Reliance Industries, controlled by billionaire Mukesh Ambani, led the gains after India's highest court asked the energy giant and former group firm Reliance Natural Resources why a gas pact between the two should not be cancelled.
The government made a petition over the weekend to intervene in the case, arguing the gas was its property and the private pact between Mukesh and estranged younger brother Anil over the gas was not valid.
"If the government succeeds in making the gas-supply agreement null and void, Reliance Industries will be free to sell the gas at market prices," Hitesh Agrawal, head of research at Angel Broking said.
"The market has sensed that the advantage is with Reliance Industries."
Reliance Industries, India's largest-listed firm with the most weight in the main index, rose 5 per cent to Rs 2,030.65. The company had challenged a lower court ruling to supply gas to Reliance Natural at a below-market price.
Reliance Natural, controlled by Anil Ambani, dropped 2.7 per cent to 80.75 rupees. Group firms Reliance Infrastructure fell 1.2 per cent to 1,135.85 rupees and No. 2 telecoms firm Reliance Communications eased 1.1 per cent to 270 rupees.
Tata Consultancy Services, the country's top IT-services firm by sales, surged 15.3 per cent to Rs 500.10, its best one-day per centage gain, after it beat forecasts with a 22 per cent rise in quarterly profit.
The news also sparked interest in other outsourcers, with No. 2 player Infosys Technologies gaining 5.7 per cent to Rs 1,972.70 and smaller rival Wipro climbing 7.1 per cent to Rs 460.05. All three stocks closed at their best levels in more than a year.
The 30-share BSE index ended up 3.03 per cent, or 446.09 points, at 15,191.01 points, its highest close since June 12. Twenty-four of its constituents rose.
The benchmark had climbed 9.2 per cent last week, the best among major markets in Asia -- as the government raised hopes for financial reforms and monsoon rains, crucial to India's domestic-demand powered economy, picked up after a weak start.
Several factors, including ample global and local liquidity, a recovery in earnings growth and strong corporate balance sheets, will spur the market over the next 12 months, Morgan Stanley analyst Ridham Desai said.
"Indian equities are in a sweet spot. We would continue to buy the dips in the market," he said.
A spike in risk-appetite worldwide also underpinned the market, with record low global interest rates and trillions of dollars in stimulus spending appearing to help the world recover from the worst recession in 80 years.
A source close to the situation said US lender CIT Group Inc's board signed off on a deal late Sunday for $3 billion in rescue financing from a group of bondholders, in a plan the lender hopes will stave off bankruptcy, further boosting sentiment.
The BSE index, which had tumbled 9.4 per cent in the first week of July after the government's budget disappointed investors looking for bold financial reforms, has bounced back and is up 57 per cent this year after slumping by more than half in 2008.
The benchmark has leapt 89 per cent from a 2009 low in early March, riding a stocks rally that has swept across the globe.
In the broader market, gainers led losers by more than 2 to 1 on relatively moderate volume of 445.6 million shares.
The 50-share NSE index rose 2.9 per cent to 4,502.25.
Asian shares rose to their highest since around the time of the collapse of Lehman Bros in September, with MSCI's measure of Asian markets excluding Japan rising 3 per cent.
Japan's Nikkei was closed for a public holiday.
At 1041 GMT, the pan-European FTSEurofirst 300 index of top shares was up 1.7 per cent.