Background
India’s evolving financial reporting system has made robust corporate governance mechanisms indispensable. The need for heightened financial reporting mechanisms was first felt after the country was rocked by multiple corporate scandals, specifically 2009’s Satyam Computer scam. The scam exposed numerous auditing-related issues, namely, the manipulative practices of auditors, inadequacy of regulatory oversight in accounting and auditing standards, and the importance of accountability of the professional conduct of auditors. It also raised crucial questions related to the independence and effectiveness of auditors. Against this backdrop, there was a reverberating demand for stronger institutional frameworks to regulate and supervise accounting and auditing standards in the country. It became imperative to set up an autonomous body for financial reporting to attract foreign investment and elevate public confidence in the financials of investee companies, leading to the establishment of the National Financial Reporting Authority (“NFRA”).
Context
Before NFRA’s creation, the accounting and auditing standards in India were monitored on a self-regulatory model by the Institute of Chartered Accountants of India (“ICAI”). The shortcomings of such a model and the lack of independence was highlighted in the Thirty-Seventh Report of the Standing Committee on Finance (2016-2017) (Sixteenth Lok Sabha), related to the Companies Bill, 2016, wherein it was stated that out of the 1,972 cases which were taken up for investigation by the Disciplinary Committee of ICAI, a permanent ban was only imposed in the Satyam Computers case and only in 14 other cases were the penalties of more than a year imposed on the members. In majority of the cases, the members were found not guilty. The ineffectiveness of such a model was taken on record when the corporate ministry stated that “…the self-regulatory mechanism of ICAI has inherent weakness as far as disciplining and enforcement is concerned and increasingly in different jurisdictions an independent regulator is being established for such oversight.”[1] Even the Supreme Court, in S. Sukumar vs The Secretary, Institute of Chartered Accountants of India & Ors.[2], emphasised the need to move away from a self-regulatory model and establish an independent regulatory oversight over the professional conduct of auditors and accounting standards.
The discovery of serious financial and corporate governance irregularities in IL&FS in early 2018, provided the much-needed impetus for the establishment of NFRA. The Government by a 2018 notification, officially established the NFRA, to raise the accounting and auditing standards in India to global levels and create an effective independent regulatory oversight over the accounting and auditing functions of body corporates and auditors. The NFRA was established under Section 132 of the Companies Act, 2013 (“CA 2013”), and was given the power to monitor and enforce compliance with high standards of audit and accounting. It also has the power to initiate investigations on a suo moto basis or on recommendations from the Central Government. The NFRA’s mandate is to protect public interest and interest of other parties, such as investors, creditors, etc., associated with body corporates by setting up high quality standards and ensuring adherence with the same.
Ever since the constitution of the NFRA, numerous actions have been taken against various auditors who have failed to uphold such high standards. One such action of NFRA, wherein show-cause notices were issued to various auditors in 2021, was challenged before the Delhi High Court (“Delhi HC”) in Deloitte Haskins & Sells LLP v. Union of India & Ors[3] (“The Deloitte Judgment”). A variety of issues such as the constitutionality of Section 132 of CA 2013 and its retroactive operation, powers of the NFRA, the separation of functions and the vicarious liability of audit firms in cases of misconduct were challenged before the Single Judge at the Delhi HC. In this blog, we focus only on the latter to understand the liability of audit firms and their partners, in case of any misconduct by any engagement partner.
Vicarious Liability
The Principle
The doctrine of vicarious liability, a common law principle in relation to the law of torts, ordinarily postulates that a person may be held liable for the tortious acts of another. It has evolved from the Latin phrase ‘qui facet per alium facit per se’, which means that ‘he who does an act through another, does the act himself’ and ‘respondeat superior’,which means that ‘let the principal be held liable’.
The Deloitte Judgment
It was argued by the Petitioners that holding a Limited Liability Partnership (“LLP”) vicariously liable for any consequences flowing from Section 132 of CA 2013 would have the effect of imposing a liability on each partner of the firm, irrespective of their involvement in the audit function. In view of this, such partners would, therefore, face liabilities despite having no role in the alleged fraud, negligence or misconduct, and such liability places an unreasonable restriction on the fundamental rights of the LLP and its partners to practice the profession under Article 19(1)(g) of the Constitution and such disproportionate penalty would also be violative of Article 14.
