IL&FS Crisis: AZB, Veritas win for BSR & Associates, Deloitte Haskins as Bombay High Court quashes SFIO complaint against auditors

The Bombay High Court today quashed the Serious Fraud Investigation Office (SFIO) complaint against Deloitte Haskins and Sells and KPMG arm BSR & Associates in connection with the IL&FS financial fraud case (N Sampath Ganesh v. Union of India)..The Court also upheld the constitutional validity of Section 140(5) of the Companies Act, 2013. .The judgment was passed by a Division Bench of Chief Justice BP Dharmadhikari and Justice Nitin Borkar in a petition by Deloitte Haskins and Sells and BSR & Associates. .The two erstwhile IL&FS audtiors had challenged the constitutional validity of Section 140 (5) of the Companies Act, 2013 , the prosecution sanction by the Ministry of Corporate Affairs (MCA), as well the move seeking a ban on BSR & Associates for five years..IL&FS Crisis: Deloitte Haskins and Sells challenges validity of S.140(5) of Companies Act before Bombay HC.The financial transactions of the IL&FS group came under the scrutiny of the SFIO after the company defaulted on debt worth Rs. 91,000 crore..The SFIO probe had revealed that auditors colluded with IL&FS Financial Services Ltd (IFIN) executives and concealed information about the wrongdoings of the management despite having full knowledge of the affairs at IL&FS..Following the SFIO findings, the MCA, under Section 140(5) of Companies Act, 2013, had moved an application seeking the removal of the auditors, and sought a five-year ban on BSR for allegedly conniving with the management of IFIN..Before the High Court, it was broadly argued that Section 140(5) of the Companies Act could be only invoked for removing or changing the auditors and not for banning them. .Since the Deloitte and BSR had ceased to be the statutory auditors of IFIN, proceedings under Section 140(5) were not maintainable, it was contended..The constitutional validity of the Section was assailed on the ground that it made an unwarranted classification between the auditors and directors of the company. .Concerns of double jeopardy vis a vis Sections 132, 447 were also raised. .Assailing their prosecution by the SFIO, the auditors broadly contended that the MCA's prosecution sanction was based on a SFIO report which ran into more than 750 pages, and had annexures running into 32,000 pages. This report was alleged to have been examined in about 30 hours. It was thus argued that there was non-application of mind on the part of the MCA..It was further argued that the report was not final in nature, but was merely an interim report.In response, the Centre argued that prosecution was based on the final report submitted by SFIO and allegations of non-application of mind ought to be rejected. .Defending the constitutionality of Section 140(5), it was submitted that the NCLT Rules 2016 contained sufficient procedure for conducting the matter against the auditor/company under the section. .After hearing the parties, the Court proceeded to decide the legal issues before it. .The Court opined that under the scheme of Section 140(5), the measure of debarment could not be seen as disproportionate. .Rejecting allegations of unreasonable classification, the Court said, ."We find that the Director of a Company or its Officers (paid servants of company) form the distinct class and are to be seen as part of the establishment of the Company. However the CA stands on entirely different footing and can not be seen as an officer of or subordinate to Company in any manner. Thus, efforts being made by the Petitioner to work out the similarity or equality amongst them can not succeed."Bombay High Court.Stating that it was absurd to assume that 140(5) envisaged punishment for professional misconduct or for crime of fraud as opposed to Sections 132 and 447, the Court also rejected the concerns of double jeopardy. .It said, "..disqualification stipulated in second proviso to S.140(5) can not be construed as a second punishment for same misconduct & it also does not attract the principle of double jeopardy. As legislative mandate of disqualification in second proviso to S. 140(5) is not a punishment either for the misconduct or the offence, obviously it is added as a measure to achieve a laudable goal stated supra.".The Court further held that when CAs defraud a company but have completed their term and left, they could not be charged. Therefore, they were not amenable to Section 140(5). ."Even when Company proposes to pass a special resolution for removing its CA under S.140(1), the CA can avoid it by putting in a resignation. The scheme of S. 140 itself interposes “resignation” procedure between the decision of Company to move such special resolution & further processing thereof. The Parliament has placed sub-sections (2) & (3) regarding the resignation between sub-sections (1) & (4) of S. 140 and there is nothing in law to demonstrate that the CA against whom the special resolution of “removal” is initiated, can not resign. Such resignation does not lead to any debarment or disqualification in his practice as CA."Bombay High Court.They can be tried for professional misconduct under Section 132 or under the Chartered Accountants Act, the Court said..As far as the issue of prosecution sanction was concerned, the Court observed that given the voluminous nature of the SFIO note and the report, it appeared highly improbable that the same was considered within 30 hours. ."The processing note would not absolve the concerned officer of his obligation to apply mind personally & therefore verify the correctness of the appreciation in the processing note itself. Again, the respondents do not plead that the officer (authority) who acted on behalf of the Central Government, was already associated with the investigation and hence, was in position to appreciate the SFIO's interim report fast with the help of other officer who is alleged to have prepared a processing note."Bombay High Court.It was further recorded that the alleged processing note given to the MCA to facilitate its consideration was neither given to the petitioners nor produced before the Court to enable it understand the situation. .In view of the above, the Court upheld that the constitutional validity of Section 140(5), but set aside the SFIO complaint against the two auditors. .The MCA application seeking a ban on BSR Associates was also held to be untenable. .The interim orders passed by the High Court shall continue for the period of eight weeks and the direction quashing the sanction to prosecute the auditors shall remain stayed till then. .IL&FS: Bombay HC grants interim relief to Deloitte Haskins and Sells from coercive action in criminal proceedings.Bombay High Court grants interim relief to KPMG arm BSR & Associates in IL&FS case.Last month, the National Company Law Appellate Tribunal had dismissed appeals by IL&FS auditors Deloitte Haskins and BSR & Associates against an order impleading them as parties in the ongoing fraud case concerning IL&FS subsidiary, ILFN..NCLAT dismisses Deloitte, BSR & Associates appeal against impleadment in alleged fraud case concerning IL&FS subsidiary.Read the list of lawyers engaged in the matter: AZB & Partners acted for BSR & Associates and Veritas Legal acted for Deloitte..Read the Order: