1. A call option (“Call Option”) grants a right to the option holder to buy shares, debentures or other securities (“Securities”) held by the Call Option provider to the option holder on the occurrence of certain events and on the basis of agreed pricing formula. The option provider has a binding obligation to sell his Securities to the option holder when the option holder exercises the Call Option.
    2. A put option (“Put Option”) grants an exit to the option holders which require the other party, namely the option provider, to the Securities held by the option holder on the occurrence of certain events and on the basis of pre-agreed pricing formula. In other words, the option provider has binding obligation to buy the Securities to the option holder when the option holder exercises the Put Option.
    3. Right of first offer (“ROFO”) is a negotiated contractual right of a shareholder whereby the selling shareholder has an obligation to first offer the Securities to the non-selling shareholder before offering to a third party. If the non-selling shareholder is not interested in purchasing the Securities or cannot reach an agreement with the selling share shareholder, than the selling shareholder may sell the Securities to a third party for a price higher than what was offered by the non-selling shareholder.
    4. Right of first refusal (“ROFR”) is a negotiated contractual right of a shareholder whereby the non-selling shareholder has a pre-emptive option to purchase the Securities of a company at a price at which a third party intends to buy the Securities of a selling shareholder. This means that the selling shareholder is required to go to a third party first and get the valuation at which the third party is willing to buy the Securities of the company and share it with the non-selling shareholder.
    5. Put Options, Call Options, ROFO and ROFR (collectively referred as “Options”) are generally incorporated in the shareholders agreement between the Investor, Promoter and the Company. This note is intended to analyses the enforceability of such Options.

    1. Section 111-A of the Companies Act, 1956
      1. Options have time and again been viewed by the courts as a right contrary to the principle of ‘free transferability’ of shares of a public limited company laid down in Section 111-A of the Companies Act, 1956 (“Companies Act”). As Section 111-A of the Companies Act is not applicable to private companies; the concept is challenged vis-à-vis section 111-A of the Companies Act only in case of listed and unlisted public companies.
      2. The original text of Section 111-A of Companies Act and the principle of ‘free transferability’ was imported in the Companies Act in September 1995 from Section 22-A of Securities Contract Regulation Act, 1956 (“SCRA”)which now stands deleted. It is also important to note that the said Section 111-A was inserted in the Companies Act by the Depositories Act, 1996 which primarily regulates depositories in Securities held in dematerialised form and matters incidental thereto.
      3. Therefore, one could argue that enactment of Section 111-A was not to emphasise on free transferability of shares of public limited companies but to provide an impetus to transfer shares in dematerialised form and a mechanism to check misuse of power by board of directors of the company.
    2. Incorporation of Option clauses in articles of association of a company
      1. While the debate on the Options in terms of 111-A of the Companies Act does not arise with respect to private companies, the inclusion of Options clause in the articles of association (“Articles”) of a company is a hotly debated topic both in cases of both, private and public companies.
      2. When shareholders agree to an Option in a shareholders agreement and do not incorporate it in the Articles of the company, the controversy arises as to whether the clause is enforceable against the Company in the absence of its incorporation in the Articles.
    3. SCRA
      1. SCRA does not expressly deal with the Options. However, Section 18 read with other relevant Sections/ notifications under SCRA provide that no person is permitted to enter into any contract for sale or purchase of securities other than a spot delivery contract or contract for cash or hand delivery or special delivery or contract in derivatives as is permissible under SCRA or the Securities and Exchange Board of India Act, 1992, and the rules and regulations made under such Acts and rules, regulations and bye-laws of a recognised stock exchange[1]. In view of the above, all dealings in Securities other than on a spot delivery basis unless settled through stock exchanges are illegal.
      2. Options are incorporated in a typical venture funding or private equity transaction, wherein a contingent contract which may result in a contract for sale or purchase of securities can only be exercised on the happening of a contingency and not merely upon the grant of such Option.
      3. Upon exercise of such Options, contract is normally performed immediately, on a spot delivery basis where the consideration for the securities is paid simultaneously upon the transfer of such securities.
      4. As SCRA does not expressly make any provisions for Options one has to refer to judicial precedents for interpreting SCRA provisions vis a vis Options. The same has been discussed below in the MCX Case (defined below).


