{"id":291441,"date":"2023-05-06T12:00:05","date_gmt":"2023-05-06T06:30:05","guid":{"rendered":"https:\/\/www.scconline.com\/blog\/?p=291441"},"modified":"2023-05-08T15:25:07","modified_gmt":"2023-05-08T09:55:07","slug":"supreme-court-upholds-constitutionality-of-section-1405-of-the-companies-act-fraud-by-auditors","status":"publish","type":"post","link":"https:\/\/blog.scconline.gen.in\/post\/2023\/05\/06\/supreme-court-upholds-constitutionality-of-section-1405-of-the-companies-act-fraud-by-auditors\/","title":{"rendered":"Supreme Court| Section 140(5) of the Companies Act constitutional; Proceedings do not come to an end on resignation\/ removal of an auditor"},"content":{"rendered":"\n<div class=\"twitter-share\"><a href=\"https:\/\/twitter.com\/intent\/tweet?via=scconline_\" class=\"twitter-share-button\">Tweet<\/a><\/div>\n<div style=\"text-align: justify; line-height: 150%;\">\n<p style=\"margin-bottom: 3%;\"><b>Supreme Court:<\/b> The Bench of <b>MR Shah<\/b>* and MM Sundresh, JJ has held that Section <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0001537348\" target=\"_blank\" rel=\"noopener\">140(5)<\/a> of the <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0002766251\" target=\"_blank\" rel=\"noopener\">Companies Act, 2013<\/a> that deals with Removal, Resignation of Auditor and Giving of Special Notice&#8221; appears in Chapter X of the Act which is titled as &#8220;Audit and Auditors&#8221;, is not discriminatory, arbitrary and\/or violative of Articles <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0001574870\" target=\"_blank\" rel=\"noopener\">14<\/a>, <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0001574926\" target=\"_blank\" rel=\"noopener\">19(1)(g)<\/a> of the <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0002726967\" target=\"_blank\" rel=\"noopener\">Constitution of India<\/a> and 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) of the Act.<\/p>\n<h4 style=\"color: #632423;\">Section 140(5) of the Companies Act &#8211; Explained<\/h4>\n<p style=\"margin-bottom: 3%;\">Section 140(5) of the Act empowers the Tribunal (NCLT), either <i>suo motu<\/i> or on an application made to it by the Central Government or by any person concerned, to take action against the auditor who has acted in a fraudulent manner or is abetting or colluding in fraud with the management of a company. If on completion of an enquiry it is found by the Tribunal that an auditor of a company has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or officers, it may by order direct the company to change its auditors.<\/p>\n<p>It is to be noted that,<\/p>\n<ul>\n<li>\n<p>The powers of the NCLT in first part of Section 140(5) is quasi-judicial in nature and the Tribunal would have the powers of a civil court to examine the role of auditors and adjudicate on their fraudulent conduct and abdication of their function.<\/p>\n<\/li>\n<li>\n<p>The powers under the first proviso to Section 140(5) can be said to be interim or <i>pro tem<\/i> measure to prevent an existing auditor from continuing and substitute him with an auditor based on a prima facie satisfaction that a fraud has been perpetrated and when circumstances warrant the substitution. Such an order can be said to be an interim order akin to a temporary suspension during the pendency of the detailed enquiry as provided in Section 140(5) of the Act and before any final order is passed by the Tribunal.<\/p>\n<\/li>\n<li>\n<p style=\"margin-bottom: 3%;\">Second proviso to Section 140(5) of the Act further provides that an auditor, whether individual or firm, against whom final order has been passed by the Tribunal under Section 140(5) shall not be eligible to be appointed as an auditor of any company for a period of five years from the date of passing of the order and the auditor shall also be liable of such action under Section <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0001537688\" target=\"_blank\" rel=\"noopener\">447<\/a> of the <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0002766251\" target=\"_blank\" rel=\"noopener\">Companies Act<\/a>.<\/p>\n<\/li>\n<\/ul>\n<p style=\"margin-bottom: 3%;\">On passing of the final order by the NCLT under first part of Section 140(5) and if an auditor is found to have been indulged into fraudulent activities or abetting or colluding in a fraud with the management of the company, consequences provided under the second proviso to Section 140(5) shall follow. Therefore, before second proviso of Section 140(5) is attracted, there must be a detailed enquiry against an auditor of a company as per first part of Section 140(5) and there must be a finding arrived at by the NCLT that the auditor of a company has, directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or officers.<\/p>\n<h4 style=\"color: #632423;\">Bombay High Court&#8217;s Impugned Judgment &#8211; &#8220;absolutely erroneous and unsustainable&#8221;<\/h4>\n<p style=\"margin-bottom: 3%;\">Bombay High Court had upheld the vires of Section 140(5) of the Act, 2013, however, it had held that once the auditor resigns as an auditor or is no more an auditor on his resignation, thereafter Section 140(5) proceedings are no longer maintainable as the petition filed by the Union of India under Section 140(5) has been satisfied by the subsequent resignation of the auditor.