Case comment: Union of India and ANR. Vs. Deloitte Haskins and Sells LLP & ANR

Facts: 

1. In 2018, the IL&FS Group Companies defaulted on debts exceeding Rs. 91,000 crores, causing significant disruptions in India’s money markets, corporate bond yields, and stock market. The Ministry of Corporate Affairs (MCA) intervened under the Companies Act, 2013, due to concerns over corporate governance failures, falsified accounts, and the potential for further economic fallout from additional defaults.
2. The MCA directed the Serious Fraud Investigation Office (SFIO) to investigate IL&FS and its subsidiaries. A petition was filed with the National Company Law Tribunal (NCLT) to remove the existing Board of Directors and appoint a new one. The NCLT granted this petition, and the new Board submitted a progress report while the SFIO provided an interim report detailing the fraud and those responsible.
3. Following the interim report, the MCA filed a petition to attach the properties of the former directors and initiated proceedings to reopen and restate the accounts of IL&FS and its subsidiaries. The auditors of IL&FS’ subsidiary, IFIN, were issued notices opposing these actions. The Reserve Bank of India conducted inspections of IL&FS and IFIN, and the SFIO filed a criminal complaint against the auditors.
4. Subsequently, the MCA and the SFIO sought the removal of the auditors and a declaration that they were ineligible for future appointments. BSR & Deloitte, the auditors, resigned and filed responses challenging the maintainability of these petitions. The NCLT upheld the maintainability of the petition under Section 140(5) of the Companies Act, but BSR challenged this in court. The High Court upheld the constitutionality of Section 140(5) but overturned the NCLT’s order, quashing the petition and cancelling the associated directions and criminal proceedings.
5. The submission against the High Court’s interpretation of Section 140(5) argued that the provision aims not only to replace auditors but also to investigate and penalize fraudulent conduct by auditors. It emphasized that the provision’s intent is to protect companies, stakeholders, and the public by barring auditors involved in fraud from practicing for five years. The submission contended that the High Court’s interpretation, which deemed the purpose of the section fulfilled upon the auditor’s resignation, was erroneous. It argued that proceedings under Section 140(5) should continue even after an auditor’s resignation, with the NCLT having the authority to pass final orders rendering the auditor ineligible for future appointments. The submission asserted that allowing auditors to avoid consequences by resigning would undermine the provision’s effectiveness.
6. Conversely, the Opposite Party argued that Section 140(5) is intended solely for the removal of auditors and not for their disqualification. It emphasized that the section’s heading indicates its purpose as concerning the removal, resignation, and special notice regarding auditors. Other sections of the Act address liabilities, penalties, and consequences for auditors involved in fraud or misconduct. The Opposite Party maintained that the NCLT’s jurisdiction under Section 140(5) is limited to directing the removal of a company’s existing auditor and does not extend to those who have already resigned. It contended that the resignation of auditors makes Section 140(5) proceedings redundant, as the purpose of removing and replacing auditors has already been achieved.
7. Furthermore, the Opposite Party raised concerns about the excessive and arbitrary nature of Section 140(5), arguing that it grants the NCLT unregulated powers in summary proceedings. It argued that the penalty of automatic disqualification is disproportionate, as similar penalties are already addressed under Section 141(3)(h) after due process. It claimed that Section 140(5) contravenes principles of proportionality and natural justice.
8. In conclusion, the Petitioner requested the court to overturn the High Court’s decision and uphold proceedings under Section 140(5) against the auditors. It argued that the resignation of auditors should not invalidate the proceedings and that the provision aims to prevent fraudulent auditors from being appointed in any company. The Opposite Party, on the other hand, maintained that Section 140(5) serves only to remove auditors and does not confer powers to disqualify them. They contended that the NCLT cannot pass orders against auditors who have already resigned and questioned the proportionality and fairness of Section 140(5).

Issues Raised:

1. Whether the resignation of auditors Deloitte and BSR nullified the proceedings under Section 140(5) of the Companies Act, 2013.
2. The scope of Section 140(5) in debarment of auditors found guilty of fraud even after resignation.
3. The validity and constitutionality of Section 140(5).

