In the judgment of Union of India and Another vs. Deloitte Haskins and Sells LLP & Another, the Supreme Court has enunciated and cleared the law pertaining to the removal and resignation of a statutory auditor vis-à-vis the proceedings initiated under Section 140(5) of the Companies Act, 2013 (“Act”). The Supreme Court upheld the constitutional validity of Section 140(5) of the Act and interpreted it as “neither discriminatory, arbitrary and/or violative of Articles 14, 19(1)(g) of the Constitution of India”. The Supreme Court clarified that the resignation of an auditor after filing an application under Section 140(5) of the Act does not automatically terminate the proceedings initiated under this Section.
Legislative Intent and Scheme of the Provisions
Section 140 titled as ‘Removal, Resignation of Auditor and giving of Special Notice’ appears in Chapter X of the Act which deals with ‘Audit and Auditors’. Section 140(1) of the Act outlines the procedure for a company to remove an auditor before the expiry of his term, Section 140(2) and (3) of the Act deal with resignation of auditors and Section 140(4) of the Act deals with giving of special notice at an annual general meeting for appointment of a new auditor other than the retiring auditor.
The chapter also bestows the NCLT with the powers under Section 140(5) to act either suo moto or on an application made to it by the Central Government or by any person concerned against an auditor who has acted in a fraudulent manner or is abetting or colluding in fraud with the management of a company. If on investigation it is conclusively proved that an auditor of a company had, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation, to the company, then the NCLT (as per first proviso to Section 140(5)) has the power to direct the company to change its auditors. The second proviso to Section 140(5) says that an auditor, whether individual or firm, against whom a final order has been passed by the NCLT, shall not be eligible to be appointed as an auditor of anycompany for a period of five years from the date of passing of the order. The same auditor shall also be liable for prosecution under Section 447 of the Act.
To contextualise the issue, IL&FS Group Companies committed a series of defaults in September 2018 when it was saddled by an aggregate debt burden of over INR 91,000 crore. It not only threatened to collapse Indian financial markets, but also sparked a stock market sell off. Taking cognizance of the imminent threats and a dip in investor confidence, the Department of Economic Affairs, Ministry of Finance issued an Office Memorandum to the Ministry of Corporate Affairs (“MCA”) requesting it to take action under the Act. Pursuant to the same, the Serious Fraud Investigation Office (“SFIO”) submitted a report after investigating IL&FS and its group companies including IFIN and ITNL.
Based on the report submitted by SFIO in relation to IFIN, MCA filed a petition under Section 140(5) of the Act before the NCLT (“the Petition”), inter alia¸ against the auditors of the IFIN, namely, BSR & Deloitte and their engagement partners as well as their team. Deloitte had retired as statutory auditors of IFIN in 2017-18 and thereafter BSR was appointed as the statutory auditor. Subsequent to the filing of the petition by the MCA, BSR tendered their resignation.
In the proceedings before the NCLT, both BSR and Deloitte challenged the maintainability of the Petition on the ground that they are no longer the auditors for IFIN, as they had tendered their resignation and, therefore, Section 140(5) of the Act is not applicable to them. The NCLT passed an order upholding the maintainability of Section 140(5) of the Act.
The order of the NCLT along with the constitutional validity of Section 140(5) was challenged by BSR and Deloitte before the Bombay High Court by way of writ petitions. The Bombay High Court while upholding the constitutional validity of Section 140(5), held that no action is maintainable against BSR and Deloitte as they are no more the auditors of IFIN. Hence, the matter reached the Supreme Court.
Supreme Court Judgment in a nut-shell
- It has been reiterated by the Supreme Court that an auditor plays a very important role so far as the affairs of any company are concerned and therefore, he should be independent and above the board.
- The powers of the NCLT in first part of Section 140(5) is quasi-judicial in nature and the NCLT would have the powers of a civil court to examine the role of auditors and adjudicate on their fraudulent conduct and abdication of their function.
- The powers under first proviso to Section 140(5), which provides for removal of the auditor can be said to be an interim or pro-tem measure to prevent an existing auditor from continuing and substitute him with an auditor based on a prima facie satisfaction that a fraud has been perpetrated and when circumstances warrant the substitution.