    In arriving to the above decision, the division bench relied on an earlier decision of the Bombay High Court in Jethalal Thakkar v Kapur[9]. Even though there was a subsequent decision of the single judge to the contrary in Niskalp Investments and Trading Company Limited v Hinduja TMT Limited[10] (“Nishkalp Case”), that seem to have not been considered. Further, Supreme Court has set aside the said order against SEBI as SEBI had agreed to amend the Securities Contracts (Regulation) (Manner of Increasing and Maintaining Public Shareholding in Recognised Stock Exchange) 2006. However, Apex Court has nowhere stated that MCX Case will not be treated as a precedent.

    1. The Supreme Court in 1992 in its decision in V B Rangaraj v V B Gopalakrishnan[2] (“Rangaraj Case”)held that a restriction on the transfer of shares contrary to the Articles of a private company was not binding on the private company or its shareholders.
    2. The Gujarat High Court in 1998 in its decision in Mafatlal Industries Limited v Gujarat Gas[3] relying on the Supreme Court’s decision in the Rangaraj Case, did not enforce the pre-emptive rights of the shareholders of a public company as the same were not incorporated Articles of the public company.
    3. The Supreme Court in 2003 in its decision in M S Madhusoodhanan v Kerala Kaumudi Private Limited[4] (“Madhusoodhanan Case”) not disagreeing with the decision in Rangaraj Case distinguished itself from the facts in Rangaraj Case on the ground that there was a clear distinction between allotment of new shares by a company and transfer of shares between shareholders.
      1. Firstly, in Rangaraj Case, the company was to issue shares, in Madhusoodhanan Case, as the agreement was inter-se shareholders, the role of the company was only to recognize the transferee as a new shareholder. It was therefore held that in Rangaraj Case, it was essential for the company to be part of an agreement to allot shares, however the same was not required in Madhusoodhanan Case.
      2. Secondly, in Rangaraj Case, the restriction was on the right of all the shareholders, present and future, however in Madhusoodhanan Case, the agreement was merely between particular shareholders, which imposed a restriction on the transferability of their shares. It was therefore held that in such a case a restriction in relation to identified members on identified shares of a private company did not amount to restriction of transferability of shares per se.
    4. The Delhi High Court in 2005 in its decision in Pushpa Katoch v. Manu Maharani Hotels Limited[5] (“Pushpa Katoch Case”) held that as per the provisions of Section 111A of the Companies Act, there could not be any fetters on the right of a shareholder to transfer his/her shares in a public company and observed that a right of pre-emption, even if found in the Articles of the Company, would be ultra vires the provisions of the Companies Act.
    5. The Single Bench of the Bombay High Court in 2010 in Western Maharashtra Development Corporation Ltd. Vs. Bajaj Auto Ltd[6] (“Bajaj Auto Case”), in relying on the decision of the Delhi High Court in Pushpa Katoch Case held that pre-emptive rights over shares in a public company even if incorporated in the Articles of the company is a fetter on the transferability of such shares and therefore patently illegal. This judgment does not deal with a situation wherein the agreement is only between the shareholders inter se.
    6. The division bench of the Bombay High Court in September 2010 in Messrs Holdings Limited v. Shyam Madanmohan Ruia[7] (“Messrs Holdings Case”), upheld the validity of such pre-emptive rights and opined that such rights do not violate the provisions of Section 111-A of the Companies Act.
      1. One of the key observations in this case was that a shareholder has freedom to transfer his shares on terms defined by him, subject to compliance with existing laws and that such arrangements do not restrict free transferability of shares. It was also held by the Court that pre-emptive rights arise out of a private contract between shareholders with a third party and these need not be embodied in the Articles of the company since the company is not a party to such arrangements.
      2. The division bench also referred to the exemption notification dated 27 June 1961 (“1961 Notification”) issued under Section 28 of the SCRA by the Central Government exempting contracts for preemption or similar rights contained in the Promotion or Collaboration Agreements or any Articles of limited company on the ground that such contracts were in the interest of trade and commerce or the economic development of the country. The Division Bench further held that because of 1961 Notification it cannot be presumed that legislature while enacting Section 111-A impliedly intended to make the agreements illegal or invalid.
    7. The division bench of the Bombay High Court has very recently in MCX Stock Exchange Limited V Securities & Exchange Board of India & Ors[8] (“MCX Case”) brought some clarity with regards to enforcement of Options in securities of a public unlisted company. The division bench differentiated between forward contracts (i.e. firm contract to buy back of shares or sell) and Options and observed the following:
      1. An Option to purchase or repurchase and a forward contract simpliciter lies in the fact that the Options are by its nature dependent on the discretion of the person who is granted the option whereas the forward contract is a reciprocal arrangement imposing obligations and benefits on the promissor and the promisee.
      2. The performance of an Option cannot be compelled by the person who has granted the Option. Contrariwise in the case of a forward contract, performance can be elicited at the behest of either of the parties. In the case of an Option, a concluded contract for purchase or repurchase arises only if the Option is exercised and upon the exercise of the Option.
      3. Under the notification that has been issued under the SCRA, a contract for the sale or purchase of securities has to be a spot delivery contract or a contract for cash or hand delivery or special delivery. In this case, the contract for sale or purchase of the securities would fructify only upon the exercise of the option in future. If the option were not to be exercised by them, no contract for sale or purchase of securities would come into existence. Moreover, if the option were to be exercised, there is nothing to indicate that the performance of the contract would be by anything other than by a spot delivery, cash or special delivery.

