This article is written by Riya Tyagi, a student of NAS College, Meerut.
Citation: 2023 SCC OnLine SC 547
Date of Judgment: 3 May 2023
BACKGROUND
Infrastructure Leasing & Financial Services Limited (IL&FS) was a major infrastructure financing and investment conglomerate in India, in which Deloitte Haskins and Sells LLP were the statutory auditor of IFIN from 2008 to 2018. And BSR LTD was appointed as the statutory auditor in 2017. Around June 2018, the aggregate value of debt liability of ILFS Group reached more than 91,000 Crores. This was also followed by an array of defaults by member companies till September 2018, which created panic selling of stock of these companies.
Noticing this state of affairs, the Department of Economic Affairs, Ministry of Finance, requested the Ministry of Corporate Affairs (hereinafter referred to as MCA) to take action. In addition, in the year 2017-18, the ILFS group reported losses of Rs. 2670 Crore. Simultaneously, the MCA directed the Serious Fraud Investigation Officer (hereinafter “SFIO”) to investigate the affairs of the group.
- On 1 October 2018, NCLT dissolved the existing board of directors through an interim order.
- The SFIO investigation report demanded by MCA revealed that the individuals who were in control of the group companies and the frauds perpetrated by them.
- Another petition was filed under Section 130 of the Companies Act by the MCA before the NCLT for directing the re-opening of the books of account of the group.
- Another petition was filed before the NCLT for the reopening of the books of account under Section 130 of the Act by the MCA.
- On January 1, 2019, the NCLT issued an order to reopen the accounts of IL&FS, IFIN, and ITNL for the previous five fiscal years due to poor management of IL&FS, IFIN, and IL&FS Transportation Networks Limited (henceforth referred to as ITNL), raising concerns about the accuracy of the financial statements and accounts.
- But one director of the board challenged the order before the NCLT, and upon its failure before the apex court. Still, the appeal was dismissed, and the initiation of a petition under section 130 was upheld on 4 June 2019.
- May 29, 2019 – a criminal complaint was filed by SFIO upon the direction of MCA under section 212(14).
- June 10, 2018, the MCA filed a company petition under section 140(5) of the Act for the removal of BSR as auditors (since the auditorship of Deloitte was already overdue to the efflux of time) of the group and to ban both Deloitte and BSR from acting as auditors for any company for a period of five years.
- On June 19, 2019, BSR resigned from the position of auditor. On the same day, BSR filed a reply to section 140(5) petition contending that since it had already resigned from the position of auditor of IFIN, section 140 did not apply to it. On the same day, BSR, along with its engagement partners, applies to it. On the same day, BSR along with its engagement partners and Deloitte also filed an application challenging the maintainability of section 140(5) petition on the same grounds.
- In its decision, the NCLT upheld the maintainability of the petition. The NCLT order, along with the vires of section 140(5), was challenged before the Bombay High Court. The High Court reversed the NCLT order and quashed the petition filed under section 140(5) and also set aside the directions issued by the MCA to SFIO under section 212(14), along with criminal proceedings instituted by the SFIO pursuant to these directions
- The order of the High Court was challenged by the Union of India before the Hon’ble Supreme Court in the present appeal. Since the appeal revolves around the interpretation of section 140(5), it is important to reproduce the same before analysing the contentions of both parties
SECTION 140 OF THE COMPANIES ACT
If the Tribunal is convinced that a company’s auditor has engaged in fraudulent behavior, either directly or indirectly, or has assisted or colluded in any fraud by the company, its directors, or its officers, it may, either on its own initiative or in response to an application from the Central Government or any other interested party, order the company to replace its auditors: With the caveat that if the Central Government submits the application and the Tribunal determines that the auditor needs to be replaced, it must issue an order within fifteen days of receiving the application stating that the auditor will no longer serve in that capacity and that the Central Government may designate another auditor in his place: Provided further that an auditor, whether individual or firm, against whom final order has been passed by the Tribunal under this section 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 and the auditor shall also be liable for action under section 447.”
ARGUMENTS OF THE APPELLANT- UNION OF INDIA/ MINISTRY OF CORPORATE AFFAIRS
1. Statutory purpose would be defeated
The object of section 140(5) is to remove auditors who have acted in a fraudulent manner. If an auditor is allowed to escape liability by simply resigning after an application is filed, the entire provision would become redundant and toothless.
2. Public interest and investor protection
IL&FS financial services were a systematically important NBFC. The alleged fraud by the auditors led to a loss of public money running into thousands of crores. A five- year disqualification is necessary to maintain public confidence in financial markets and the auditing profession.
3. Purposive interpretation required
Section 140 (5) does not expressly limit its application to a ‘current auditor’ only. The words must be read purposively to include an auditor who was in office when the fraudulent conduct occurred, even if he has subsequently resigned.
4. NCLT has wide powers
The NCLT is empowered not only to remove the auditor but also to pass consequential orders. The second proviso to section 140(5) which provides for 5- year disqualification is automatic once the tribunal records a finding of fraud.
ARGUMENTS OF THE RESPONDENT- DELOITTE HASKINS & SELLS LLP
1. Proceeding do not survive resignation
The language of section 140(5) states that the tribunal may “direct the company to change its auditors”. Once the auditor has already resigned, there is no auditor to ‘change’ or ‘remove’’. Therefore, the very basis of the application disappears.
2. Violation of article 19(1)(g)
The automatic disqualification for 5 years from being appointed as auditor of any company amounts to a civil death for the firm and its partners. Such a drastic penalty without a full-fledged criminal trial violates the fundamental right to practice a profession under article 19(1)(g).
3. Breach of natural justice
The proceeding under section 140(5) is summary in nature. Imposing a penalty of 5- year disqualification based on a prima facie finding, without proof beyond reasonable doubt, is excessive and arbitrary. It violates article 14.
4. No vicarious liability for firm
Even if one partner is found at fault, disqualifying the entire firm including innocent partners is disproportionate. Liability should be individual and not extend to the whole firm.
ISSUES
1.Whether the legislative intent of Section 140(5) is removal of the auditor, either by the company, government or through resignation?
2.Whether proceeding under section 140 (5) was maintainable after resignation tendered by BSR before passing of final order by NCLT under the said section?
3.Whether the direction issued by MCA to SFIO for initiating criminal proceedings against BSR and Delloite under Section 212(14) valid?
4.Is Section 140(5) of the Companies Act, 2013 unconstitutional?
DECISION
After observation, the Supreme Court held that the main purpose of section 140(5) is to make the provision more stringent and to provide consequences to the auditor. And the Supreme Court emphasises that the auditor has acted fraudulently. So, an auditor is ineligible to be appointed as an auditor for any company for a period of 5 years. And the auditor cannot escape these consequences by resigning as auditor of a company.
