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Like Rapunzel In A Call/Put Option Tower?

Published on Wed, Jan 08,2014 | 13:22, Updated at Wed, Jan 08 at 17:03Source : 

By: Menaka Doshi, Executive Editor, CNBC-TV18 

Often the truth is stranger than fiction! And that applies perfectly to the issue of legal validity of call and put options (or drag & tag rights and RoFRS) in India! 

Till October last year key regulators SEBI and RBI considered the validity of such pre-emption rights  as legal fiction. SEBI held them invalid as the SCRA allowed only spot contracts (though one could argue that was never meant to apply to such optionalities in shareholder agreements). RBI disallowed call and put options that guaranteed a fixed price exit as that, in RBI’s books, amounted to debt masquerading as equity. And so call and put options, ubiquitous between shareholders in joint venture agreements or in strategic investment agreements, took on dark, villainous tones. Like the stepmother in a Brothers Grimm fairy tale! 

That finally changed in October 2013, when SEBI amended the SCRA to permit the inclusion of pre-emption rights in shareholder agreements and articles of association.

Yes there were conditions – a minimum holding period of 1 year, price to be in compliance with all laws and contract to be settled by actual delivery of securities – but they didn’t hurt as much as the condition that such rights would be valid only PROSPECTIVELY. And that didn’t hurt as much as SEBI throwing the ball in RBI’s court by saying all such rights/options have to be FEMA COMPLIANT! In short, SEBI’s go ahead meant little till RBI did the same. 

And so we waited …and waited …and waited. In late October The Firm came into information (source based) that RBI was ready to permit call and put options and the like…as long as they did not offer an assured return or fixed price exit. And that RBI may delink the option linked exit price from DCF! 

After waiting some more RBI has finally spoken. On December 30th 2013, it notified the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India)(Seventeenth Amendment) Regulations 2013. which it says

Amendment to Regulation 5

“Further, shares or convertible debentures containing an optionality clause but without any option/right to exit at an assured price shall be reckoned as eligible instruments to be issued to a person resident outside India by an Indian company subject to the terms and conditions as specified in Schedule I .”

It goes on to amend Regulation 9  by adding

Amendment to Regulation 9

“Further, subject to minimum lock-in period of one year or minimum lock-in period as prescribed under Annex-B of Schedule 1 whichever is higher, a person resident outside India holding the shares or debentures of an Indian company containing an optionality clause in accordance with these Regulations and exercising the option/right, may exit without any assured return, subject to the following conditions:

(i) In case of listed company, at the market price determined on the floor of the recognised stock exchanges;

(ii) In case of equity shares of unlisted company, at a price not exceeding that arrived on the basis of Return on Equity (RoE) as per latest audited balance sheet. Any agreement permitting return linked to equity as above shall not be treated as violation of FDI policy.

(iii) In case of Preference shares or debentures, at a price worked out as per any internationally accepted pricing methodology at the time of exit, duly certified by a Chartered Accountant or a SEBI registered Merchant Banker. The guiding principle would be that the non-resident investor is not guaranteed any assured exit price at the time of making such investment/agreements and shall exit at the price prevailing at the time of exit, subject to lockin period requirement.”

In simple English that means (or so I think) that in the case of a foreign investor using such an option to exit an Indian investment the exit pricing will be as follows

  1. Exit price for listed equity = market price
  2. Exit price for unlisted equity = < RoE based price
  3. Exit price for pref shares/debentures = internationally accepted pricing methodology certified by CA/Merchant Banker


  1. Is expected and fine.
  2. Is confusing as a foreign investor has to invest at a floor price linked to DCF valuation but exit at less than an RoE based price
  3. Is good news as it leaves the pricing method upto the parties involved

So what does this mean for Indian unlisted companies seeking foreign investors? Or foreign investors seeking to exit an unlisted investment? Bharat Vasani, Group General Counsel, Tata group says

“The RBI has put an end to a long pending controversy with regard to its position on put and call option in favour of non- residents. However, in the process of legalising put/call options, it has put in conditionalities which could be perceived negatively by the long term foreign investors - as RoE is not the appropriate method to determine fair value of shares. Particularly when they are required to invest using DCF valuations as the floor price. The positive development is a fair degree of flexibility introduced by RBI, of investing via compulsorily convertible preference shares/debentures route -  as conversion to equity for exit is no longer necessary.” 

RBI’s concerns are not unwarranted. But will this safeguard amount to throwing the baby out with the bath water? Will it discourage foreign investors from investing in unlisted equity? And what about those already invested in India…like Rapunzel will they find themselves locked in a tower? Atleast that fiction ends with a ‘happily ever after’!

PS: Your comments are welcome…you can write to me at


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