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Law minister Kapil Sibal. Photo: Mint (Mint)
Law minister Kapil Sibal. Photo: Mint

Eye on foreign investment, Sibal approves options in M&A, PE deals

Law ministry clears proposal to amend decades-old Securities Contracts (Regulations) Act and lifts restrictions

Mumbai: Indian companies can now use options to structure mergers and acquisitions, and private equity (PE) deals, with the law minister approving of a regulation on their use drafted by the Securities and Exchange Board of India (Sebi) that has been pending with the ministry since last year.

The ministry has cleared the proposal to amend the decades-old Securities Contracts (Regulations) Act, or SCRA, and lift restrictions on put and call options, with an aim to encourage foreign investments in Indian firms and clear ambiguity surrounding the Act, law minister Kapil Sibal said over the phone.

“I have cleared it. It was proposed by the Securities and Exchange Board of India, but the file was pending for several months. We checked the legality of the recommendations and approved it. The file has been sent to the finance ministry and it will be forwarded to Sebi in due course for public notification," said Sibal, who took over as law minister from Ashwani Kumar, who quit last week.

Though India’s stock market regulator has been interpreting put option as illegal in share purchase agreements under SCRA, stating that such options mimicked derivative contracts, it last year recommended the government to amend the rules in order to bring clarity and exempt share purchase agreements from restrictions on attaching put options.

A put option is the right to sell certain assets or securities at a pre-fixed price on a future date. A call option is a right to buy securities at a particular price on a future date. These options are essentially meant to provide exit rights under investment agreements. Typically, PE investments and foreign direct investments have such an exit option. The put option allows an investor the right to sell shares to the promoter of the investee company.

Allowing put and call options in share purchase agreements will encourage a number of investment deals by foreign firms in India at a time when the government is keen on attracting overseas money to narrow the fiscal deficit.

“This was long overdue. Two private shareholders entering an agreement resulting in delivery of shares cannot be taken as a speculative contract," said Somasekhar Sundaresan, a partner at J Sagar Associates, a law firm. “So, such agreements should be exempted from any prohibition on options. This will finally bring the much-needed clarity."

Though such options are typical in share purchase deals globally, Sebi has discouraged such forward contracts, especially for big-ticket share transactions and those involving listed firms.

In recent years, Sebi refused to clear several deals that had put options in their share purchase agreements. Vedanta Resources Plc’s $9.6 billion proposal to acquire a controlling stake in Cairn India Ltd was delayed for several months when Sebi questioned the two parties on a put option clause in their share agreement. More recently, a put option clause had to be removed from Diageo Plc’s share purchase agreement for the acquisition of a majority stake in Vijay Mallaya-led United Spirits Ltd before getting Sebi clearance.

“In privately held insurance firms also, agreements contain several clauses whereby share purchase at a pre-fixed price is allowed," a corporate lawyer said, requesting anonymity.

Several Indian firms have been demanding an amendment to SCRA to allow put and call options in investment agreements to provide comfort to acquirers and joint venture partners, especially the foreign ones, and allow investors, especially acquirers, to hedge their risks.

“Globally, such put and call options are allowed," Sibal said. “I find Sebi’s recommendations valid and will encourage more foreign investments in Indian firms."

In 1969, the Union government declared in a notification that contracts for the sale or purchase of securities other than “spot delivery contracts" or contracts for cash, hand delivery or special delivery in any securities as prescribed, required its prior approval.

Since spot delivery contracts are defined as those that provide for actual delivery of securities and the payment of a price for them either on the same day of the contract or the next day, it was interpreted that contracts in options (such as that in investment agreements) that were not settled on the same day or the next day would also be curtailed. In any event, section 20 of SCRA, 1956, declared all options in securities illegal.

In 1995, when Sebi was conferred powers to regulate all capital market activities, though this section was amended, and issuance and trading of options in securities were legalized, other provisions of SCRA and interpretations by Sebi continued to cause ambiguity.

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