SPA Which Gives Option To Resell Shares To Vendor, Not A ‘Forward Contract’: Bombay High Court

The bench of Justices K. R. Shriram and Rajesh S. Patil, were dealing with an arbitral award, where the Arbitral Tribunal had ruled that the option contained in the SPA was unenforceable since it constituted a contract in derivatives which was not traded on a stock exchange, the same being illegal under Section 18A of the Securities Contracts (Regulation) Act, 1956 (SCRA).

Upholding the order of the Single Judge where it had set aside the arbitral award, the Division Bench held that merely because the contract contains a “put option” in respect of securities, the contract cannot be termed as a trade or contract in derivatives. Thus, the Court held that the option contemplated under the SPA was not prohibited in law.

“Call option” gives the buyer a right to buy, and a “put option” gives him a right to sell, in both cases without an obligation, the underlying asset at a given price on or before a given date. Forward contract is a contract between two parties to buy or sell an asset at a specified price on a future date.

Under a Share Purchase Agreement (SPA) executed between the parties, the respondent, Edelweiss Financial Services Ltd, purchased certain shares of Percept Limited (appellant no. 2) held by Percept Finserve (appellant no. 1).

As per the SPA, the appellants were required to complete the restructuring of the entire Percept group. Alleging that Percept failed to complete the restructuring within the stipulated period, Edelweiss claimed that it was entitled to resell the shares of Percept Ltd, and exit the investment. It argued that as per the SPA, as amended by the Amendment Agreement, Percept Finserve was bound to repurchase the shares from Edelweiss at a particular price.

Consequently, Edelweiss commenced arbitration proceedings against the appellants.

While concluding that the appellants had breached their obligations under the SPA, the Sole Arbitrator rejected Edelweiss’s claim on the ground that the relevant clauses of the SPA were unenforceable since they were in breach of the Securities Contracts (Regulation) Act, 1956 (SCRA).

The Arbitrator opined that SPA, which gave an option to Edelweiss to demand repurchase of its shareholding in Percept, was illegal because it constituted a forward contract, which is prohibited under Section 16 of the SCRA read with the Circular, dated 01.03.2000, issued by SEBI.

The Arbitrator further held that the option concerning the future purchase of shares, was a “call option”. Since the same constituted a contract in derivatives which was not traded on a stock exchange, it was illegal under Section 18A of SCRA, the Arbitrator ruled.

Against the award of the Arbitral Tribunal, the respondent, Edelweiss, filed an application under Section 34 of the Arbitration and Conciliation Act, 1996 (A&C Act) before the Bombay High Court.

Reversing the findings of the Arbitrator, the Single Judge held that the relevant clauses of the SPA were perfectly legal and they did not constitute a contract in derivatives which is prohibited by Section 18A of SCRA.

The Court further ruled that the Arbitrator’s views that the repurchase option contained in the SPA was a forward contract and thus, illegal and unenforceable, was an incorrect view. The Single Judge thus set aside the Award.

Challenging the order of the Single Judge, the appellant, Percept, filed an appeal before the Division Bench of the Bombay High Court.

The Division Bench held that the relevant clauses of the SPA did not contemplate a contract for sale or purchase of shares at a future date. Referring to the relevant clauses of the SPA, the Court took note that a contract for repurchase of shares would come into being in the future, only when the conditions specified in the SPA were satisfied, and only when the respondent, Edelweiss, chose to exercise the said option on the occurrence of a stipulated contingency.

While holding that, on the date when the SPA was entered into, there was no contract for resale or repurchase of shares, the Court reckoned, “The contract would come into being, if at all, at a future point of time, when two conditions are satisfied, viz., (i) failure of condition subsequent attributable to appellant no.1 and (ii) exercise by Edelweiss of its option to require repurchase of shares by appellant no.1 upon such failure. It is only after Edelweiss exercises such option that the contract is complete.”

Referring to the decision of the Supreme Court in MCX Stock Exchange Ltd. vs. SEBI (2012), the bench observed, “As held in MCX (Supra), a contract giving an option to a purchaser to require repurchase of securities by his vendor on some contingency occurring would only mean that there was no present obligation at all but the obligation arose by reason of some contingency occurring.”

The appellant, Percept Finserve, argued that since the clauses in the SPA contain a “put option”, they amounted to a contract in derivatives, and thus they were unenforceable.

The bench held that Section 18A read with Section 16 of SCRA, and the SEBI Circular dated 01.03.2000, do not prohibit entering into a call or a put option for sale. The said provisions only prohibit trading or dealing in such options by treating it as a security, the Court ruled.

“Merely because the contract contains a put option in respect of securities, the contract cannot be termed as a trade or contract in derivatives. Simply making a put option concerning a security cannot be termed as illegal and that too under the provisions of Section 18A of SCRA,” the Court said.

The Court thus concluded that the relevant clauses of SPA are not contract for sale or purchase of securities, but they are merely an option which the promisee (Edelweiss) may or may not exercise. “Entering into such option does not amount to making of a contract in a derivative”, the Court said, while adding that such a contract was never prohibited under the law.

The Court thus dismissed the appeal imposing a cost of Rs. 5 Lakhs on the appellants.

Case Title: Percept Finserve Pvt Ltd & Anr. versus Edelweiss Financial Services Ltd

Citation: 2023 LiveLaw (Bom) 83

Dated: 01.02.2023

Counsel for the Appellants: Mr. Aditya Pimple a/w. Mr. Deepak Deshmukh and Ms. Nisha Kaba i/b. Naik Naik and Co.

Counsel for the Respondent: Mr. Karl Tamboly a/w. Ms. Priyanka Shetty, Mr. Harshit Jaiswal and Mr. Aditya Singh Chauhan i/b. AZB and Partners

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