(First Published on Linkedin)
1. Background & Problem Statement: Can an unlisted public company issue a put option to a non-resident investor? While such options are commonly used for investor protection, they sit at the intersection of two regulatory regimes that pull in opposite directions: FEMA and SCRA.
2. FEMA’s Position: No Assured Exit – Post the high-profile Tata-Docomo case, the RBI revised its stance to explicitly prohibit assured returns for non-residents. Under FEMA Non-Debt Instrument Rules, a non-resident cannot be assured a fixed return or pre-determined exit price—any exit must be at fair market value (FMV) as per a valuation on the exit date. The objective: to prevent equity instruments from masquerading as debt.
3. SCRA’s Position: Must Specify Exercise Price – SEBI’s Notification dated October 3, 2013 validated put/call options in shareholder agreements, provided they specify the exercise price and period. Without this, the option may be deemed unenforceable under securities law. So, unlike FEMA, SCRA expects the price to be pre-agreed to uphold enforceability.
4. Applicability to Unlisted Public Cos (Bhagwati Developers) The Supreme Court in Bhagwati Developers held that shares of unlisted public companies are covered under SCRA. Therefore, any contract in securities (like a put option) must comply with the SEBI 2013 conditions—including a stated price—creating a direct conflict with FEMA.
5. And therefore….. This is a classic regulatory paradox:
– Exercise Price mentioned? SCRA is satisfied, FEMA is violated.
– Exercise Price not mentioned? FEMA is satisfied, SCRA is violated.
Structuring it? A pricing formula based on FMV at the time of exercise may be provided to comply with the capped FMV norms at the time of non-residents’ exit, while complying with a formula for determining the exercise price (rather than the exercise price itself).