A "put option" is a clause included in a contract that gives one party the right but not the obligation to sell their shares to a third party for a predetermined sum. The Indian Foreign Exchange Regime entails certain prohibitions on the inclusion of a put options in a contract concerning a transaction for the sale/issue of specific securities by an Indian Company/resident to a non-resident investor.      

The law relating to foreign exchange is provided for in the Foreign Exchange and Management Act, 1999 (“Act”) along with the Foreign Exchange Management (Non-Debt) Rules, 2019 Rules (“Rules”). The Act and Rules lay down the law for facilitating trade and payments.

Rule 5 of the Rules provides the following:

“A person resident outside India holding equity instruments of an Indian company containing an optionality clause in accordance with these rules and exercising the option or right may exit without any assured return, subject to the pricing guidelines prescribed in these rules and a minimum lock-in period of one year or minimum lock-in period as prescribed in these rules, whichever is higher.”

The relevant pricing guideline is as under:      

“Rule 21(c)(iii) Explanation - The guiding principle shall be that the person resident outside India is not guaranteed any assured exit price at the time of making such investment or agreement and shall exit at the price prevailing at the time of exit.”

According to the pricing guidelines, the transfer of shares of an unlisted company from a person residing outside of India to a person residing in India must be at a price that does not exceed the capital instrument's value as determined by any internationally recognized pricing methodology for valuation on an arms-length basis and duly attested by a chartered accountant, a Securities and Exchange Board of India registered merchant banker or a practicing cost accountant.

The aforesaid provisions under the foreign exchange management regime of India specifically prohibit the inclusion of a put option clause in an investment agreement where a foreign investor invests in an Indian company. This provision enables the investor to seek a sum of money from the company on account of the occurrence of certain events. Nevertheless, most transactional documents executed between the parties include a put options clause providing an exit to the investor on the account of certain events at a price higher than the prevailing price. This has been done so that the transaction does not guarantee an assured exit return on its investment and should rely upon the fair market value prevailing at the time of exit.

Regarding the enforceability of these put options, numerous international arbitration tribunals have upheld the validity of put option clauses in agreements between the involved parties.

The Supreme Court of India, along with various High Courts, have consistently been presented with opportunities to assess and make rulings on such matters whenever the aforementioned awards have been contested before them.

An arbitral award that accepted the application of a put option was challenged before the Supreme Court on the grounds of being against the fundamental policy of Indian Law. The Supreme Court analyzed the facts in hand and held that a mere violation of any provision of law cannot be understood to be covered under this ground for challenging the award under Section 4 of the Arbitration and Conciliation Act, 1996. The Court relied on the judgment of Renusagar to hold that for successfully challenging an award on the ground of violation of Fundamental Policy of Indian Law, one has to prove that the award amounts to any breach of core values of any Indian Law which cannot be compromised.

Even an objection on the grounds of public policy would only be applicable in a scenario where the act offends the core values of a country’s national policy.

On the other hand, the High Courts have even taken a different view altogether where it analyzed the clause incorporated under the contract and held that the terms of the contract did not provide for an open-ended clause. However, the foreign investor enforced the clause for claiming damages for breach of contract.

In Cruz City Mauritius Holdings v. Unitech Ltd., if the construction of the project building was delayed, a put option clause required payment of the investment amount plus a 15% IRR (internal rate of return). After such a delay, the counterparty did not make payment, and damages were awarded. The award was challenged before the High Court of Delhi and it held that the damages were awarded due to the breach of pre-agreed terms in the contract and the defaulting party had to pay. Even in the case of Shakti Nath and ors v. Alpha Tiger Cyprus Investment, the Court clearly stated that the one who accepts the contract with open eyes must bear the burden of the contract along with its benefits. The arbitration award explicitly provided that the aggrieved party claimed damages for breach of contract under Section 73 of the Indian Contract Act rather than enforcing the put options clause provided under the Agreement.

Time and again, Courts in India have been upholding foreign arbitral awards which allow the enforceability of put options in contracts amongst Indian parties. The challenge to such awards under Section 34 of the Arbitration Act also has not proven to survive.  

The High Court of Delhi maintains its position by holding,

“One of the principal objectives of the New York Convention is to ensure enforcement of awards notwithstanding that the awards are not rendered in conformity to the national laws.”

which explicitly leads to the conclusion that contravention of the FEMA guidelines providing against assured exit return to foreign investors can be upheld through a foreign arbitral award.

It is apparent that the put options, though barred by the FEMA Guidelines can still prevail under the guise of foreign awards and on the condition that the put options clause may be a close-ended one. However, RBI nowhere mentions the extent of returns under these clauses and prohibits any transaction that provides an assured exit return under the transaction.

Upon examining the prevailing situation, there is a dire need for clarification by RBI on the said matter under which it can cover the extent of enforceability of these clauses when allowed under a foreign award or as the prevailing circumstance, every party would choose an international commercial arbitration to enforce the put option which has been incorporated under the agreements.

Abhishek Malhotra is an Associate at Saga Legal.