Critique of Section 140(5) of Indian Companies Act & Resignation of Auditors: Assessing the Viability of Termination of Proceedings

As authors of this article, we present a comprehensive analysis of the Supreme Court’s landmark decision in the case of Union of India and Others vs. Deloitte Haskins and Sells LLP & Others, which explores the constitutionality of Section 140(5) of the Companies Act, 2013. In this article, we will delve into the court’s meticulous […]

As authors of this article, we present a comprehensive analysis of the Supreme Court’s landmark decision in the case of Union of India and Others vs. Deloitte Haskins and Sells LLP & Others, which explores the constitutionality of Section 140(5) of the Companies Act, 2013. In this article, we will delve into the court’s meticulous examination of the case and its conclusion regarding the compatibility of Section 140(5) with constitutional principles, particularly in relation to the resignation and removal of statutory auditors. The Supreme Court’s judgment meticulously scrutinized the provisions of Section 140(5) of the Act and carefully evaluated its compliance with fundamental constitutional rights, such as non-discrimination and protection against arbitrariness. Our analysis will delve into the court’s in-depth interpretation of the constitutional validity of Section 140(5), focusing on its examination of Articles 14 and 19(1)(g) of the Indian Constitution. Furthermore, we will explore the court’s reasoning behind its conclusion that the voluntary retirement or resignation of auditors subsequent to the initiation of proceedings under Section 140(5) does not automatically terminate such proceedings. This critical aspect of the judgment has significant implications for auditors and the enforcement of accountability measures within the corporate sector.
Decoding Legislative Intent
Section 140, which is titled “Removal, Resignation of Auditor and Giving of Special Notice,” finds its place within Chapter X of the Companies Act, which specifically addresses the crucial area of “Audit and Auditors.” This section encompasses several subsections that delineate the processes and requirements related to the removal, resignation, and appointment of auditors in a company.
Section 140(1) of the Act provides explicit guidelines on how a company can initiate the removal of an auditor before its term expires. This provision ensures a proper procedure is followed when considering the removal of an auditor from their position. Furthermore, Section 140(2) and (3) of the Act specifically deal with the resignation of auditors, establishing the necessary steps and protocols to be followed by auditors when they choose to resign from their role. These provisions promote transparency and accountability during the resignation process. In addition, Section 140(4) of the Act addresses the aspect of giving special notice at an annual general meeting when appointing a new auditor, particularly when the retiring auditor will not be reappointed. This provision ensures that the appointment process of a new auditor is conducted with appropriate notice and diligence.
Importantly, Chapter X of the Act grants the National Company Law Tribunal (‘NCLT’) extensive powers through Section 140(5). The NCLT can exercise these powers either on its own motion or upon receiving an application from the Central Government or any concerned individual who suspects an auditor’s involvement in fraudulent activities or collusion with the company’s management in fraudulent acts. This provision empowers the NCLT to investigate such instances thoroughly.
Once the NCLT concludes its investigation and establishes conclusive evidence of fraudulent behaviour or collusion by the auditor, it is vested with the authority, as stipulated in the first proviso to Section 140(5), to direct the company to change its auditors. This provision ensures that appropriate action is taken to maintain the integrity of the audit process within companies. Moreover, the second proviso to Section 140(5) imposes additional consequences on auditors against whom a final order has been passed by the NCLT. It bars them, whether they are individuals or firms, from being eligible for appointment as auditors of any company for a duration of five years from the date of the order. Furthermore, auditors subject to such orders may also face prosecution under Section 447 of the Act, which deals specifically with fraudulent activities.
These provisions and powers within Chapter X of the Companies Act, including those outlined in Section 140, collectively contribute to enhancing corporate governance, ensuring transparency, and holding auditors accountable for their actions. By setting forth clear guidelines and empowering the NCLT to address fraudulent practices, these provisions play a crucial role in maintaining the integrity of the audit process and upholding the principles of good corporate practices in India.
