Supreme Court upholds constitutional validity of Section 140(5) Companies Act; says auditors cannot escape being probed if they resign

The Supreme Court on Wednesday set aside an order of the Bombay High Court that had quashed the Serious Fraud Investigation Office (SFIO) complaint against Deloitte Haskins and Sells and KPMG arm BSR & Associates in connection with the Infrastructure Leasing & Financial Services (IL&FS) financial fraud case. (Union of India vs Deloitte Haskins).A bench of Justice MR Shah and MM Sundresh held that the High Court erred in holding that the resignation of auditor means that proceedings against auditor before the National Company Law Tribunal (NCLT) under Section 140(5) will end."Subsequent resignation of an auditor after the application is filed under section 140(5) by itself shall not terminate the proceedings under section 140(5). Resignation and/or removal of an auditor cannot be said to be an end of the proceedings under section 140(5). There are further consequences also on culmination of the enquiry under section 140(5) proceedings", the Court said..The Court explained that if such a position is taken, auditors, whenever they face proceedings, will resign and that this could not have been the legislature's intention."At the cost of repetition, it is observed that in a given case, an auditor, who in fact 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."."There must be a final order passed by tribunal irrespective of his resignation to see if he has colluded or acted in fraudulent manner," the Court underscored..The Court was hearing 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.The High Court had also upheld the validity of the Section 140(5)..The apex court said 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 object and purpose of second proviso to section 140(5)...is to make the provision more stringent and to provide for consequences for an auditor when such an auditor is found to have been perpetrating a fraud and is removed by the NCLT for such fraud.".It added that Section 140(5) cannot be called to be excessive or arbitrary use of power by NCLT to determine offences of grave nature and stated that the ample opportunity shall be given by NCLT before passing a final order."Merely because the auditor can be removed as an auditor of a company including the other provisions, section 140(5) which has been enacted with a special object and purpose cannot be said to be arbitrary and/or ultra vires."Therefore, the Court set aside the order of the Bombay High Court and directed that proceedings commence before the trial court again. On the constitutional validity of Section 140(5), the bench held that it is not violative of Articles 14 and 19 of the Indian Constitution as there is no manifest arbitrary use of power."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.".It is for Parliament to decide the tenure of the penalty in the form of automatic disqualification of auditors and of the entire firm including partners in such cases, the bench added.Additional Solicitor General Balbir Singh appeared for the appellants..[Read judgment]