INTRODUCTION:

A shareholder's put option is a contractual right, but not a duty, to sell their shares at a certain
price upon the occurrence of a predetermined event. If a shareholder has a put option, they
may sell their shares back to the firm at a certain price in the future (either a predetermined
amount or an amount based on a formula) and at a certain period (before or after the option
expires). Take two fictitious people, Shareholder 1 & Shareholder 2, who are the company's
stockholders. Shareholder 1 puts in $10,000, whereas Shareholder 2 puts in $15,000.

Stockholder 1 wishes to stay a shareholder if and only if the firm reaches a specified revenue
goal within five years; else, Stockholder 1 wants to sell their shares and leave the company.
Shareholder 1 has the opportunity to demand that the firm repurchase their shares at a certain
price or according to a set formula, as outlined in the put option provision of the shareholders'
agreement covering those shares.

Let's pretend A and B are the only owners of a newly formed joint venture corporation.
Anxious that B may breach the shareholders' agreement and be unable to remedy the
situation, shareholder A expresses this worry to the board. A shareholder agreement may
include a put option provision whereby A may sell its shares to B & withdraw from the firm
in the event of a default, therefore mitigating A's loss exposure. When a default occurs, A
may force B to buy A's shares at a predetermined price, and B can remain a part of the
business.

Put options in a shareholders' agreement are a useful instrument for limiting shareholders'
exposure to loss and giving them a simple way to get their money out of the company. To be
efficient, a put option must precisely declare whether or not the shareholder has the rights to
sell shares, identify the number or proportion of shares that really are subject to the put
option, and comply with all relevant state and federal legislation.

REGULATIONS AND THE JUDICIAIL PRECEDENT:

Put options have grown ubiquitous across the world, but in India they have run against a
number of regulatory roadblocks. Put options were formerly banned in India, but since early
2013 a combination of legislative reforms and favourable court interpretation has made their
enforcement much simpler.
In a notice published on October 3, 2013, SEBI nullified the SEBI 2000 Notification & also
included option contracts under the purview of the SCRA, therefore expanding the scope of
authorised transactions under the Act. Incorporating option contracts into shareholders
agreements for the purpose of purchasing or selling stocks & AOA of companies/body
corporates was permitted by the SEBI 2013 Notification, provided that the following
conditions were met:1

1. After engaging into this agreement, the seller must have legal title & ownership to the
underlying securities for at least one year.
2. Any amount paid for the purpose of purchasing or selling stocks upon exercising of
any option included therein must be in accordance with all relevant laws and
regulations in effect at the time of such sale or purchase; and
3. The contract must be settled by the physical transfer of the underlying securities. In
addition, "FEMA"2 as well as its implementing regulations must be followed for these
transactions to be valid.

When reading § 18A of Act3 in conjunction with § 23(1)(d), that allows for "contracts in
derivatives," option contracts are explicitly excluded from the scope of contracts in
derivatives, as noted in the SEBI 2013 Notification. If a derivative contract (I) is transacted
on a renowned stocks market or (II) if it is settled on the repository of a well-known stock
exchange and if it complies with the rules and by-laws of these kind of stock market, then the
agreement is legitimate and valid according to § 18A of the Act, which states that such
contracts are lawful and valid.4

In one instance, the Bombay High Court5 maintained the judgement made in the MCX Stock
Exchange verdict,6 “which found that a put option provision in a contract entered into before
to 2013 did not come under the jurisdiction of a "forward contract" under the SCRA since
option contracts, unlike forward contracts, were fulfilled on a spot delivery basis on the date
they came into existence. The Bombay High Court found that the fact that promoter was
allowed time to buy the shares following the exercise of put option did not, in and of itself,

1
Notification No. LAD-NRO/GN/2013-14/26/6667 dated October 3, 2013.
2
The Foreign Exchange & Management Act of 1999.
3
The Securities Contracts (Regulation) Act, 1956.
4
The Securities Contracts (Regulation) Act, 1956.
5
Edelweiss Financial Services Limited v. Percept Finserve Private Limited, Arbitration Petition No. 220 of 2014
decided on 27 March 2019.
6
2012(114) Bom LR 1002.
render it a forward contract since there was no evidence to establish that there was any lag
time between delivery and payment of the shares”.

