Supreme Court affirms Constitutional Validity of Section 140(5) of Companies Act, 2013

The Indian Supreme Court upheld the constitutional validity of Section 140(5) of the Companies Act, 2013, stating that it was not biased or unreasonable. During its verdict, the Court specified that Section 140(5) did not breach Articles 14 and 19(1)(g) of the Indian Constitution.

Brief Facts of Case:

The Union of India filed Criminal Appeals against the impugned order and judgement of the High Court of Bombay. The High Court upheld the constitutionality of Section 140(5) of the Companies Act, 2013 (hereinafter referred to as the "Act, 2013") but set aside the direction under Section 212(14) of the Act, 2013. This direction was issued by the Union of India to the Serious Fraud Investigation Office (hereinafter referred to as "SFIO") and consequently set aside the prosecution lodged by the SFIO via Criminal Complaint. 

Brief Background of the Case:

In 2018, the IL&FS Group Companies (hereinafter referred to as "IFIN") defaulted on their debt burden of over Rs. 91,000 crores, leading to a potential collapse of India's money markets, causing corporate bond yields to soar, and triggering a sell-off in the stock market. To address the situation, the Department of Economic Affairs and the Ministry of Finance issued an Office Memorandum urging the Ministry of Corporate Affairs to take necessary action under the Act, 2013. The Memorandum highlighted the issues that IFIN faced, including a debt contagion of over Rs. 91,000 crores, failure of corporate governance, and window-dressed accounts, among others.

Procedural History:

The Ministry of Corporate Affairs instructed the SFIO to investigate IFIN and filed a Company Petition against IFIN's Board of Directors before the National Company Law Tribunal (hereinafter referred to as "NCLT"), seeking the appointment of a new Board of Directors. The Tribunal replaced the Board of Directors with a new one and submitted a report on the progress to the Ministry of Corporate Affairs. After receiving an Office Order in September 2018, the SFIO investigated IFIN and the Employees Welfare Trust. The SFIO then submitted an interim report in November of the same year, identifying illegal activities and fraud committed by IFIN's management.

Based on this SFIO Report, the Ministry of Corporate Affairs filed a Miscellaneous Application seeking to attach the properties of the former directors of IFIN. They also filed a petition under Section 130 of the Companies Act, 2018 (hereinafter referred to as the "Act, 2018"), requesting that the accounts of IFIN and other companies be re-opened and recast. Meanwhile, the Reserve Bank of India inspected IFIN under Section 45N of the Reserve Bank of India Act, 1934 (hereinafter referred to as the "RBI Act") and submitted the report in March 2019. IFIN issued a notice to remove BSR & Associates LLP (hereinafter referred to as "BSR”) as auditors, but BSR denied the allegations.

According to the Office Order in 2018, SFIO had submitted a report of IFIN. The Ministry of Corporate Affairs requested the Regional Director and SFIO to start proceedings/prosecution under various Sections of the Act, 2013 and the Indian Penal Code. The SFIO filed a criminal complaint against the auditors/ex-auditors of IFIN. The Ministry of Corporate Affairs also filed a petition against the auditors of IFIN, requesting their removal and declaring that they are not eligible to be appointed as an auditor for any company for five years.

BSR resigned from IFIN and filed a reply, arguing that they were no longer the auditors for IFIN and that there was no case for fraud against them. Deloitte Haskins & Sells LLP (hereinafter referred to as "Deloitte"), challenged the maintainability of the Section 140(5) petition before the NCLT, arguing that they were no longer IFIN's auditors. The High Court upheld the validity of the Section but set aside the NCLT's order and quashed the criminal proceedings instituted by the SFIO.

Contentions of the Appellants:

The appellants argued that the High Court had misinterpreted Section 140(5) of the Act, 2013. The High Court had interpreted it as only aimed at breaking the collusion between an auditor and a company, but they argued that Section 140(5) intended to effect a change of auditor in a company suspected of fraud. The High Court also erroneously proceeded to quash Section 140(5) petition and the order passed by the NCLT, Mumbai upholding its maintainability.

They contested the High Court's decision and explained that Section 140(5) of the Act, 2013 provides for action against an auditor who acts fraudulently. Furthermore, they argue that the act of resignation of BSR after filing the Petition under Section 140(5) of the Act, 2013 should not render the proceedings void.

