Introduction:
There have been many amendments regarding the companies act of 2013. The latest being the addition of the financial statement in schedule III with new clauses, as of 24 March 2021.[1] My focus and highlight for this particular article will be on Section 194 of the Companies Act of 2013.[2] As of now, Section 194 of the Companies Act of 2013 has been omitted as of the year 2017.
Chapter XII, Section 194 of the then Companies Act of 2013 describes, dealing with the prohibitions on the grounds of forward dealings in securities of a company by the director or any key managerial personnel. The Companies’ Amendment Act of 2017, came in pursuance of recommendations based on a report of the Company Law Commission[3], which then omitted Section 194 and is no longer a part of the Companies Act of 2013 since the SEBI regulations based on insider trading are considered wide enough to cover these instances of fraud.[4]
This section talks about the need to prevent and prohibit forward dealings mostly by the directors or any key managerial personnel of a company regarding securities, as they would be having sensitive information about that particular company which could lead them gaining profits of that particular company and this could further damage the investor’s position on that particular company.
Background and Before its Application
The Companies Act of 1956[5] had no provisions based on the prohibition of forward dealings by directors or key managerial personnel of the company. Section 194 of the Companies Act of 2013 was rather a new section incorporated by the government of India. Still, there exist well-established judicial precedents as well as moral obligations based on lawful means that the directors have legal obligations based on trust and also duties to act reasonably and honestly in the best interests of the companies where they hold such positions. Their duties emit based on holding positions that may be synonymous to investors as well as trustees of their companies.
The Director of a company is considered to occupy the position of an agent, the general principles of agency would govern the relations of the director and also the third parties who deal with the company. In Ferguson v. Wilson[6], the court had held that the directors are considered to be the agents of the company and the company acts only through directors and has no persons in it. It is the company that is liable when the directors on behalf of the company act accordingly.
In Lands Allotment Co., Re[7], it was held by the court that directors of a company have always been treated as a trustee, as the financial matters are controlled by them and they are liable if they misapply them and this makes it a breach of trust. Section 194 of the Companies Act emanates from the jurisprudence of such obligations & duties of directors as per Section 166 of the Companies Act, of not making undue gain from their companies.
Section 194 and its Application
This section used to be applied when any of the key managerial staff or directors of the company got involved in forward dealings of securities as laid down in Section 194. This section prohibited these kinds of transactions by imposing fines, penalties, and imprisonment for, who were found guilty of such dealings. Amitav Ganguly has rightly mentioned forward dealings as, “a contract where both parties would agree for their performance at a future date at specified terms, in a particular price, set on the date of contractual obligation”.[8]
The Problems with Section 194
This section is considered vague and ambiguous as to the explanation provided in the said section sometimes, which is difficult to decipher. In Section 194(1) sub-clause (a) and (1) sub-clause (b), the language used is almost the same except the only difference in both parts is part (1) sub-clause (b) having the phrase ‘he may elect’. This lets both parts have the little scope and makes it difficult to apply sometimes when it comes to practice.
Section 194(1) applies to all directors and key managerial personnel irrespective of the company they are part of, but the explanation in section 194(1) uses a term namely, ‘whole-time directors’, and makes it further ambiguous, that the said Section only restricts and is applicable to whole-time directors.
According to Vivek and Anshuman, “the restriction set out in Section 194(1) applies in case the call option/put option available to the directors / KMP, is exercisable at a specified price and within a specified period. Therefore, according to the considered view of the authors, it is clear that the restriction in the said provision will apply only in case the call/put option is subject to a specified price and is required to be exercised within a specified period.”[9] This can actually lead to potential loopholes for the directors or KMPs to enter into contracts in the particular companies they are directors or KMPs and this can, however, not providing for a specified price or a time period could potentially render such option contracts void due to uncertainty under the Indian Contract Act, 1872.
Section 194 and SEBI Regulations
Chapter VA of SEBI act of 1992, Section 12A specifies and prohibits a person who might use manipulative and deceptive devices, engage in insider trading, and substantial acquisition of securities or control for his/her own advantages. This section of the SEBI act makes further dealings and other activities related to it more clear and further elaborates and prohibits a person from engaging in any type of fraudulent activity based on securities of a company.
Conclusion
Section 194 laid down provisions based on forward dealings in securities and prohibited directors or KMPs from indulging in such activities, this made sure that the interest of the company and shareholders be protected. The omission of this section was an important step taken by the government of India, as there was limited clarity regarding the terms used and interpretations. With the omission of Section 194, it has cleared the confusion regarding forward dealings which were there between both the SEBI Act and this Section of Companies Act. This change might help in filling the loopholes that would have been caused by this section based on its vague provisions and interpretation. Even though the law has been harmonized, strict laws regarding forward dealings should be laid down more specifying the technicalities of these kinds of sophisticated frauds.
References:
[1] Divesh Goyal, 10 Company Law Amendments effective from 01 April 2021, TaxGuru (July. 20, 2021, 8:15 AM), https://taxguru.in/company-law/10-company-law-amendments-effective-01st-april-2021.html.
[2] The Companies Act, S. 194 (2013).
[3] Trilegal, Companies (Amendment) Act 2017-key features, Mondaq (July. 20, 2021, 8:19 AM), https://www.mondaq.com/india/corporate-and-company-law/670216/companies-amendment-act-2017–key-changes.
[4] Varun Marwah, Top 5 changes in the Companies (Amendment) Act, 2017, Bar and Bench (July. 20, 2021, 8:25 AM), https://www.barandbench.com/news/10top-5-changes-companies-amendment-act-2017.
[5] The Companies Act, (1956).
[6] LR 2 Ch LR 77 (1866).
[7] 1 Ch 616, 631(1894).
[8] Amitav Ganguly, Prohibition on forward dealings in securities by directors or key managerial personnel, TaxGuru (July. 20, 2021, 9:18 AM), https://taxguru.in/company-law/prohibition-dealings-securities-director-key-managerial-personnel.html.
[9] Vivek Sriram and Anshuman Bharadwaj, India: Put And Call Options For Directors And Key Managerial Personnel Under The Companies Act, 2013 – A Closer Look, Mondaq (July. 20, 2021, 10:08 AM), https://www.mondaq.com/india/directors-and-officers/556504/put-and-call-options-for-directors-and-key-managerial-personnel-under-the-companies-act-2013-a-closer-look.
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