Implications
of Alleged Fraud: Auditors disqualification under section 140(5) of Companies
Act, 2013.
Case Details: Union of India vs Deloitte Haskins and
Sells LLP
Citation: MANU/SC/0518/2023
Hon'ble
Judges/Coram: M.R. Shah
and M.M. Sundresh, JJ.
Decided On: 03.05.2023.
Introduction
In
a landmark decision, the Supreme Court of India addressed the constitutionality
of Section 140(5) of the Companies Act, 2013 and upheld its validity. In its
judgement, the court stated that the provision does not violate Articles 14 and
19(1)(g) of the Indian Constitution by being arbitrary, excessive,
discriminatory, or otherwise unconstitutional. The ruling emphasises the importance
of auditors in safeguarding the interests of stakeholders and validates the
constitutionality of Section 140(5) in cases of auditor fraud.
Brief
facts of the case
IL&FS
Financial Services Limited ("IFIN") hired Deloitte Haskins and
Sells LLP ("Deloitte") and BSR & Associates LLP ("BSR")
as statutory auditors. In 2017, BSR
became IFIN's joint statutory auditor after Deloitte's eight-years tenure.
In
September 2018, IFIN Group Companies defaulted on more than INR 91,000 crores
in debt, corporate governance and accounting fraud caused this massive debt
disaster. Deloitte and BSR performed IFIN's 2017-18 statutory audit. It
threatened Indian financial markets and caused stock market sell-offs.
Accordingly, the Serious Fraud Investigation Office ("SFIO")
examined IFIN and its group companies, issued a report, and brought actions
against Deloitte and BSR under Section 140(5) of the Act. BSR submitted a
resignation letter arguing that Section 140(5) did not apply to them since they
were no longer IFIN's auditors. In 2018,
Deloitte resigned as IFIN's statutory auditors for similar reasons.
BSR
and Deloitte argued before the Hon’ble National Company Law Tribunal ("NCLT")
that Section 140(5) of the Act does not apply to them because they resigned as
IFIN's auditors, NCLT upheld section 140(5).
BSR
and Deloitte filed writ petitions before the Hon’ble Bombay High Court
challenging the order of the National Company Law Tribunal. The Bombay High
Court ruled that no action can be brought against BSR and Deloitte as they are
no longer IFIN's auditors. Thus, the matter was brought before the Supreme
Court.
The
bench observed
·
The bench held that the
legislature does not intend for an auditor to be able to resign to escape the
consequences of a final order under the second proviso to Section 140(5). In
the event that the proceedings are terminated after the auditor's retirement,
resignation, or removal, the second proviso to Section 140(5) becomes null and
void and the intent of Section 140(5) is defeated. Therefore, Section 140(5) of
the Act is neither arbitrary nor beyond its authority.
·
It has been determined
that auditors play a very important role in the affairs of the company and must
therefore act in the larger public interest and take into account all other
stakeholders. Therefore, the provision cannot be deemed discriminatory and in
violation of Article 14 of the Indian Constitution.
·
The Supreme Court
emphasised Section 140(5), stating that it is a substantive provision resulting
from the NCLT's determination that the auditor acted improperly. As per the statute, for the next five (5)
years, the auditor is ineligible to be appointed as auditor of any the
company. As a result, an auditor cannot
avoid these repercussions simply by leaving as a company's auditor.
·
However, the penalty of
automatic disqualification of auditors and the entire firm, including partners,
from becoming the auditor of any other company for five years is grossly
disproportionate. In this regard, the Court stated that the ultimate
responsibility for disqualification rests with the legislature.
·
It has been held
unequivocally that the subsequent resignation of an auditor after a Section
140(5) application was filed does not terminate the proceedings under Section
140(5).
Conclusion
The
decision has far-reaching repercussions for the auditing profession and
reinforces India's regulatory framework governing auditing practises. The
Supreme Court reaffirms auditor accountability and responsibility in ensuring
the integrity and reliability of financial reporting by supporting the
constitutional validity of Section 140(5) and affirming the NCLT's powers to
prosecute against auditors. The Supreme Court has adopted a harsh position
against auditor misconduct and collusion by stating that the legal
repercussions of fraud cannot be avoided by mere stepping down. This judgement will undoubtedly serve as a
deterrent to professional malpractice not only for auditors but also for other
professions.
This Article has been compiled by Anurag
Tewari (Associate)
You can direct your queries or comments to the author at
info@factumlegal.com
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