The appellants argued that Section 140(5) enables a quasi-judicial tribunal equipped with a civil court's powers to examine the auditors' role and adjudicate on their fraudulent conduct. They also contend that Deloitte's role should be examined, and if found guilty, the satisfaction of the Tribunal may result in a change of auditor. 

The appellants further contended that the High Court has fundamentally erred in holding that the report needs to be completed. They argue that the investigation is complete in all other respects. Therefore, the appellants prayed for quashing the impugned order of the High Court.

Contentions of the Respondents:

The respondents had argued that the High Court's decision to uphold Section 140(5) of the Companies Act, 2013 violated several articles of the Constitution. Respondents had challenged the validity of Section 140(5) of the Act, 2013, which dealt with the involuntary removal of an auditor by the NCLT and had also challenged two NCLT orders issued under the aforementioned Section. The High Court had upheld the validity of Section 140(5) of the Act, 2013 and stated that the NCLT could only examine the need to change an auditor and not debar them for five years. The Act, 2013 provided a comprehensive scheme for regulating and punishing auditors, making it impossible for auditors to evade punishment for fraud, professional misconduct, or aiding fraud. Therefore, Section 140(5) only served the purpose of removing an auditor and was not a standalone provision for disqualifying auditors.

Section 140(5) empowered the NCLT to direct a company to change its auditor if the auditor was found guilty of fraud and had not resigned or been removed by the company. The NCLT could order the removal of the auditor under the non-obstante clause provided in Section 140(5) of the Act, 2013. The phrase "change" meant "replace with or exchange for another." Once an auditor has resigned, no order of change could be issued. They argued that the NCLT's order to appoint MMC as the statutory auditor of IFIN under the first proviso to Section 140(5) was without jurisdiction, as BSR had resigned as an auditor. There was no need to invoke the first proviso. Furthermore, the statutory auditor appointment application was contrary to the law since Section 140(5) of the Act, 2013 did not apply to past auditors, and the first proviso was only a interim measure pending a jurisdiction order under Section 140(5). Only the Central Government had the authority to appoint or change auditors under the first proviso. Additionally, the Ministry withheld key facts from the NCLT at the time of filing.

Regarding the direction issued under Section 212(14) and the prosecution under Section 212(15), it was submitted that the Central Government could only direct the SFIO to investigate a company's affairs under certain conditions. The SFIO must submit an investigation report to the Central Government only upon completion of the investigation. The Central Government may direct SFIO to initiate prosecution against a company or its officers if it considers it necessary after examination of only the investigation report. The SFIO had filed no final investigation report, so the direction for prosecution in question could not have been issued, and the complaint could not have been filed. 

On behalf of the respondents, the learned counsel prayed for dismissing the appeals and upholding the impugned judgment and order passed by the High Court.

Observations of the Court:

The Court discussed Section 140(5) of the Act, 2013, which dealt with the removal, resignation, and providing special notice to auditors. This provision was introduced to provide stricter accountability for auditors after the Companies Bill, 2009. The High Court upheld the validity of Section 140(5) of the Act, 2013, but also held that Section 140(5) proceedings were no longer maintainable after an auditor resigned or was no longer an auditor on their resignation. However, The Supreme Court clarified that this view of the High Court was erroneous and unsustainable because the proceedings under Section 140(5) of the Act, 2013 must go to their logical end, and subsequent resignation or discontinuance of an auditor shall not terminate the proceedings.

The Apex Court also explained that Section 140(5) empowers the NCLT to take necessary action against an auditor who has acted fraudulently or colluded with the management of the company. The NCLT has the power to remove the auditor and appoint a new one if it finds that the auditor has acted fraudulently or abetted or colluded in any fraud. The second proviso to Section 140(5) of the Act, 2013 states that an auditor against whom the NCLT has passed a final order shall not be eligible to be appointed as an auditor of any company for a period of five years.

Furthermore, the Apex Court highlighted that all provisions under the Act, 2013 including Section 140(5), operate in different fields, and Section 140(5) has been enacted with a specific object and purpose. The second proviso to Section 140(5) provides that an auditor shall not be eligible to become an auditor in any other company for five years after the NCLT passes a final order. Therefore, Section 140(5) cannot be considered arbitrary or ultra vires merely because the auditor can be removed as an auditor of a company under other provisions.