Reliance was also placed on Sections 27, 28 and 30 of the Limited Liability Partnership Act, 2008 (“LLP Act”), to further substantiate the argument that an act of fraud by one partner cannot be attributed to another partner of the LLP or partnership firm, if the latter is not involved in the alleged fraud.[4] Therefore, it was argued that implicating a non-participating partner would run contrary to the protection under the LLP Act, and hence be invalid. Thereafter, whilst also relying on the CA 2013, it was argued that Section 132 came into force after the LLP Act, and therefore, it cannot be construed to destroy, diminish, alter or modify the rights and protections conferred by the LLP Act.
The Respondents, on the other end, argued that a partner of a firm that is appointed as an auditor, acts as a representative and agent of such entity. They placed reliance on the Accounting Standards (“SA”) to further argue that the partner of an audit firm, appointed in terms of Section 139 of CA 2013, owes his engagement and involvement in the audit to the appointment of the firm itself; and SAs require the appointed auditor to exercise ‘control and oversight’ over the functions of its partners in an audit. Therefore, it was argued that discharge of functions by a member of an audit firm must not be viewed as distinct or removed from the engagement of the firm as an auditor itself.
Finally, reliance was placed on Sections 25 and 26 of the Partnership Act, 1932, according to which, every partner is jointly held liable with other partners and also severally for all acts of the firm. Likewise, Section 27(2) of the LLP Act expressly holds an LLP responsible for the actions of its partners. In light of this, it was submitted that the argument of vicarious liability was clearly misconceived.
In its judgment, the Delhi HC observed that the CA 2013, allows the firm as well as the engagement partners to be held liable under Section 147 of CA 2013, which was operationalised before Section 132 of CA 2013. Hence, claiming that Section 132 of CA 2013 creates a liability that is uncontemplated is incorrect, and liability of an audit firm by virtue of the actions of its partners does not violate Article 14 of the Constitution. They held that any interpretation proposing distinct spheres of liability for a firm and its partners is inherently flawed. Opining on the relationship between a firm and its members, they held that “the relationship between a firm and its members while delivering auditing services is one of complete integration, where roles and responsibilities overlap to ensure the highest levels of professional service. The nature of such services does not permit a firm to distance itself from the actions of its partners, especially when those actions are performed in furtherance of the firm’s obligations. Therefore, liability, whether incurred by the firm or its members, cannot operate in silos but is instead a shared and unified responsibility that reflects the cohesive nature of their engagement.”
In its interpretation of Section 27 and 28 of the LLP Act, they observed that any act of audit by an engagement partner would be considered to be ‘in the course of the business’, and therefore, the liability under Section 27(2) for wrongful acts or omissions of a partner would be imposed upon the LLP. Further, while Section 28(2) states that a partner does not become personally liable for the wrongful acts of another partner of the LLP, it would have to be construed bearing in mind the fact that the audit firm is being appointed as the auditor and the engagement or involvement of its partner becomes inextricably connected with that function.
Conclusion
The Delhi HC finally concluded that Section 132 is neither an overreach nor is it arbitrary, as it enforces professional accountability. They held that, “any attempt to isolate the liability of the firm from the actions of its members would result in a fragmentation of accountability, contrary to the statutory intent and purpose of ensuring public trust in financial reporting.” The position of law that emerges is that vicarious liability, as in the case of an auditor, has always been in the legislative scheme and there is no infirmity in law that imposes a penalty on a firm or an individual, as the firm’s oversight over the functioning of its auditors to ensure compliance with the SAs is integral to its statutory functions.
[1] Thirty-Seventh Report of the Standing Committee on Finance (2016-2017) (Sixteenth Lok Sabha) related to the Companies Bill, 2016 at pg. 52-54.
[2] (2018) 14 SCC 360.
[3] 2025 SCC OnLine Del 641.
[4] Section 28(2) and Section 30 of the LLP Act.
