Proceedings u/s 140(5) of Companies Act persist after Resignation of Auditors: Supreme Court upholds Constitutional Validity of Provision [Read Order]
u – s – 140A(5) – of – Companies – Act – Resignation – of – Auditors – Supreme – Court – Constitutional – TAXSCAN
u – s – 140A(5) – of – Companies – Act – Resignation – of – Auditors – Supreme – Court – Constitutional – TAXSCAN
Auditors play a very important role in the affairs of the company and therefore they have to act in the larger public interest.”
- Justice MR Shah & Justice M M Sundresh, Supreme Court of India
The Supreme Court of India has recently held that the provision for prosecution and punishment under Section 140(5) of the Companies Act, 2013 is neither discriminatory, arbitrary and/or violative of the Constitution of India.
A series of defaults by the IL&FS Group Companies, which had an aggregate debt burden of more than Rs. 91,000 crores, occurred between June to September, 2018 and threatened to collapse the money markets of India, added pressure to corporate bond yields and sparked a sell off in the stock market.
The Department of Economic Affairs, Ministry of Finance issued an Office Memorandum dated 30.09.2018 in respect of IL&FS to the Ministry of Corporate Affairs, Union of India requesting it to take action under the Companies Act, 2013.
Thereafter the Ministry of Corporate Affairs filed a Petition under Section 140(5) of the Companies Act, 2013 dated 10.06.2019, inter alia, against the auditors of the IFIN, namely, BSR & Deloitte and the engagement partners as well as their team. In the petition under Section 140(5), it was inter alia prayed to remove BSR as auditors of IFIN, declare that Deloitte shall be deemed to be removed as Statutory Auditor for IL&FS for F.Y. 2012-13 to F.Y. 2017-18, permit the Ministry of Corporate Affairs to appoint an auditor for IFIN under the first proviso of Section 140(5) of the Act, 2013 and declare/direct that BSR, its engagement partners, Deloitte and its engagement partners shall not be eligible to be appointed as an auditor for any company for a period of five years under the second proviso of Section 140(5) of the Act, 2013.
Deloitte had filed an application dated 19.06.2019 challenging the maintainability of Section 140(5) petition before the NCLT on the ground that Deloitte is no longer the auditor for IFIN. However, the directions issued and the order of the NCLT upheld the maintainability of the Section 140(5) petition which were challenged at the jurisdictional High Court.
Though the High Court has upheld the validity of Section 140(5) of the Act, 2013, the High Court has interpreted section 140(5) of the Act, 2013 and had set aside the order passed by
the NCLT upholding the maintainability of Section 140(5) petition and had quashed Section 140(5) petition and had set aside/quashed the directions issued by the Ministry of Corporate Affairs and the SFIO and also had quashed/set aside criminal proceedings instituted by the SFIO. Hence, the present appeals were filed by the appellant-State.
According to Section 140(5) of the Companies Act, 2013, if the National Company Law Tribunal (NCLT) determines that an auditor of a company has been involved in any fraudulent activity, either directly or indirectly, or has aided or colluded in such an activity, then upon application by the Central Government, the tribunal can order the company to replace its auditor. Furthermore, such an auditor would be barred from being appointed by any other company for a period of five years and could face legal action under Section 447 (Punishment of Fraud).
The Bench of Justice M R Shah and Justice M M Sundresh noted that, “Now so far as the submission that the penalty in the form of automatic disqualification of auditors and of the entire firm including partners and that too for a period of five years to become the auditor of any other company is highly disproportionate is concerned, it is ultimately for the legislature/Parliament to provide the debarment.”
It was also observed that, on the principle of joint and several liability, the auditors and the entire firm including partners shall be liable and therefore can be subjected to section 140(5) and the consequences mentioned in section 140(5) of the Companies Act, 2013.
The bench had also opined that with respect to the constitutional validity/vires of Section 140(5), that the same cannot be said to be arbitrary, excessive or violative of Article 14 or Article 19(1)(g) of the Constitution of India, as alleged, as contended.
The Bench, in consideration of the contentions of the representatives, set aside the impugned judgement and order passed by the High Court quashing and setting aside the direction under Section 212(14) of the Companies Act, 2013 dated 29.05.2019 issued by the Union of India to SFIO.
The said Criminal Complaint CC No. 20/2019 was remanded to be proceeded further by the concerned Trial Court in accordance with law and on its own merits. The High Court had set aside the 212(14) direction mainly on two grounds, firstly, for issuance of direction to prosecute within 30 hours of the IFIN SFIO Report which demonstrates non-application of mind and secondly for being incomplete.
The Bench also observed with respect to the provision and the role of auditors that, “It is required to be noted that the role of auditors cannot be equated with directors and/or management. Auditors play a very important role in the affairs of the company and therefore they have to act in the larger public interest and all other stakeholders including investors etc. Chapter X of the Act specifically for the “Audit and Auditors” looking at the importance of the auditors.”
Amidst the decision, the bench had made the strong observation that, “Acting 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.”
To Read the full text of the Order CLICK HERE
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