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Understanding Provisional Contracts Under Indian SEBI Laws

Introduction: Provisional Contracts

Provisional contracts are temporary agreements made between two parties, often utilised in the Indian stock market where the trading parties do not immediately settle their trades. Instead, they agree upon a future date for final settlement. This provision allows for flexibility in financial markets, reducing the risk of liquidity and enhancing the pace of transactions.



Origin and Legal Framework

The concept of provisional contracts finds its origin in the common law principles of contract law. In India, it is primarily governed by the Securities Contracts (Regulation) Act, 1956 (SCRA), the Securities and Exchange Board of India Act, 1992 (SEBI Act), and the rules and regulations made thereunder.



Provisional Contracts under SEBI

Under the regulations put forth by the Securities and Exchange Board of India (SEBI), provisional contracts are deemed to be an irregularity. As per Section 13 of SCRA, no member of a recognised stock exchange can enter into any contract that violates the rules of the stock exchange. This includes engaging in "provisional contracts," which SEBI views as being contrary to the efficient and transparent functioning of the stock market.

SEBI's standpoint on provisional contracts is aimed at ensuring that the securities market functions in a manner that protects the interests of investors and promotes the development and regulation of the securities market.



Case Law

The issue of provisional contracts has come up in a number of legal disputes. In Shriram Pistons & Rings Ltd. Vs. N.K. Goel and Ors. [AIR 1985 Del 49], the court observed that contracts of a provisional nature were inconsistent with the rules and bye-laws of the stock exchange and were not enforceable.



Implications of Provisional Contracts

Engaging in provisional contracts can lead to several consequences:

  1. Regulatory Penalties: Any member of a stock exchange who enters into a provisional contract could be liable for penalties under the SEBI Act. SEBI has the power to impose monetary penalties, suspend or cancel the registration of the stockbroker, among other measures.

  2. Contractual Risk: Provisional contracts do not have legal enforceability. This means that if one party fails to fulfill their part of the contract, the other party may not have legal recourse.

  3. Market Risk: Provisional contracts can increase the risk of price manipulation and insider trading in the stock market. It may also lead to unhealthy speculation.


Conclusion

In conclusion, provisional contracts, while offering flexibility, present legal and financial risks due to their non-enforceability and contravention of the securities market regulations. SEBI, as a regulatory authority, aims to promote the transparent, efficient and healthy functioning of the securities market, which requires avoiding such practices. Therefore, while navigating the complex world of stock market transactions, investors and brokers must be aware of the legal framework, including rules against the use of provisional contracts, to ensure their actions are compliant and within the purview of the law.

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