The decision of the Court:

The Supreme Court dismissed the challenge against the constitutional validity of Section 140(5) of the Companies Act, 2013. The Court concluded that Section 140(5) was not discriminatory or arbitrary. The Court clarified that Section 140(5) of the Act, 2013 did not contravene Articles 14 and 19(1)(g) of the Constitution of India. Consequently, the order of the High Court that nullified the application/proceedings under Section 140(5) was quashed. The order of the NCLT, which declared the proceedings under Section 140(5) would remain maintainable even after the resignation of the auditors, was also quashed and set aside. As a result, the application/proceedings under Section 140(5) of the Act, 2013 were upheld.

The Supreme Court also quashed and set aside the impugned judgment and order of the High Court that set aside the direction under Section 212(14) of the Companies Act, 2013. Moreover, they also quashed and set aside the impugned judgment and order of the High Court that set aside the prosecution lodged by the SFIO via Criminal Complaint.

Therefore, the Appeals filed by the Union of India were allowed, while Criminal Appeals filed by Deloitte were dismissed.

Case Title: Union of India and Anr v Deloitte Haskins and Sells LLP & Anr

Case No.: Criminal Appeal no. 2305 – 2307 of 2022

Citation: 2023 Latest Caselaw 434 SC

Coram: Hon’ble Mr. Justice M.R Shah and Hon’ble Mr. Justice M.M Sundresh

Advocates for Petitioner: Mr. Balbir Singh, ASG, Mr. Naman Tandon, Adv., Mr. Samarvir Singh, Adv., Mr. Aditya Sikka, Adv., Mr. Kanu Agarwal, Adv., Mr. Himanshu Gupta, Adv., Mr. Vikash Kumar Jha, Adv., Ms. Ritu Anand, Adv., Ms. Vasudha Vijaysheel, Adv., Mr. Adhiraj Singh Chauhan, Adv., Ms. Padmaja Sharma, Adv., Ms. Neela Kedar Gokhale, Adv., Ms. Sanskriti Pathak, Adv., Ms. Bani Dikshit, Adv., Mr. Arvind Kumar Sharma, AOR, Mr. Sanjay Jain, ASG, Mr. Balasubramanian, Sr. Adv., Mr. Rajat Nair, Adv., Mr. Bhuvan Kapoor, Adv., Mr.Anukalp Jain, Adv., Mr. Deepabali Dutta, Adv., Mr. Pratyush Shrivastava, Adv.

Advocates for Respondent: Mr. Arvind Datar, Sr. Adv., Mr. V.Giri, Sr. Adv., Ms. Misha Rohatgi Mohta, AOR, Ms. Suveni Bhagt, Adv., Ms. Ayushi Sharma, Adv., Mr. Nakul Mohta, Adv., Mr. Nischaya Nigam, Adv., Mr. Kapil Sibal, Sr. Adv., Mr. Mahesh Agarwal, Adv., Mr. Rishi Agrawala, Adv., Mr. Rahul Dwarkadas, Adv., Ms. Prachi Dhanani, Adv., Ms. Rishika Harish, Adv., Ms. Niyati Kohli, Adv., Ms. Juhi Bahirwani, Adv., Mr. Pratham Vir Agarwal, Adv., Ms. Rohini Jaiswal, Adv., Ms. Manavi Agarwal, Adv., Mr. E. C. Agrawala, AOR, Mr. Mukul Rohatgi, Sr. Adv., Mr. Darius Khambata, Sr. Adv., Mr. Neeraj Kishan Kaul, Sr. Adv., Mr. V.P. Singh, Adv., Mr. Aditya Jalan, Adv., Ms. Anannya Ghosh, AOR, Mr. Raghav Seth, Adv.Ms. Bhagya K. Yadav, Adv., Ms. Vanya Chabra, Adv., Mr. Anant Mishra, Adv., Ms. Shreya Chaudhary, Adv., Mr. Brian Moses, Adv., Mr. Siddharth Dave, Sr. Adv., Ms. Aakanksha Kaul, Adv., Mr. Adit Khorana, Adv., Ms. Vidhi Thakur, Adv., Mr. Prastut Dalvi, Adv., Mr. Chandra Prakash, AOR, Mr. Bharat Bagla, Adv., Mr. Siddharth Dharmadhikari, Adv., Mr. Aaditya Aniruddha Pande, AOR, Ms. Kirti Dadheech, Adv., Mr. Sachin Patil, AOR 

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