Because section 18A of the SCRA regulates trading and dealing in options as a security rather
than engaging into a put option per se, the Bombay High Court looked into "whether
contracts with put option provisions were in the form of a 'contract in derivatives' and found
that they could be traded legally within that section". It was decided that the mere presence of
a put option in connection to stocks was insufficient to classify a transaction as a derivatives
contract.

The Delhi High Court recently rendered a ruling in a case 7 where overseas investors were
awarded damages for the violation of a SHA that included a put option that would have netted
them a 19% return after taxes. One of the main arguments against the award was that it gave a
non-resident investor a guaranteed exit price in violation of RBI 2014 Circulars by acting as
an indirect enforcement of the put option. However, the Delhi High Court disregarded this
claim, ruling that the non-state investor's damages judgement U/S 73 of the Act 8 did not go
against the RBI 2014 Circulars.

In cases where a foreign corporation is claiming breach of contract, the Delhi HC has stated
unequivocally that the "RBI 2014 Circulars" is not permitted to apply. Investors have a right
to their remedies, including monetary damages, if they put their money into a company based
on false promises.9 And the Delhi High Court went into more detail about "Unitech cannot
avoid its responsibility to Cruz City even if it is assumed that the Keepwell Agreement were
created to entice Cruz City to make investment by promising certain profits. The Award must
be enforced since Cruz City had already invested in Kerrush based on Unitech's
representations, even though Unitech may be subject to legal action for violating FEMA." As
a direct result of this, the court affirmed the judgement that awarded Cruz City I Mauritius
Holding damages that were equivalent to the reciprocation specified in the ‘Put option’
section of the partie’s contract.

ADVICE:

7
Shakti Nath v. Alpha Tiger Cyprus Investments No.3 Limited, (2017) SCC OnLine Del 6894 (SJ).
8
The Indian Contract Act, 1872.
9
Cruz City I Mauritius Holdings v. Unitech Limited, (2017) 239 DLT 649.
Thus, Piguet Equity Pvt Ltd, ("Investor") may approach Blues Pvt Ltd, ("Company") for the
Put option provision in the SHA, and it is cleared from the mentioned before examples that
the current court trend has elaborated the fundamental transformation in the government's
trade regulatory structure, and the fact that the formerly existed approach has now converted
to a more liberal approach. For a long time, Indian investors have been concerned about the
legality of their put options. Changes implemented by Indian authorities since 2013 have been
a huge relief for both international and domestic companies.

However, put options must be properly structured within investment agreements &
shareholders agreements to guarantee compliance with all regulations.

The following is a summary of the guidelines for writing a put option clause in the most
secure way: The put option provision only needs to make sure the contract is a spot delivery
contract at the time performance is due if all parties are locals. The purchase price cannot be
more than the property's fair market value if the Option Holder is a foreign national. The
contract should also have a lock-in term of at least 1 (one) year.

A "strategic sale provision" could be attached to a put option clause if the Option Writer is
required to sell the securities subject to the put option if the put option cannot be executed for
any reason, including the failure of the Option Writer to obtain regulatory permission, in
order to satisfy a non-resident Option Holder's desire to "sell at an agreed-upon price
regardless of the fair market value of the assets at the time of implementation of the put
option clause". If Tata Sons breaches the put option clause or the strategic sale condition, the
Option Holder may sue for damages under the Delhi High Court's decision.10

10
NTT Docomo Inc. v. Tata Sons Limited, O.M.P.(EFA)(COMM.) 7/2016 and IAs 14897/2016, 2585/2017,
decided on April 28, 2017.