  4. Our Observation
    1. Given the contradiction on the issue and commenting on the overall picture it is fair to conclude that Indian courts have generally not complete clarity due to multiplicity of contradictory judgment of different High Courts.
    2. Courts have either refused to recognise clauses in shareholders agreements or, even when consistent with company legislation, enforced such clauses only if they have been incorporated in the Articles of the Company. Unless the Options are not endorsed by the Supreme Court, the extensiveness of the same cannot be taken for granted. So the take away from the analysis is:
      1. Incorporation of Option clauses in Articles of a company and entering into inter se agreements with the commercials for Options:
        • While, the Division Bench in Messers Holdings Case has specifically stated that such consensual agreements between particular shareholders relating to their shares can be enforced like any other agreements and it is not required for such arrangements to be embodied in the Articles of a company, it is questionable as to whether the principles enumerated in Rangaraj Case, namely for a company to be bound by a restriction on transfer of shares the same would have to form part of the Articles of the company, have been negated by the decision of Messers Holdings Case.
        • It may be noted that the principles laid down by the Supreme Court in Rangaraj Case were further analysed by the Supreme Court in Madhusoodhan Case which concluded that the judgment arrived at by the Supreme Court in Rangaraj Case was on account of the restriction being a blanket restriction on all the shareholders present and future and could not be imported to a private agreement between particular shareholders.
        • Messers Holdings Case has agreed with the interpretation of Supreme Court in Madhusoodhan Case and in the spirit of free transferability has extended this concept to private arrangements between shareholders in a public company. However, if certain provisions are required to enforced against a company, the rationale relied on Messers Holdings Case for not incorporating such transfer restrictions in the Articles of the company or making the company a party to such arrangements, may not necessarily hold well. Consequently, in our view the rationale behind Rangaraj Case may come into play which means that principles laid down in Rangaraj still hold good.
        • The Bombay High Court in 2011 in its decision of Jer Rutton Kevasmanek and Another v. Gharda Chemicals Limited[11] (“Jer Rutton”) has said that if the Options clause is incorporated only in the Articles and no separate agreement has been entered into recording the commercials on Options, Section 9 of the Companies Act will come into play and the Options clause in the Articles will be unenforceable as such clauses in cases of public companies are contrary to Section 111 A of the Companies Act.
        • Accordingly, we recommend that such clauses should be incorporated in the Articles of both private and public companies alongwith their inclusion in shareholders agreements.
      2. Enforceability of Options vis-à-vis the concept of free transferability of shares of a public company enshrined under Section 111A of the Companies Act and SCRA:
        • The decision in Madhusoodhan Case is an authority on the proposition that consensual agreements between particular shareholders relating to their specific shares do not impose restriction on the transferability of shares. Further, such consensual agreements between particular shareholders relating to their shares can be enforced like any other agreements.
        • Though Messer Holdings Case recognises the rights inter se among shareholders in case of restrictions on transfer of shares by providing a more liberal interpretation it is a High Court judgement. Therefore, for blanket transferability restrictions on all shareholders, the law still is still unclear.
        • Further, MCX Case recognises enforceability of the Options under SCRA. However, Supreme Court has set aside the order against SEBI. Nonetheless, we believe the Bombay High Court judgment has precedent value.
        • Unless, Messers Holding Case is endorsed by the Supreme Court or the new Companies Bill 2013 comes into force, this issue remains contentious. Until further development, parties can draw comfort from the ruling of the Bombay High Court in the MCX Case and enter into Option agreements.

This update was released on 27 Aug 2013.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or for any assistance.

Legal Update Team
Advocates, Solicitors and Notaries
T: +91 22 40565252
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