SC sets aside Bombay HC order, paves way for prosecution of 2 former IL&FS audit firms

New Delhi: The Supreme Court on Wednesday set aside the Bombay High Court verdict which had quashed the SFIO probe against audit firms BSR and Associates and Deloitte Haskins and Sells, both former auditors of IL&FS Financial Services, over alleged financial irregularities.

Allowing the appeal of the Serious Fraud Investigation Office (SFIO) and the Centre against the high court verdict, the top court also upheld the validity of Section 140(5) of the Companies Act, 2013.

The provision deals with removal and resignation of auditors and imposes a five-year ban on an auditing firm that is proven to have "acted in a fraudulent manner", or to have "abetted or colluded in any fraud".

“The challenge to the constitutional validity of section 140(5) of the Companies Act, 2013 fails and it is observed and held that section 140(5) is neither discriminatory, arbitrary and/or violative of Articles 14, 19(1)(g) of the Constitution of India, as alleged,” a bench of justices M R Shah and M M Sundresh said in its 103 page judgement.

It set aside the high court judgement which had quashed the proceedings against the audit firms under section 140(5) of the Act on the ground that the auditors had resigned.

“The application/proceedings under section 140(5) of the Act, 2013 is held to be maintainable even after the resignation of the concerned auditors and now the NCLT (National Company Law Tribunal) therefore to pass a final order on such application after holding enquiry in accordance with law ...,” it said.

The top court, however, made clear that it has not expressed any opinion on merits on the allegations against the auditors and it would be ultimately for the NCLT to pass a final order on the plea of SFIO.

“The impugned judgment and order passed by the High Court quashing and setting aside the prosecution lodged by the SFIO ... on the file of Special Court (Companies Act) and Additional Sessions Judge, Greater Mumbai is also hereby quashed and set aside. Now the said Criminal Complaint ... be proceeded further by the concerned Trial Court in accordance with law and on its own merits,” it ordered.

The Centre and the SFIO had come in appeal challenging the 2020 verdict of the high court granting relief to the audit firms -- BSR and Associates, and Deloitte Haskins and Sells. They were former auditors of IL&FS Financial Services.

Prior to this, BSR and Deloitte had moved HC last year challenging the validity of the Union government's plea before the NCLT seeking their removal as auditors of ILFS, and had challenged the constitutional validity of section 140 (5) of Companies Act.

While the Bombay High Court had held that section 140 (5) of the Companies Act was constitutionally valid, its provisions of debarment against "fraudulent" audit firms cannot be applied to such auditors that have already resigned or rotated out of a company facing allegations of financial irregularities.

The high court had held that the provisions of the section did not apply to former auditors in the present case since BSR had already resigned and Deloitte had been rotated out by ILFS before the case reached NCLT.

The high court verdict had come on the petitions filed by both the firms and other former ILFS auditors, N Ganesh Sampath, Kalpesh Mehta, and Udayan Sen.

They had challenged the Union government's plea before the NCLT seeking that they be prosecuted under section 140 (5) of the companies Act and be banned from auditing for five years.

Besides the constitutional validity of the section, they had also challenged criminal proceedings initiated against them by the Union Ministry of Corporate Affairs following an investigation report filed by the SFIO before a special court there.

As per records, IL&FS Group Companies had an aggregate debt burden of more than Rs 91,000 crore and a series of defaults had taken place between June and September, 2018 threatening to collapse the money markets of India.

This had led to initiation of action against the firms and their auditors.