Supreme Court says that resignation of an auditor shall not terminate the proceedings under Section 140(5) of the Companies Act, 2013

On May 03, 2023, the Supreme Court of India was hearing the pleas filed by the Union of India against the judgment of the High Court of Bombay that quashed Section 140(5) (the Companies Act, 2013) petition. The High Court also set aside the directions issued by the Ministry of Corporate Affairs and the SFIO (Serious Fraud Investigation Office) and quashed criminal proceedings instituted by the SFIO. The matter was heard by a two-judge bench of the Supreme Court consisting of Justices MM Sundresh and MR Shah. The bench said 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).” The Supreme Court of India also said that Section 140(5) was enacted with a special object and its purpose could not be said to be arbitrary and/or ultra vires. It added, “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. 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.”

In this case, a series of defaults by the IL&FS Group Companies, which had an aggregate debt burden of more than Rs. 91,000 crores, threatened to collapse the money markets of India, added pressure to corporate bond yields, and sparked a sell-off in the stock market. The Ministry of Corporate Affairs directed the SFIO to investigate the affairs of IL&FS and its subsidiaries. The NCLT directed that the accounts of IL&FS, IFIN & ITNL for the past 5 financial years be re-opened and recast on the ground that the affairs of IL&FS, IFIN & ITNL had been mismanaged casting doubt on the reliability of the financial statements/accounts. The Supreme Court upheld the initiation of the proceedings by the Ministry of Corporate Affairs and the SFIO was asked to initiate proceedings/prosecution. The Ministry of Corporate Affairs filed a Petition under Section 140(5) against the auditors of the IFIN, namely, BSR & Deloitte and the engagement partners. Deloitte and BSR filed an application challenging the maintainability of Section 140(5) petition before the NCLT on the ground that they are no longer the auditor for IFIN. Further, NCLT passed an order upholding the maintainability of Section 140(5) petition. Thereafter, the BSR filed a writ petition before the High Court, inter alia, challenging the vires of Section 140(5) of the Act. 

By the impugned judgment and order, though the High Court has upheld the validity of Section 140(5) of the Act, 2013, the High Court has interpreted Section 140(5) of the Act, 2013 and set aside the order passed by the NCLT upholding the maintainability of Section 140(5) petition and quashed Section 140(5) petition. The matter was further heard by the Supreme Court of India. The top Court observed that the proceedings under Section 140(5) are maintainable even after the resignation of the concerned auditors. The proceedings initiated under the first part of section 140(5) have to go to its logical end and subsequent resignation and/or discontinuance of an auditor shall not terminate the proceedings under section 140(5).  The bench further stated that “Merely because the direction to prosecute was issued within 30 hours, by that itself, it cannot be presumed that there was a non-application of mind.” The top Court further opined that a detailed note was prepared by the officer which was ultimately placed before the final authority who ultimately took a decision and issued a direction to prosecute. The High Court materially erred that the investigation concerning IFIN was incomplete and appeals filed by the union were allowed whereas appeals filed by  Deloitte and its partners were dismissed.