Supreme Court Upholds Constitutional Validity of Section 140(5) of Companies Act: Auditor’s cannot Escape Proceedings by Resigning

Supreme Court Upholds Constitutional Validity of Section 140(5) of Companies Act: Auditor’s cannot Escape Proceedings by Resigning

The Supreme Court by its coram comprising of Justices MR Shah and MM Sundresh has upheld the constitutional validity of Section 140(5) of Companies Act 2013, which deals with the removal and resignation of auditors and that therefore no auditor can escape by way of resignation or termination of tenure due to efflux of time. The Court held that Section 140(5) cannot be said to be arbitrary, excessive and violative of Article 14 of the Constitution or violative of fundamental rights.

The Court was adjudicating the Central government's plea challenging a Bombay High Court order to quash all prosecution against BSR & Associates, and Deloitte Haskins and Sells, both former auditors of IL&FS Financial Services Ltd, pending before the National Company Law Tribunal (NCLT).

The question before the bench pertained to the interpretation of Section 140(5) of the Companies Act, 2013 (hereinafter referred to as the ‘Act, 2013’) and the Investigation Report dated 28 May, 2019 (hereinafter referred to as the ‘IFIN SFIO Report’) in respect of IL&FS Financial Services Limited (hereinafter referred to as the ‘IFIN’).

The Court set aside the impugned judgment and order passed by the High Court quashing and setting aside the NCLT order holding that even after the resignation of the auditors, the proceedings under section 140(5) shall be maintainable. The Court also quashed the impugned judgment and order passed by the High Court quashing and setting aside the prosecution lodged by the SFIO.

The Court observed “…on true interpretation and scheme of Section 140(5) of the Act, 2013, once the enquiry/proceedings is/are initiated under first part of section 140(5) of the Act, either suo motu by the Tribunal or on an application made to it by the Central Government or by any person concerned, it must come to its logical end and irrespective of the fact whether during such enquiry/proceedings the auditor has resigned or not, there must be a final order to be passed by the Tribunal on whether such an auditor has, in fact, directly or indirectly, acted in a fraudulent manner or not.”

The Supreme Court was of the considered view that the intention of the legislature behind Section 140(5) is very clear that irrespective of the other provisions of the Act, the NCLT is vested with power to see if the auditor acted in a fraudulent manner.

The Court asserted that an auditor, who has, directly or indirectly, acted in a fraudulent manner, to avoid any further consequence under the second proviso to section 140(5), resigns to avoid any consequence under the second proviso to section 140(5), it cannot be permitted.

It was the case on behalf of the original writ petitioners on the constitutionality/vires of section 140(5) that section 140(5) is excessive and arbitrary as it provides unguided and untrammeled powers to NCLT for determination of a serious offence of fraud and consequence of mandatory disqualification with grave consequences akin to civil death. However, the bench rejected this argument as having no substance.

The bench noted that NCLT exercises the quasi-judicial powers under Section 140(5) with all the powers akin to civil court. Ample opportunity shall be given by the NCLT before passing any final order.

The second contention was that section 140(5) is violative of Article 14 of the Constitution of India as it discriminates against the auditors unfairly in comparison to similarly placed alleged perpetrators, such as directors, management etc. Rejecting this argument, the Court said:

“It is required to be noted that the role of auditors cannot be equated with directors and/or management. Auditors play 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 to the importance of the auditors. Therefore, Section 140(5) cannot be said to be discriminatory and/or violative of Article 14 of the Constitution of India.”

The next submission was 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. In this regard, the Court said that it is ultimately for the legislature/Parliament to provide the debarment.

In this context, the Court held that, “On the principle of joint and severe 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 Act, 2013. So far as the submission that the disqualification is akin to civil death and section 140(5) impinges upon BSR and its partners’ fundamental right to carry on its profession, as guaranteed under Article 19(1)(g) of the Constitution is concerned, nobody can be permitted to say that despite acting fraudulently, directly or indirectly, they had a right to continue and/or carrying on their profession.”

Lastly, the Court held that, Section 140(5), is not violative of Articles 14 and 19 of the Indian Constitution as there is no manifest arbitrary use of power.