Claims Of the Appellants

Among several other claims some of the prime and supreme contentions laid by the Appellants in the instant case are as follows:

• That ‘Deloitte Haskins & Sells LLP’ was no longer the auditors of ‘IFIN’ at the end of the Annual General Meeting for Financial Year 2017-2018 on account of expiry of their terms under section 139 of the Companies Act 2013.
• Putting reliance on the case of Ramesh Hirachand Kundanmal v. Municipal Corporation of Greater Bombay, the appellants contended that the Hon’ble Tribunal in the impugned order have not rendered that the Appellant herein is a necessary or proper party to the CP No. 3638/2018
• The Tribunal does not have jurisdiction to pass an order against auditors under the provision of section 241 or section 242 of the Companies Act 2013 as this provision pertains to mismanagement and oppression of the affairs of the company, but an auditor is not involved in the management of the affairs of the company.
• That the fact that section 339 of Companies Act, 2013 is applicable in the present case in in the light of section 246 of the act is baseless because section 339 of the Act is applicable to the directors, managers or officers of the company only and not to the auditors, as the auditors are not carrying on the business of the company.
• The Report of the SFIO on which the entire impleadment application is based does not contain any allegations against the appellant of any unlawful gains and so there cannot be any question of disgorgement under the provision of section 339 of the act read with section 246 of the Companies act, 2013.

Response Of the Respondent

In arguments presented the Respondent laid down several responses challenging the claims put forward by the Appellants. The relevant responses in connection with the above-mentioned claims are as follows:

• The Central Government has humbly submitted that the Tribunal has ample powers under the provisions of Section 241(12) read with the provisions of section 242 of the Companies Act, 2013.
• The Respondent herein highlighted various allegations as quoted in the 2nd Report of SFIO/ ICAI Report/ RBI Inspection viz

1. The Statutory Auditors made connivance with the management of the company.
2. That the Auditors have concealed material facts as they have not reported falsified books and fraudulent statements from financial Year 2011-2012 to 2017-2018.
3. That the Auditors have not performed their duties with due diligence.
4. The auditors have attempted to postpone the provisions and recognitions of NPA as they have transferred the loans by mere book entry which showed old loans as closed and non-provisioning of new loans.

• That under the provisions of Sections 143(2) and 143(12) of the Companies Act, 2013 it is the duty of the auditor that if the auditor has reason to believe that if an offence of fraud has been committed, involving account, in the company by its employees or officers then the auditor must report the same. But in the present case the auditors failed to perform their statutory duty and did not report the same to the Central Government.
• That Respondent herein submitted that opinion was not solely formed based on SFIO Report as alleged by the Appellants. Rather, other facts were considered viz, RBI Inspection Report, ICAI Report, etc while filing its application for impleadment.

Rationale:  

The Supreme Court held that the resignation of auditors does not nullify proceedings under Section 140(5) if fraud is involved. The court emphasized the importance of maintaining auditor independence and accountability, ensuring that fraudulent auditors do not avoid consequences by merely resigning. The court noted that Section 140(5) allows the National Company Law Tribunal (NCLT) to investigate and debar auditors involved in fraudulent activities for up to five years​.

Defects of law: 

1. Ambiguity in Section 140(5): The provision was criticized for not clearly defining the scope of actions against auditors’ post-resignation, leading to differing interpretations by lower courts​. 
2. Constitutionality Issues: Arguments were made regarding the violation of fundamental rights under Articles 14 and 19(1)(g) of the Constitution, contending that the provision grants excessive powers without adequate safeguards​.
3. Proportionality: The provision was challenged for being excessively punitive, potentially leading to disproportionate penalties without a comprehensive trial​.

Inference:  

The Supreme Court’s decision reinforces stringent measures against auditors involved in financial fraud, highlighting the necessity of accountability in corporate governance. The ruling underscores that auditors cannot evade responsibility through resignation and affirms the broader aim of protecting stakeholders and maintaining public trust in financial reporting. The judgment may prompt legislative reviews to clarify and balance the punitive aspects of Section 140(5), ensuring both accountability and fairness in its application​ (itatonline.org)​​ (Legal Readings)​.

Overall, this case sets a significant precedent for the treatment of auditors in fraud cases, emphasizing the critical role of statutory mechanisms in safeguarding corporate integrity.

Mourya Kotimalli Ponnapalli

4^th Year law Student Reva University 

Bangalore.