to require a purchase of the shares in accordance with clause 8.5.1 above. Upon its Percept Finserve’s failure to purchase the shares, Edelweiss invoked arbitration before a sole arbitrator who rejected Edelweiss’s claim on the ground that the clause was illegal and unenforceable, being in breach of the SCRA. Edelweiss challenged the award before a single judge of the Bombay High Court who found that clauses 8.5 and 8.5.1 were perfectly legal and that there was no prohibition on the exercise of the option by Edelweiss. It is against this order that Percept Finserve preferred an appeal to a division bench of the same Court.

The division bench expressed complete agreement with the views of the single judge in holding that the option contained in clauses 8.5 and 8.5.1 are legal and enforceable. The Court placed reliance on a previous discussion in MCX Stock Exchange v. SEBI, which recognized the distinction between an option (which was permitted) and a forward contract (which was prohibited). MCX too related to an option available to a purchaser of securities to require the vendor thereof to repurchase the securities upon the happening of a contingency. Hence, there was no present obligation in this case on Percept Finserve to purchase the shares from Edelweiss, which obligation arose only upon a contingency which, in this case, was non-compliance with the conditions subsequent. The contract for a sale and purchase of securities would come into effect only after two conditions are satisfied, namely (i) that Percept Finserve has failed to satisfy the conditions subsequent in the SPA, and (ii) Edelweiss has chosen to exercise its option to require Percept Finserve to purchase its shares at a 10% internal rate of return. Hence, it is clear that the distinction between a forward contact and option struck at the heart of whether the relevant clauses were enforceable or not.

Status of Options Under Section 18A, SCRA

Another question that came up before the Bombay High Court was whether the options contained in the SPA were contrary to section 18A of the SCRA. In the NUJS Law Review article referred to above, I had a chance to elaborate on the implications of options under this provision:

SEBI has sought to outlaw options on the ground that they contra­vene §18A of the SCRA, which provides that derivatives are valid only if they are entered into on stock exchanges. The argument proceeds on the basis that since options in customary investment agreements are exclusively entered into between the parties (on an “over-the-counter” basis) without trading or settle­ment on the stock exchange, they violate §18A.

This approach, however, is not consistent with the overall frame­work of the SCRA. At the outset, the legislative intention behind the inclusion of §18A is clear: it was intended only to overcome the challenge that derivatives (such as options in securities) may constitute wager.  It has no impact on the enforceability or otherwise of derivatives in general and options in particular.

Furthermore, the question of wager and therefore the relevance of §18A do not arise in the case of physically settled options, the type that is the subject matter of this paper. In such a physically settled option, one party agrees to grant to the other party an option (put or call) over securities. It only involves the creation of an option. §18A on the other hand deals with trading in derivatives (which presumably includes options). At most, the relevance of §18A can arise when an option holder seeks to sell the option (as opposed to the underlying shares) to another party. In such a case, the subject matter of the sale would be the option (namely the right to buy or sell shares) and not the shares themselves. Since physically settled options in customary investment contracts involve the creation of options, and not trading in options, there is no bar against such contracts being entered into and implemented outside the stock exchange. This fine jurisprudential distinction has not received the attention it deserves.” [footnotes omitted]

In the case in discussion, the distinction between creation of an option and trading in an option did receive attention, where the conclusion of the Court follows the similar reasoning discussed above. The Court notes that “[s]imply making a put option concerning a security cannot be termed illegal and that too under the provisions of Section 18 of SCRA” [paragraph 20], as such a contract does not amount to a derivative and was never prohibited. For this reason too, the validity of clauses 8.5 and 8.5.1 cannot be impugned.


The Court in Percept Finserve was concerned with an important issue on corporate and securities law jurisprudence relating to the distinction between a forward contract and option. This distinction has significant implications on the enforceability of specific clauses in contractual arrangements such as share purchase agreements and shareholders’ agreements. While the case relates to the pre-2013 position, and the SEBI notification in that year clears the air as to options in several types of commercial transactions, the distinction becomes nevertheless crucial to ensure certainty and clarity of implementation of the provisions of the SCRA. To that extent, the Bombay High Court’s ruling performs the role of settling any controversy by reemphasizing the required conceptual clarity on concepts such as forward contracts and options in securities.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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