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{New Section 194 of the Companies Act 2013}
There exist well established judicial precedents as well laws that the
directors have fiduciary obligations and also duties to act reasonably
and honestly in the best interests of the companies where they hold
such positions. Their duties emanate due to holding positions which
may be synonymous to agents as well as trustees of their

In view of the director occupying the position of an agent the

general principles of agency would govern the relations of the
director with the company and also govern the third parties who
deal with the company through its directors. In Ferguson v.
Wilson (1866) LR 2 Ch LR 77, the court had held that the
company has no person, it can act only through directors and the
case is, as regards those directors, merely the ordinary case of
principal and agent.

The director is also considered as a trustee although not in the strict

sense of the position. In Lands Allotment Co., Re, {1894} 1 Ch
616, 631, it was held by the court that although the directors are
not, properly speaking, trustees, yet they have always been
considered and treated as trustees of money which comes to their
hands or which are actually under their control and directors are
held liable to make good monies which they have misapplied upon
the same footing as if they were trustees
The Companies Act 2013 {new Act 2013} for the first time has laid
down the duties of directors in unequivocal terms in section 166 in
contrast to erstwhile Companies Act 1956. However, before the
enactment of section 166 there had already been plethora of judicial
decisions pronounced over decades, laying down many fiduciary
obligations and duties of directors as precedent laws.

This new section emanates from the jurisprudence of such

obligations & duties of directors of not making undue gains from
their companies.
Interestingly this section covers whole time directors and not
directors who are commonly known as ordinary directors or director
Pertinently the duties of directors, whether whole time director or
otherwise would remain the same. Moreover, keeping in view the
preceding background this section has been built so that directors
do not deal with the securities of the company {including rights and
interest in the securities} to make undue gains from the company.
Thus this section deals and prohibits forward dealing in securities
i.e. certain kinds of future contracts, in relation to the shares or
debentures of the company/ holding/subsidiary/ associate
In addition to the whole time directors, the Key Managerial
Personnel {KMP} are also prohibited to do forward dealings.
At the outset it would be desirable to understand certain terms in the
context of these provisions which, however, have not been defined in
Companies Act 2013.
Forward dealings would mean a contract where-under the parties agree
for their performance at a future date at specified terms, notably price,
determined on the date of contract.

A futures contract means a legally binding contract to buy or sell the
underlying securities {which would cover shares or debentures} on a
future date specified in the contract, but the one which can be settled
either by delivery of the underlying securities or in cash, i.e., by paying or
receiving cash equal to the difference between the price contracted earlier
and the price in the spot market at maturity.
An options contract is one that gives the buyer the right but not the
obligation to buy/sell the underlying securities {which would cover shares
or debentures} at the contracted price within or at the date specified in
the contract. Thus, the buyer or holder of the option purchases the right
to the option from the seller who is thus contractually bound to settle the
option when the buyer exercises the right. The option to buy or sell the
securities in future may be a teji, a mandi, a teji mandi, a galli, a put
or a put and call option. An option to buy is called call option and an
option to sell a put option.
The sub section {1} of section 194 prohibits the following persons: Any director of a company, or
any of key managerial personnel of a company
from buying: in the company, or
in its holding company, or
in its subsidiary company, or
in its associate company,
{a} the following: a right to call for delivery, or
a right to make delivery,

at a specified price and within a specified time, of a specified number of

relevant shares or a specified amount of relevant debentures; or
{b} a right, as he may elect: to call for delivery, or
to make delivery,
at a specified price and within a specified time, of a specified number of
relevant shares or a specified amount of relevant debentures.
Interestingly from the opening line of the sub section it appears that
any director { whether he is an ordinary director, managing director,
whole time director, or independent director or nominee director}
shall come under the ambit of the provision, however, if one reads
the explanation to sub section {3} it would be clear that only whole
time director is covered. Even from the Notes on Clauses of the
Companies Bill 2011 it is obvious that only whole time director is
taken into account. It is not apparent why construction of the
section is in this way.
The restriction is also on key managerial personnel who have been
defined in section 2 {51} of the Companies Act 2013 as:1. the Chief Executive Officer or the managing
director or the manager;
2. the company secretary;
3. the whole-time director ;
4. the chief financial officer ; and
5. such other officer as may be prescribed.
From the above definition one notes that the term whole time
director again appears. It is not apparent as to why restriction has
also been imposed separately on whole time director in the body of
the section.
shares/debentures of the company where such whole time director
or KMP holds position, but also relating to securities of holding/
subsidiary and associate companies.
Pertinently, the prohibition as laid down is in respect of buying only
and not any other acquisition like through receipt of gift, pledge,
etc. Moreover sale is not contemplated.

The words a right to call for delivery or a right to make delivery

have not been defined. It, however, appears that the sub section
provides for restriction on delivery of securities underlying an option
being call or put, and, does not apply where there is no delivery of
It may be noted from the above that although the director and KMP
of a company are prohibited, their relatives or associated entities
are not prohibited. This could be unintended lacunae in the
It may also be pointed out that this provision appears to apply to a
private as well as to a public company, whether their securities are
listed or not. However, in a practical sense these restrictions would
be more apt in relation to listed securities.

This is a penal sub section {2} stating that if a director or any key
managerial personnel of the company contravenes the provisions of subsection (1), such director or key managerial personnel shall be
punishable: with imprisonment for a term which may extend to two years, {but
no minimum term has been laid down}, or
with fine which shall not be less than one lakh rupees but which
may be maximum of five lakh rupees, or
with both.
The last sub section {3} lays down the consequences of
contravention and provides that where a director or other key
managerial personnel acquires any securities { which only refers to
shares or debentures in sub section [1]} in contravention of subsection (1), he shall, subject to the provisions contained in subsection (2), be liable to surrender the same to the company.
Moreover the company is prohibited to register the transfer of the
securities, {which only refer to shares and debentures}, in physical
form, so acquired in the name of the director or other key
managerial personnel, in its register of members or debenture
holders. In case the shares/debentures are in dematerialised form,
the company shall inform the depository not to record such
acquisition of shares/debentures.

Further, such shares/debentures, in both the cases of physical or

dematerialised forms, shall continue to remain in the names of the
transferors. Hence there shall be no transaction of sale and
purchase of said shares/debentures in contravention of this
provision. Pertinently the penal provision in sub section {2} shall
also apply.
The Explanation given in this sub section states that for the
purposes of this section, relevant shares and relevant
debentures mean shares and debentures of the company in which
the concerned person is a whole-time director or other key
managerial personnel. The shares and debentures of holding and
subsidiary companies are also covered but not that of associate
company which seems to be contrary to sub section [1].
Although the provision is new and the objectives are laudable, it would
have been better to have more clarity on various terms used in the
section as also on the interpretations. It is apparent that more difficult a
provision is to interpret there will be more lapses on compliances.
Government should issue clarifications to make this more effective.

4th August 2015