- Such an order can be said to be an interim order akin to a temporary suspension during the pendency of the detailed enquiry as provided under Section 140(5) and before any final order is passed by the Tribunal.
- The powers under second proviso to Section 140(5), which envisages debarment of the auditor or the firm for five years when a final order is passed by the NCLT and provides that an auditor against whom final order has been passed by the NCLT, shall not be eligible to be appointed as an auditor of any company for a period of five years from the date of passing of the order is a substantive provision and it operates on the final order passed by the NCLT.
- The second proviso to Section 140(5) was introduced after a detailed analysis of the recommendations of the Standing Committee and with a view to make Section 140(5) more stringent and to provide for consequences to an auditor involved in fraudulent conduct.
- It has been declared that before second proviso to Section 140(5) is attracted, there must be a detailed enquiry against an auditor of a company as per first part of Section 140(5) and there must be a clear finding arrived by the NCLT that the auditor directly or indirectly acted in a fraudulent manner, colluded or abetted in relation to the company, its directors or its officers.
- It has been conclusively held that subsequent resignation of an auditor after an application is filed under Section 140(5), by itself shall not terminate the proceedings under the Section. Resignation and/or removal of an auditor cannot be said to be an end of the proceedings under Section 140(5).
- It is not the intention of the legislature that an auditor can resign to avoid the consequences of the final order under second proviso to Section 140(5). In case the proceedings are terminated after the retirement, resignation or removal of the auditor, the second proviso to Section 140(5) shall be rendered otiose and the purpose of Section 140(5) shall be frustrated. Hence, Section 140(5) of the Act is not arbitrary or ultra vires.
- The use of word ‘any’ under second proviso to Section 140(5) is significant. On the passing of the final order by the NCLT, the delinquent auditor shall not only be removed as an auditor of the company in question but shall also not be eligible to be appointed as an auditor of any company for a period of five years.
- The intention of the legislature while enacting Section 140(5) is very clear and the powers conferred upon the NCLT under Section 140(5) shall operate ‘without prejudice to any action under the provisions of the Companies Act, 2013 or any other law for the time being in force’.
- On the contention that Section 140(5) operates unfairly in comparison to similarly placed alleged perpetrators, such as directors and/or management, it has been held that auditors play a very important role in the affairs of the company, therefore, they have to act in larger public interest and consider all the other stakeholders. Hence, the provision cannot be said to be discriminatory and violative of Article 14 of the Constitution of India.
- The Supreme Court also rejected the contention that the subsequent disqualification of auditor is akin to civil death and Section 140(5) impinges upon fundamental right to carry on its profession, as guaranteed under Article 19(1)(g) of the Constitution. It observed that an action in a fraudulent manner, directly or indirectly, by an auditor is a very serious misconduct and, therefore, the necessary consequence of indulging into such fraudulent act shall follow.
This judgment clearly brings into picture the stringent accountability of the auditors and the pro-active role they are expected to play so far as the affairs of any company are concerned. While auditors may not necessarily view themselves as being responsible for fraud, however the public and the regulators expect them to play a crucial role in safeguarding their relevant interests, especially where large sums of public money are involved. Therefore, as has been rightly pointed out by the Supreme Court, the subsequent resignation/ removal of auditors pursuant to alleged commission of fraud shall not act as a defence and hence the proceedings initiated under Section 140(5) of the Act shall be maintainable.
It is interesting to note that on the question whether the automatic disqualification of auditors and the entire firm, including partners, for a period of five years to be an auditor of any other company is highly disproportionate, the Supreme Court answered that it is ultimately for the Legislature / Parliament to decide. The Supreme Court, after interpreting the provision has held that even on the principle of joint and severe liability, the auditors and the entire firm including partners shall be liable and therefore can be subjected to Section 140(5) of the Act and consequences mentioned therein shall follow.
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Vikash Kumar Jha, Cyril Amarchand Mangaldas
 2023 SCC OnLine SC 557