Options Contract: The Spot Delivery Dilemma

INTRODUCTION:

Options contracts have become a common practice where the option holder has the right to buy the underlying shares of the selling shareholder. Previously, regulatory bodies such as the Securities and Exchange Board of India (“SEBI”) and the Courts considered put/call options as impermissible as they were considered to be contracts in derivative which is in violation of section 18A of the Securities Contracts Regulation Act, 1956 (“SCRA”). However, through subsequent rulings and clarifications issued by SEBI, a transaction involving a put/call option is not considered a contract in derivative, [1] although it may be exercised on a spot delivery basis. But there could be instances where the put/call option involves acquisition of more than 25% of the total shareholding in a listed entity which would in turn attract the obligations under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Code”) which prescribes for a mandatory open offer. If so, wouldn't this make it impractical to adhere to the spot delivery obligations under the SCRA?

BACKGROUND AND ANALYSIS:

In 2013, in light of the MCX Judgment, SEBI expanded the range of acceptable contracts within the SCRA, explicitly recognizing option contracts as permissible through the SEBI 2013 Circular [2] (“Circular”). Hence upon a close reading of the SCRA read with the Circular, it is apparent that the transfer of shares through a put/call option is restricted to spot delivery contracts amongst other legal modes of transfer.

Spot Delivery Contract:

The SCRA defines a ‘Spot Delivery Contract’ as a contract, where the delivery of securities and the payment of consideration is done within the same day or the next day. [3] It is evident from this definition that to engage in such a contract, the seller must affect an actual delivery of the securities, and the buyer must make the payment either on the same day or the next day [4] .

Open Offer:

Regulation 3 of the Takeover Code prescribes that if an acquirer along with the persons acting in concert acquires shares in the target company which entitles them to exercise twenty-five per cent (25%) or more of the voting rights in such target company, then the acquirer must initiate an open offer.

The Conflict:

Regulation 22 of the Takeover Code states that the acquirer is prohibited from completing the acquisition of shares until the conclusion of the offer period which usually lasts for more than a week. If a call option grants the option holder the right to acquire a substantial 30% shareholding in a listed entity, this goes beyond the Takeover code threshold of 25%, which mandates the issuance of an open offer and simultaneously, there arises a concern regarding compliance with the SCRA for a spot delivery contract, where the exchange of shares and consideration must occur on the same day or the following day.

WHAT THEN?

Given the circumstances, the option holder finds himself in a challenging situation where despite his bona-fide intent to fulfil the obligations under the Takeover code, he unwittingly violates the provisions outlined in the SCRA. This predicament highlights a scenario where compliance with one set of regulations results in the contravention of another. It is apparent that SEBI did not intend for such a conflict to arise, and the delay incurred in meeting the obligations under the takeover code, may be treated as an exception and no penalty may be imposed as a consequence of non-compliance with SCRA. Although there is no official clarity provided by SEBI on this.

CONCLUSION AND WAY FORWARD

It is to be seen whether the facts of the current situation warrants a penalty. Whether the option holder acted deliberately in violation of the law or in conscious disregard of its obligation under the SCRA or the Takeover Code (as the case may be) is the relevant fact to be considered before imposition of a penalty. [5] The parties could approach the SEBI through the informal guidance under the SEBI (Informal Guidance) scheme, 2011 to clarify the position but the challenge remains since the informal guidance by SEBI is not binding [6] . However, a Circular issued by the SEBI which is binding under the law may help resolve the conflict and spare the contracting parties from consequences of unintended violation of the law.

References:

[1] MCX Stock Exchange Ltd v. SEBI, (2012) 108 CLA 258
[2] Notification No. LAD-NRO/GN/2013-14/26/6667 dated October 3, 2013
[3] Section 2(i) of the Securities Contract Regulation Act, 1956
[4] Securities Exchange Board of India vs M/S Opee Stock-Link Ltd, 2016 SCC OnLine SC
687
[5] Samrat Holdings Limited vs the Adjudicating Officer 2001 SCC OnLine SAT
[6] Rule 12 and Rule 13 of the Securities and Exchange Board of India (Informal Guidance)
Scheme, 2003