Contracts in Securities — Types, Validity & Derivatives

Topic 5 — Spot Delivery, Forward, Ready Delivery & Exchange-Traded Derivatives | SEBI Law Officer

The SCRA draws sharp distinctions between different types of contracts in securities. Not all contracts are legally valid — validity depends on the type of contract (spot, ready, forward), the exchange on which it is made, and the nature of delivery and settlement. The 2002 Amendment introduced Section 18A, which gave legal validity to exchange-traded derivatives — a transformative change that forms the foundation of India's modern derivatives market.

1. Types of Contracts — Overview

Contract Type	Delivery	Exchange Required?	Legal Status
Spot Delivery	T+0 or T+1 (actual)	No — valid even outside	Always valid
Ready Delivery	Immediately / reasonable time	Yes — on recognised exchange	Valid on exchange
Forward Contract	Specific future date	Yes — void if outside exchange	Valid on exchange only
Derivatives (Futures/Options)	Standardised future dates	Yes + Clearing house	Valid on exchange (post-2002)
Options in Securities (OTC, pre-2002)	Future right, not obligation	Prohibited outside exchange	Prohibited under Sec 16/20

2. Spot Delivery Contracts [Section 2(i)]

Section 2(i): A contract which provides for the actual delivery of securities and the payment of a price therefor either on the same day as the date of the contract or on the next day — the actual period taken for postal dispatch of securities or remittance of money being excluded from computation.

Five key features of a spot delivery contract:

<w:r><w:rPr><w:b/><w:bCs/><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">Immediacy: </w:t></w:r><w:r><w:rPr><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">Delivery and payment within T+0 or T+1. No deferred settlement whatsoever.</w:t></w:r>
<w:r><w:rPr><w:b/><w:bCs/><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">Actual delivery: </w:t></w:r><w:r><w:rPr><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">The securities must actually be transferred — not merely a paper settlement or a contract for difference.</w:t></w:r>
<w:r><w:rPr><w:b/><w:bCs/><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">No speculation: </w:t></w:r><w:r><w:rPr><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">By requiring immediate delivery, spot contracts eliminate the speculative element that forward contracts carry.</w:t></w:r>
<w:r><w:rPr><w:b/><w:bCs/><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">Valid outside exchange: </w:t></w:r><w:r><w:rPr><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">This is the MOST IMPORTANT feature. Unlike other contracts, spot delivery contracts are valid even outside a recognised stock exchange (Section 13 proviso).</w:t></w:r>
<w:r><w:rPr><w:b/><w:bCs/><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">Postal allowance: </w:t></w:r><w:r><w:rPr><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">Time for postal dispatch of physical certificates or bank remittance is excluded — a practical concession from the pre-electronic era.</w:t></w:r>

✅ Modern Relevance — T+1 Settlement

NSE and BSE implemented T+1 (next day) settlement for all equity securities from January 2023. This is the exchange-mandated version of near-spot settlement. Even before this change, the SCRA's Section 2(i) recognised same-day and next-day settlement as the least speculative form of securities transaction.

3. Ready Delivery Contracts [Section 2(g)]

Section 2(g): A contract for the purchase or sale of securities for performance of which no time is specified and which is to be performed immediately or within a reasonable time.

A ready delivery contract occupies an intermediate position: no specific date is fixed but performance is 'immediately or within a reasonable time'. What constitutes 'reasonable time' depends on market custom and the nature of the securities. Ready delivery contracts on recognised stock exchanges are valid; off-exchange ready delivery contracts in listed securities are subject to Section 13's restrictions.

4. Forward Contracts

A forward contract is a contract for the purchase or sale of securities at a future date specified at the time of contract. The price may be fixed at contract or determined later. Key rule:

<w:r><w:rPr><w:b/><w:bCs/><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">Off-exchange forward contracts in listed securities = VOID under Section 16. </w:t></w:r><w:r><w:rPr><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">They facilitate speculation without the exchange's oversight, margin requirements, and settlement guarantee.</w:t></w:r>
<w:r><w:rPr><w:b/><w:bCs/><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">On-exchange standardised forward contracts = 'Futures' — valid derivatives </w:t></w:r><w:r><w:rPr><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">under Section 18A (post-2002 amendment).</w:t></w:r>

Feature	Spot/Ready Contract	Forward Contract
Settlement date	T+0, T+1 or immediately	Specific future date
Speculation potential	Low — immediate delivery required	Higher — price movements over time
Valid outside exchange?	Yes (spot only)	No — void under Section 16
Exchange requirement	Not required for spot contracts	Required for legal validity
Regulation post-2002	Section 2(i) / Section 2(g)	Section 18A (as futures/derivatives)

5. Section 18A — Validity of Derivatives [2002 Amendment]

Section 18A: Notwithstanding anything contained in any other law for the time being in force, contracts in derivative shall be legal and valid if such contracts are — (a) traded on a recognised stock exchange; (b) settled on the clearing house of the recognised stock exchange, in accordance with rules and bye-laws of such stock exchange.

