On September 30, 2018, Ministry of Corporate Affairs (MCA) directed the Serious Fraud Investigation Office (SFIO) vide Section 212(14) of the Act to initiate investigative proceedings against IFIN, a subsidiary of IL&FS Financial Services and its auditors for their alleged role in the financial irregularities of IFIN. BSR Associates became the auditor of IFIN on 27/11/2017 jointly with its earlier auditor Deloitte till 31/3/2018. After 01/04/2018, BSR continued as a sole company auditor and resigned on 19/06/2019.
In May 2019, IFIN issued a notice to BSR for their removal as auditors of the company. In furtherance, the MCA issued a sanction order on 29/05/2019 directing initiation of action against both the auditors under Section 140(5) of the Act and removal of BSR as the auditors of IFIN.
Section 140 (5) of Companies Act, 2013 provides that National Company Law Tribunal (NCLT) on an application by the Central Government if finds that an auditor of a company has directly/indirectly acted/abetted/colluded in any fraudulent activity, the tribunal may direct the company to change its auditors and such an auditor shall not be eligible to be appointed by any other company for five years, in addition to being liable for action under Section 447 (Punishment of Fraud). MCA also directed criminal prosecution of BSR under Section 417, 420 read with 120 of IPC, 1860.
The UOI finally filed a company petition through the MCA against Deloitte and KPMG’s subsidiary BSR Associates in NCLT seeking their removal as the statutory auditors of IFIN and debarment of five years. In June 2019, BSR finally resigned as the statutory auditor of IFIN and challenged the maintainability of the company petition filed by the MCA. Their plea was however dismissed by the NCLT on August 9, 2019. BSR Associates, Deloitte Haskins & Sells and other external auditors had then moved the High Court of Bombay which had granted an interim stay on the NCLT’s decision of debarment of the audit firms vide its order on September 5, 2019.
Issues before the Court
- Whether Section 140(5) of the Companies Act, 2013 is unconstitutional.
- Whether Section 140(5) violates the principle of double jeopardy.
- Whether NCLT can exercise the jurisdiction under S.140(5) of the 2013 Act after the CA to be removed has resigned or ceased to be the statutory auditor of the concerned Company.
- Whether the direction to prosecute the audit firms after reading the SFIO report is with due application of mind.
Arguments of the Petitioners
The counsels for the petitioners brought to the Court’s notice that a report concerning the affairs of IFIN was submitted by SFIO to the MCA on 29/05/2019 which further directed the SFIO to file a complaint on 30/05/2019. The contention was that it is not humanly possible to go through a 732-page report further containing relevant annexures running into 32,000 pages in a mere span of 30 hours by two officers simultaneously as claimed by the MCA, and hence the order sanctioned was without application of mind. Further, the petitioners argued that no action can be initiated against the audit firm under Section 140(5) since they had already tendered their resignation.
The second contention stated that the report submitted by the SFIO was an interim report and not a final one and “as such prosecution cannot be filed on its strength.” A copy of the same interim report was not provided by the MCA to the petitioners despite repeated demands.
Concerning the constitutionality of Section 140(5), Advocate Kambata appearing for BSR associates relied upon Shri Ram Krishna Dalmia and Ors. vs. Shri Justice S. R. Tendolkar and Ors (AIR 1958 SC 538) and Ameerunnissa Begum and Ors. (AIR 1953 SC 91) to show that there was no intelligible differentia existing between company auditors and directors/office bearer of the company. He argued that the section unreasonably differentiates against the company auditors and as such is unconstitutional vide Article 14.
Further on, he contended that the penalty of 5 years of debarment is a mandatory civil death for the company auditor, the consequences of which are drastic for him and his family and as such the punishment must be given vide the doctrine of proportionality.
Advocate Desai appearing for one of the petitioners further submitted that order of MCA was based on the interim report while the investigation was still incomplete by the SFIO and argued that when fraud is detected both Section 140(5) and Section 447 of the Act spring into action, giving a different meaning to fraud and as such constitutes double jeopardy.
Arguments of the Respondents
Advocate Chinoy appearing for the UOI submitted that second proviso to section 140(5) is a substantive provision. He stated that the resignation of auditors against whom proceedings are initiated under section 140(5) is out of the question since the law does not permit company auditors to resign at their free will before completion of certain formalities. He relied upon Subramanium Swamy vs. CBI (2014) 8 SCC 682 and Swiss Ribbons P ltd. vs. UOI (2019) 4 SCC 17 to state that there is a presumption of constitutionality of Section 140(5) and the petitioners have to make out a clear case of transgression of constitutional principles.
Further relying on Director of Enforcement vs. M.C.T.M. Corp. (P) Ltd.- (1996) 2 Supreme Court Cases 471, he claimed that barring the auditors from acting and practising for a short duration does not account for prosecution or punishment. Dealing with the argument of proportionality advanced by the petitioner, he stated that section 140(5) springs into life when fraud or collusion is perceived which is essentially misconduct of a superior degree than mere negligence and only after the satisfaction of NCLT. He thereby inferred that double jeopardy under Article 20(2) can only be attracted when there is prosecution concerning an offence which is lacking in the present case.
He further submitted that the auditors are independent representative of the shareholders and are not subordinate to the director, hence the differentia is tangible per se. It was submitted that the report by SFIO is final under Section 212(11) and it will be hypothetical to presume that a large report cannot be looked in within 30 hours without application of mind. Hence, the order dated 20/05/2019 by MCA stands ground and is valid.
- Change in auditor and debarment vide Section 140(5) is after satisfaction of NCLT and cannot be seen as a disproportionate act.
- Director of a Company or its Officers form a distinct class and are to be seen as part of the establishment of the Company. However, the CA stands on an entirely different footing and cannot be seen as an officer of or subordinate to Company in any manner. Thus, no discrimination has been made vide Section 140(5).
- There is a difference between disqualification and punishment, the former may not constitute an offence while the latter always does. As offences are not dealt with by the NCLT, disqualification stipulated in the second proviso to Section 140(5) is for the misconduct of the auditor and not a fraud. It cannot be construed as a second punishment and does not attract the principle of double jeopardy.
- The report of SFIO running into 750 pages considered by two MCA officers within 30 hours one after the other, appears to be highly improbable.
- If the CA has already ceased to be such CA, that final order cannot be passed against him as he cannot be or need not be changed.
- CAs who defrauded the Company but have completed their term and left cannot be changed and therefore are not amenable to Section 140(5) of the Act. They can be tried for professional misconduct under Section 132 or under the Chartered Accountants Act.
Pronounced by Chief Justice B.P. Dharamadhikari and Justice Nitin R. Borkar.
- Upheld the constitutional validity of Section 140(5) of the Act.
- Dismissed the plea of MCA seeking a ban of the two audit firms for five years vide Section 140(5)
of the Act and held the order dated 29/5/2019 passed by NCLT with effect to the above be void.
- Held that Section 140(5) of the Act cannot be exercised against auditors who have resigned/ ceased to be the auditor of the company after the completion of their term.
- Proceedings under S. 212(14) of the Act issued by UOI via SFIO is unsustainable and is set aside.
- The consequential criminal prosecution lodged against the audit firms was hence found not maintainable and quashed.
- Ministry of Corporate Affairs is further given an eight-week time to appeal against the order passed by the Bombay High Court.
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