<\/p>\n<p style=\"\">The Supreme Court found this view to be absolutely erroneous and unsustainable. The Court came to this conclusion after observing that<\/p>\n<p style=\"margin-left: 36pt; margin-bottom: 3%;\"><b>&#8220;If the interpretation given by the High Court that once an auditor resigns, the proceedings under Section 140(5) stand terminated and are no longer further required to be proceeded, in that case, an auditor to avoid the final order and the consequence of final order as provided under the second proviso to Section 140(5) may resign and avoid any final order by the Tribunal. That cannot be the intention of the legislature.&#8221;<\/b><\/p>\n<p style=\"margin-bottom: 3%;\">Holding that resignation and\/or removal of an auditor cannot be said to be an end of the proceedings under Section 140(5), the Supreme Court observed that there are further consequences also on culmination of the enquiry under Section 140(5) proceedings and passing a final order by the Tribunal on the conduct of an auditor, whether such a auditor has, directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or officers, as provided under the second proviso to Section 140(5) of the Act, 2013. <span style=\"font-weight: bold; font-style: italic;\">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).<\/span><\/p>\n<h4 style=\"color: #632423;\">Tribunal&#8217;s Power &#8211; Not Excessive or Arbitrary<\/h4>\n<p style=\"\">The Court also noted that in Section 140(5), it is specifically mentioned that &#8220;without prejudice to any action under the provisions of this Act or any other law for the time being in force&#8221;. Therefore, the intention of the legislature while enacting Section 140(5) is very clear and the powers conferred upon the Tribunal under Section 140(5) shall be without prejudice to any action under the provisions of the <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0002766251\" target=\"_blank\" rel=\"noopener\">Companies Act, 2013<\/a> or any other law for the time being in force.<\/p>\n<p style=\"margin-left: 36pt; margin-bottom: 3%;\"><b>&#8220;Therefore, irrespective of any other provisions of the Act, 2013, the Tribunal is vested with the powers under Section 140(5) of the Act to pass a final order against the auditor on the allegation that such an auditor of the company has, directly or indirectly, acted in a fraudulent manner.&#8221;<\/b><\/p>\n<p style=\"margin-bottom: 3%;\">The constitutionality\/vires of Section 140(5) was challenged for being excessive and arbitrary as it provides unguided and untrammelled powers to NCLT for determination of a serious offence of fraud and consequence of mandatory disqualification with grave consequences akin to civil death. The Court rejected the submission and held that NCLT shall exercise the quasi-judicial powers under Section 140(5) with all the powers akin to civil court. Ample opportunity shall be given by the NCLT before passing any final order.<\/p>\n<h4 style=\"color: #632423;\">Section 140(5) &#8211; Not violative of Article 14 of the Constitution<\/h4>\n<p style=\"margin-bottom: 3%;\">It was submitted before the Court that, Section 140(5) is violative of Article <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0001574870\" target=\"_blank\" rel=\"noopener\">14<\/a> of the <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0002726967\" target=\"_blank\" rel=\"noopener\">Constitution of India<\/a> and discriminates against the auditors unfairly in comparison to similarly placed alleged perpetrators, such as directors, management etc.<\/p>\n<p style=\"margin-bottom: 3%;\">The Court, however, rejected the submission and observed 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 &#8220;Audit and Auditors&#8221; looking to the importance of the auditors. Therefore, Section 140(5) cannot be said to be discriminatory and\/or violative of Article <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0001574870\" target=\"_blank\" rel=\"noopener\">14<\/a> of the <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0002726967\" target=\"_blank\" rel=\"noopener\">Constitution of India<\/a>.<\/p>\n<h4 style=\"color: #632423;\">Penalty of Automatic Disqualification &#8211; Not violative of under Article 19(1)(g) of the Constitution of India<\/h4>\n<p style=\"margin-bottom: 3%;\">The Court rejected the submission that the penalty in the form of automatic disqualification of auditors and of the entire firm including partners and that too for a period of five years to become the auditor of any other company is highly disproportionate. On the principle of joint and severe liability, the auditors and the entire firm including partners shall be liable and therefore can be subjected to Section 140(5) and the consequences mentioned in Section 140(5) of the Act, 2013.