Option Contracts

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Subject – Company law 1 Option Contracts -An analysis of position in India Background Put and call options are one of the preferred mechanisms for investors in India, both foreign and domestic, and in different type of transactions like joint venture, stock market, etc. In lay man’s term a put option enjoyed by A against B gives A an option to sell certain securities at a future date at some specified price. Whereas a call option enjoyed by A against B gives A an option to compel B to sell the specified securities at a specified date and for a specified price.

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These options are founded in commercial practicalities. In some cases the promoter has call options by which he can buy out the investors. The investment carries certain pre emptive rights as well like Right to First Refusal, Drag Along Rights, etc. This is a standard that is practiced internationally, even in India though not expressly. The recent changes by regularity authorities like RBI, SEBI and Judiciary has made the position of investors very turbulent in India. Section 2(d) of the Securities Contract (Regulation) Act, 1956 defines “options in securities” as a purchase or sell of a right to buy or sell securities in the future. The judiciary has upheld that options are not obligation but a right. Section 20 of the Securities Contract (Regulation) Act, 1956 (SCRA) had prohibited options upon securities. A 1995 amendment[1] had deleted the concerned provision, but still the air of ambiguity regarding option contracts wasn’t clear as a March 1, 2000 circular of SEBI[2] had prohibited the use of option contracts. If both the amendment and circular is read together it is logically deducible that option contracts are only valid till they are (a) spot delivery contracts; (b) hand delivery; (c) contracts for cash; (d) special delivery and (e) contracts for derivatives permissible under the SCRA or the SEBI 1992 rules.[3] Since the Amendment is still in force along with the circular by SEBI in 2000 that clarified it’s position related to prohibition on option contracts, there exists an contradiction between the 1995 amendment of SCRA and 2000 circular of SEBI. CURRENT SITUATION The SEBI by a recent 2013[4] circular has agreed to include clauses related to pre emptive rights, right of first offer, tag-along right, drag-along right and call and put options, when contained in shareholders’ agreements, as valid contracts, for the purpose of the SCRA. Some judicial decisions that lead to the strategic acceptance of option contracts by SEBI has been enumerated below : In 2005 the Bombay High Court[5] dealing with the buy-back clause in a share agreement held that such a contract would not be valid under SCRA as it is not a spot delivery contract. In 2011, SEBI issued an informal guidance[6] that an agreed purchase of shares of a listed company through call or put options of a listed company is invalid,

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