In Union of India v. Deloitte Haskins and Sells LLP [i], the Hon’ble Supreme Court of India found Deloitte Haskins and Sells LLP guilty of failing to fulfil its auditing obligations as outlined in the Companies Act, 2013 (‘Act’). The central government referred the case earlier to the National Company Law Tribunal ('NCLT'), which accused Deloitte of overlooking financial irregularities at Infrastructure Leasing & Financial Services Limited (‘IL&FS’). After a thorough investigation, the NCLT found Deloitte guilty of professional misconduct and imposed a fine of Rs.1 crore. Despite Deloitte's appeal to the Supreme Court, the decision was upheld.
This ruling underscores the importance of auditors exercising due diligence and maintaining independence in their audits. It also serves as a stark reminder for the auditing profession to uphold rigorous standards in its practices. The penalties imposed by the NCLT and the Supreme Court should serve as a deterrent to other auditors who may be tempted to cut corners or neglect their duties.
Facts
Between June and September 2018, the IL&FS Group Companies, with an aggregate debt burden of more than Rs. 91,000 crores, suffered a series of defaults that threatened to collapse the Indian money markets.
The Department of Economic Affairs, Ministry of Finance, issued an office memorandum on 30.09.2018. It urged the Ministry of Corporate Affairs (‘MCA’) and the Union of India (‘UOI’) to take action under the Act.
Meanwhile, upon receipt of a report from the Registrar of Companies (ROC) under s. 208 of the Act, the MCA directed the Serious Fraud Investigation Office (‘SFIO’) to investigate the affairs of IL&FS and its subsidiaries.
On 01.08.2018, the MCA filed a company petition against IL&FS and its then-existing board of directors (‘BOD’) before the NCLT. The petition sought the removal of the company's BOD and the appointment of a new BOD. The NCLT passed an interim order, superseding the then-existing BOD of IL&FS with a new BOD.
The MCA also filed a petition before the NCLT under s. 130 of the Act to reopen the company's books and accounts. But the IL&FS Financial Services Ltd. (‘IFIN’) auditors (BSR & Deloitte) vehemently opposed this petition.
The petition was approved, leading to the reopening of the company’s books and accounts for the past five years. Later, the Reserve Bank of India investigated the group and submitted an investigation/inspection report to IFIN. Thereafter, IFIN issued a notice seeking to remove BSR as auditors.
MCA further filed a petition under s. 140(5) of the Act dated 10.06.2019, seeking to remove BSR & Deloitte as IFIN auditors and debar them for five years.
Thereafter, BSR finally resigned as the statutory auditor of IFIN and challenged the maintainability of s. 140(5) petition before the NCLT on the ground that BSR is no longer the auditor for IFIN. The NCLT, however, dismissed their plea on 09.08.2019.
BSR Associates, Deloitte Haskins & Sells and other external auditors had then moved to 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 05.09.2019 and challenged the constitutional validity of s. 140(5) of the Act.
High Court Decision
The Bombay High Court upheld the validity of s.140(5) of the Act and set aside the NCLT's order, debarring the two audit firms. The court directed the NCLT to pass a fresh order after giving the audit firms an opportunity to be heard.
The court held that s. 140(5) of the Act cannot be exercised against auditors who have resigned or ceased to be the auditor of the company after the completion of their term.
The court declared the proceedings under s. 212(14) of the Act, initiated by the UOI via the SFIO, as unsustainable and set them aside.
Aggrieved by this order of the Bombay High Court, UOI filed an appeal before the Supreme Court.
Supreme Court Decision
The Supreme Court upheld the constitutional validity of s. 140(5) of the Act and held that it does not violate a. 14, 19(1) (g) of the Constitution of India.
The court dismissed Deloitte's contention that an auditor's resignation terminates proceedings under s. 140(5) of the Act if the auditor has directly or indirectly acted fraudulently.
The court stated that s. 140(5) aims to ensure that auditors who have acted fraudulently are not allowed to continue as auditors of companies. The court observed that an auditor's resignation does not undo the damage caused by the auditor's fraudulent conduct.
The court also held that Deloitte's resignation as IFIN's auditor did not imply that it had admitted to any wrongdoing. Deloitte had resigned to circumvent the possibility of being held liable for IFIN's management's fraudulent conduct.
Our Analysis
The Supreme Court's judgment represents a welcome development. It underscores auditors' accountability and promotes the protection of investors and other stakeholders' interests. The judgment will additionally safeguard the interests of companies' stakeholders by ensuring that fraudulent auditors are prevented from continuing to practice as auditors.
This case signalled that s. 140(5) of the Act would not become nugatory merely upon the auditor's resignation. The decision passed by the High Court of Bombay in this case was deemed erroneous as it was based on a narrow interpretation of the Act's provisions. The Supreme Court ruled that no provision in the Companies Act was discriminatory or against the Constitution.
We believe that the Supreme Court's judgment is a positive development for the corporate governance landscape in India. It sends a strong message to auditors that they will be held accountable for their actions and will help protect the interests of investors and other stakeholders.
End Note
[i] (2023) 8 SCC 56.
Authored by Jitin Bharadwaj, Associate at Metalegal Advocates. The views are personal and do not constitute legal opinion.