In Crl.A. Nos. 2305-2307 of 2022-SC- Sec.140(5) of Companies Act, 2013 is not violative of Articles 14, 19(1)(g) of Constitution, rules Top Court while setting aside Bombay HC order whereby it was held that application u/s 140(5) shall not be maintainable on resignation of auditors- BSR & Deloitte
Justices M.R. Shah & M.M. Sundresh [03-05-2023]

Read Judgment:Union Of India And Another Vs. Deloitte Haskins And Sells LLP & Anr 

Tulip Kanth

New Delhi,  May 4, 2023: While observing that the Bombay High Court had materially erred in holding that on resignation of auditors – BSR & Deloitte and on appointment of new auditors, application under section 140(5) of the Companies Act,2013 shall not be maintainable, the Supreme Court has upheld the validity of constitutional validity of section 140(5).

“Therefore, the enquiry/proceedings initiated under the first part of section 140(5) has to go to its logical end and subsequent resignation and/or discontinuance of an auditor shall not terminate the enquiry/proceedings under section 140(5)”, the Division Bench of Justice M.R. Shah & Justice M.M. Sundresh said.

The factual background of this case was such that a series of defaults by the IL&FS Group Companies, which had an aggregate debt burden of more than Rs 91,000 crores, occurred between June to September, 2018, added pressure to corporate bond yields and sparked a sell off in the stock market. The MCA, upon receipt of a report from the Registrar of Companies under Section 208, directed the SFIO to investigate into the affairs of IL&FS and its subsidiaries.

Further SFIO submitted an interim report in respect of IL&FS and one Employees Welfare Trust pertaining to the IL&FS Group. This report was on the individuals who were in control of the affairs of the IL&FS Group and the illegalities and fraud perpetrated by them. Through MCA’s petition, the NCLT directed that the accounts of IL&FS, IFIN & ITNL for the past 5 financial years be re-opened and recast.

The auditors of IFIN (BSR & Deloitte) were given notice of Section 130 petition who opposed the said petition. After RBI submitted an investigation/inspection report to IFIN, a notice was issued under Section 140(1) on BSR seeking to remove them as auditors. MCA also filed a Petition under Section 140(5) against the auditors of the IFIN, namely, BSR & Deloitte and the engagement partners as well as their team.

BSR and its engagement partners filed a reply to Section 140(5) petition before the NCLT contending that they were not the auditors for IFIN any longer as they had tendered their resignation and therefore Section 140(5) was  not applicable to them. Deloitte also filed an application challenging the maintainability of Section 140(5) petition before the NCLT on the ground that Deloitte is no longer the auditor for IFIN. 

The NCLT passed an order upholding the maintainability of Section 140(5) petition. BSR filed a  writ petition before the High Court challenging the vires of Section 140(5) & the directions issued and the order of the NCLT. By the impugned judgment,  the High Court upheld the validity of Section 140(5) and also quashed/set aside criminal proceedings instituted by the SFIO. Hence, the present appeals were filed.

The Bench was of the view that 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). 

Noting that 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, the Bench further observed that the enquiry/proceedings initiated under the first part of section 140(5) has to go to its logical end and subsequent resignation and/or discontinuance of an auditor shall not terminate the enquiry/proceedings under section 140(5). 

It was also asserted that acting in a fraudulent manner, directly or indirectly, by an auditor is a very serious misconduct and therefore the necessary consequence of indulging into such fraudulent act shall follow.

Dismissing the challenge to the constitutional validity of section 140(5) of the Companies Act, 2013, the Bench  held that section 140(5) is neither discriminatory, arbitrary and/or violative of Articles 14, 19(1)(g) of the Constitution of India.

The impugned judgment and order passed by the High Court quashing and setting aside the application/proceedings under section 140(5) on the ground that as the auditors have resigned and therefore thereafter the same was not maintainable, was quashed and set aside by the Bench.

The Bench also held that the application/proceedings under section 140(5) would be maintainable even after the resignation of the concerned auditors and now the NCLT would pass a final order on such application after holding an enquiry.

Thus, while holding that Criminal Complaint can be proceeded further by the concerned Trial Court and allowing the appeals filed by the Union of India, the Bench dismissed the appeals filed by Deloitte and its partners.