A derivative contract that requires either physical settlement or net share settlement should be classified in equity assuming all other conditions for equity classification are met. We’ll get to those other conditions later.
Physical settlement means physical delivery of shares by one party to the other party. Net share settlement means delivery of only the net share difference effectively representing the gain (or loss) realized from the derivative instrument. In either case, this question should be answered ‘yes’ only if the contract requires either physical settlement or net share settlement. If the contract offers settlement alternatives one of which is either physical settlement or net share settlement, the answer to this question is ‘no’.