Section 18A is the most important provision for derivatives in the entire SCRA. Two conditions must BOTH be satisfied:

<w:r><w:rPr><w:b/><w:bCs/><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">(a) Traded on a recognised stock exchange: </w:t></w:r><w:r><w:rPr><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">OTC (over-the-counter) derivatives in securities are NOT protected by Section 18A and remain potentially void/unenforceable.</w:t></w:r>
<w:r><w:rPr><w:b/><w:bCs/><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">(b) Settled on the clearing house: </w:t></w:r><w:r><w:rPr><w:color w:val="323E4F"/><w:sz w:val="21"/><w:szCs w:val="21"/></w:rPr><w:t xml:space="preserve">Clearing corporation novation ensures the clearinghouse becomes the buyer to every seller and seller to every buyer — eliminating counterparty risk.</w:t></w:r>

⚠️ 'Notwithstanding any other law'

Section 18A overrides all other laws — including the wagering contract void provision of Section 30, Indian Contract Act, 1872. This means exchange-traded derivatives cannot be challenged as wagering agreements. This is critical for exam answers on the relationship between the ICA and SCRA.

6. Options in Securities — Old vs New Regime

Aspect	Pre-2002 Position	Post-2002 Position
Legal basis	Section 20 prohibited options in securities	Options = derivatives; Section 18A validates on exchange
Exchange-traded options	No clear framework; trading in grey area	Fully valid as derivatives; NSE/BSE offer options
OTC options	Prohibited; void under Section 20	Still unprotected; Section 18A does not apply
Badla system	Operated as quasi-forward/quasi-option	Abolished in 2001; replaced by rolling settlement

7. Wagering Contracts & SCRA — The Intersection

A historical challenge to securities contracts was whether contracts settled by price difference (without delivery) were wagering agreements void under Section 30 of the Indian Contract Act, 1872. The SCRA and judicial decisions resolved this:

📖 Firm Mool Chand Munnalal v. Union of India AIR 1979 SC 1620

Facts: Whether contracts for purchase and sale of securities settled by price difference (without physical delivery) were wagering contracts void under Section 30 ICA.

Held: The Supreme Court held that contracts in securities on recognised stock exchanges — even if settled by price difference — are NOT wagering contracts under Section 30 ICA. They serve legitimate economic purposes: price discovery, risk transfer, and hedging.

Ratio: Exchange-traded settlement-by-difference contracts are not wagering agreements. The SCRA framework provides the legal basis. Post-2002, Section 18A explicitly overrides all other laws for exchange-traded derivatives.

8. Contract Notes — Mandatory Requirements

Section 13 read with Rule 13 SCRR: Every member of a recognised stock exchange shall issue a contract note for every transaction in securities. A contract note is a legally binding confirmation of the transaction between the broker and client.

Requirements for a valid contract note:

Must be in the prescribed form, signed by the member or authorised representative.
Must specify: name of buyer/seller, description of securities, price, quantity, date, exchange, settlement date.
Must be issued within 24 hours of the transaction (SEBI circular requirement).
Constitutes legal proof of the transaction — admissible in arbitration and court proceedings.
Non-issuance is a violation of SCRA and SEBI regulations — attracts penalty under Section 23B.

🎯 EXAM POINTERS — Topic 5: Contracts in Securities

Spot delivery contract: T+0 or T+1; actual delivery; valid EVEN OUTSIDE exchange — most tested distinction.
Ready delivery contract: no specific time; immediately/reasonable time; on recognised exchange.
Forward contract OUTSIDE exchange = VOID under Section 16. INSIDE exchange = 'futures' = derivatives.
Section 18A (2002 amendment): exchange-traded derivatives = legal and valid notwithstanding any other law.
TWO conditions for Section 18A: (1) traded on recognised exchange; (2) settled through clearing house.
Section 18A overrides Section 30 ICA (wagering contracts) — exchange derivatives cannot be challenged as wagers.
Badla system abolished in 2001; replaced by rolling settlement (T+2, now T+1) and standardised derivatives.
OTC options/forwards = not protected by Section 18A; potentially void/unenforceable.
Contract notes: mandatory within 24 hours; prescribed form; signed; non-issuance = violation attracting penalty.
Firm Mool Chand (1979 SC): exchange contracts settled by price difference ≠ wagering agreements.

← Topic 4: Listing of Securities [Sec 21-22] | Next → Topic 6: Prohibition of Contracts [Sec 13-17]

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