Background of the Matter
The IL&FS Group Companies encountered a series of defaults in September 2018, burdened by a substantial debt of over INR 91,000 crore. These defaults not only posed a severe threat to the stability of the Indian financial markets but also triggered a significant sell-off in the stock market. Recognizing the impending risks and the decline in investor confidence, the Department of Economic Affairs, Ministry of Finance, took proactive measures by issuing an Office Memorandum to the Ministry of Corporate Affairs (‘MCA’), urging action under the relevant legislation. In response to the Office Memorandum, the Serious Fraud Investigation Office (‘SFIO’) conducted an in-depth investigation into IL&FS and its group companies, including IFIN and ITNL.
The SFIO subsequently submitted a comprehensive report highlighting their findings and recommendations regarding the matter. Based on the SFIO’s report, the MCA filed a petition under Section 140(5) of the Act before the National Company Law Tribunal (NCLT), specifically targeting the auditors of IFIN, namely BSR & Deloitte, along with their engagement partners and team. Deloitte had already retired as the statutory auditor of IFIN in the 2017-18 financial year, and BSR had been appointed as the successor. Following the filing of the petition by the MCA, BSR tendered their resignation. During the NCLT proceedings, both BSR and Deloitte contested the maintainability of the petition, arguing that they were no longer the auditors of IFIN due to their resignation. They contended that Section 140(5) of the Act was not applicable to them. However, the NCLT issued an order affirming the maintainability of Section 140(5) of the Act. BSR and Deloitte subsequently challenged the NCLT’s order, as well as the constitutional validity of Section 140(5), by filing writ petitions before the Bombay High Court. The Bombay High Court upheld the constitutionality of Section 140(5) but concluded that no action could be pursued against BSR and Deloitte since they were no longer the auditors of IFIN. Dissatisfied with the outcome, the matter was eventually brought before the Supreme Court for resolution.
Critique of Apex Court Judgement
The Supreme Court addressed the issue of resignation and termination of auditors under Section 140(5) of the Companies Act. The court ruled that the filing of an application according to Section 140(5) followed by an auditor’s resignation does not immediately end the procedures begun under that provision. This also implies that accepting such a stance would allow auditors who were subject to proceedings to avoid consequences by merely resigning, which would be contrary to the legislative objective underlying the clause. This ruling provides protection from any misconduct and ensures that auditors will be held responsible for their acts.
The Court instead emphasised the need for a final ruling by the tribunal to decide whether or not the auditor engaged in misconduct or fraud. This emphasis on a thorough inquiry makes sure that auditors cannot evade investigation by resigning from their positions or being dismissed. The Court’s decision confirms that an in-depth investigation of auditors’ involvement in fraudulent activities is essential for upholding corporate governance and transparency. It also addressed the constitutional validity of Section 140(5) and found it to be in compliance with Articles 14 and 19 of the Indian Constitution. It denied the claim that the provision was an arbitrary use of authority and highlighted the critical role auditors play in defending the company’s and stakeholders’ interests by emphasizing Chapter X of the Act.
Concluding Thoughts
The Supreme Court’s ruling on the resignation and termination of auditors under Section 140(5) of the Companies Act is a positive move in highlighting the auditors’ proactive role in preserving the integrity of business activities and enhancing their accountability. The court guarantees that auditors cannot escape the consequences of their acts by making it clear that resignations or removals of auditors following charges of fraud will not be considered a defence and that proceedings started under Section 140(5) would proceed. It is vital to understand that while auditors may not perceive themselves as personally liable for fraud, they are nonetheless expected to aggressively protect the interests of the general public and regulators, particularly in situations involving substantial sums of public funds. The court’s ruling highlights the significance of auditors’ work in fostering transparency, accountability, and public confidence in the finance sector. It serves as a reminder that auditors bear a significant responsibility and should act on what’s best for all parties involved.
Moving forward, it would be ideal to find a balance between holding people accountable and safeguarding their legal rights and reputations as professionals. Clear guidelines are needed to differentiate between genuine resignations and attempts to avoid accountability. To address the broader challenges of accountability and transparency, a comprehensive approach to corporate governance that includes all pertinent stakeholders, such as directors, management, and regulators, should be taken into consideration. Overall, the Supreme Court’s decision emphasises the significance of auditors in upholding the integrity of company operations and emphasises the necessity for auditors to rigorously discharge their duties.