<\/p>\n<p style=\"margin-bottom: 3%;\">The Court was also unimpressed by the submission that the disqualification is akin to civil death and Section 140(5) impinges upon fundamental right to carry on its profession, as guaranteed under Article <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0001574926\" target=\"_blank\" rel=\"noopener\">19(1)(g)<\/a> of the <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0002726967\" target=\"_blank\" rel=\"noopener\">Constitution<\/a>. It observed that 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. <span style=\"font-weight: bold; font-style: italic;\">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.<\/span> Therefore, taking into consideration the object and purpose for which Section 140(5) of the Act is enacted, the same cannot be said to be arbitrary, excessive and violative of Article <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0001574870\" target=\"_blank\" rel=\"noopener\">14<\/a> of the <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0002726967\" target=\"_blank\" rel=\"noopener\">Constitution of India<\/a> and\/or violative of fundamental rights guaranteed under Article <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0001574926\" target=\"_blank\" rel=\"noopener\">19(1)(g)<\/a> of the <a href=\"https:\/\/www.scconline.com\/DocumentLink.aspx?q=JTXT-0002726967\" target=\"_blank\" rel=\"noopener\">Constitution of India<\/a>, as alleged.<\/p>\n<p style=\"margin-bottom: 3%;\">[<span style=\"font-weight: bold; color: #632423;\">Union of India v. Deloitte Haskins and Sells LLP, <a href=\"http:\/\/www.scconline.com\/DocumentLink\/rrfDGU93\" target=\"_blank\" rel=\"noopener\">2023 SCC OnLine SC 557<\/a>, decided on 03-05-2023<\/span>]<\/p>\n<p style=\"text-indent: 18pt;\"><strong><span style=\"color: #000080;\">*Judgment Authored by Justice MR Shah<\/span><\/strong><\/p>\n<blockquote class=\"wp-embedded-content\" data-secret=\"JbOasr4GNl\"><p><a href=\"https:\/\/www.scconline.com\/blog\/post\/2022\/05\/16\/know-thy-judge-justice-m-r-shah\/\">Know Thy Judge | Justice M. R. Shah<\/a><\/p><\/blockquote>\n<p><iframe loading=\"lazy\" class=\"wp-embedded-content\" sandbox=\"allow-scripts\" security=\"restricted\" style=\"position: absolute; clip: rect(1px, 1px, 1px, 1px);\" title=\"&#8220;Know Thy Judge | Justice M. R. Shah&#8221; &#8212; SCC Blog\" src=\"https:\/\/www.scconline.com\/blog\/post\/2022\/05\/16\/know-thy-judge-justice-m-r-shah\/embed\/#?secret=yx8nsJOuJX#?secret=JbOasr4GNl\" data-secret=\"JbOasr4GNl\" width=\"600\" height=\"338\" frameborder=\"0\" marginwidth=\"0\" marginheight=\"0\" scrolling=\"no\"><\/iframe><\/p>\n<hr\/>\n<p>Advocates who appeared in this case :<\/p>\n<p style=\"margin-left: 18pt;\">Mr. Tushar Mehta, SG Mr. Balbir Singh, A.S.G. Mr. Aditya Sikka, Adv. Mr. Naman Tandon, Adv. Mr. Samarvir Singh, adv. Mr. Kanu Agarwal, Adv. Mr. Vikash Jha, Adv. Vasudha Vijayshree, Adv. Ritu Anand, Adv. Pratyush Srivastava, Adv. Ms. Sansriti Pathak, Adv. Ms. Bani Dikshit, Adv. Mr. Arvind Kumar Sharma, AOR Mr. Chandra Prakash, AOR Ms. Anannya Ghosh, AOR Mr. Aaditya Aniruddha Pande, AOR Mr. Sachin Patil, AOR Ms. Misha Rohatgi, AOR Ms. Suveni B., Adv. Ms. Ayushi Sharma, Adv. Mr. Nakul Mohata, Adv. Mr. Bharat Monga, Adv. Mr. Devansh Shrivastava, Adv. ms. Riya Dhingra, Adv. Mr. Mohd. Ovais, Adv. Mr. Mahesh Agarwal, Adv. Mr. Rishi Agrawala, Adv. Mr. Rahul Dwarkadas, Adv. Ms. Prachi Dhanani, Adv. Ms. Rishika Harish, Adv. Ms. Niyati Kohli, Adv. Ms. Juhi Bahirwani, Adv. Mr. Pratham Vir Agarwal, Adv. Ms. Rohini Jaiswal, Adv. Ms. Manavi Agarwal, Adv. Mr. E.C. Agrawala, AOR<\/p>\n<\/div>\n","protected":false},"excerpt":{"rendered":"<p><i>Supreme Court observed that if the interpretation that once an auditor resigns, the proceedings under Section 140(5) stand terminated and are no longer further required to be proceeded, an auditor may resign to avoid Tribunal&#8217;s final order and its consequence as provided under the second proviso to Section 140(5).<\/i><\/p>\n","protected":false},"author":121,"featured_media":291451,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[3,9],"tags":[57400,31714,3274,57403,57398,50401,47213,12231,57401,57402,57399,5363],"class_list":["post-291441","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-casebriefs","category-supremecourt","tag-auditors","tag-companies-act-2013","tag-constitutionality","tag-discriminatory-provisions","tag-fraud-by-auditor","tag-justice-mm-sundresh","tag-justice-mr-shah","tag-legislative-intent","tag-removal-of-auditor","tag-resignation-by-auditor","tag-section-1405-of-companies-act","tag-supreme-court"],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v23.4 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>Supreme Court upholds constitutionality of Section 140(5) of the Companies Act | SCC Blog<\/title>\n<meta name=\"description\" content=\"Supreme Court upheld constitutional validity of Section 140(5) ofCompanies Act 2013 saying that proceedings do not end on resignation\/ removal of auditor.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/blog.scconline.gen.in\/post\/2023\/05\/06\/supreme-court-upholds-constitutionality-of-section-1405-of-the-companies-act-fraud-by-auditors\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Supreme Court| Section 140(5) of the Companies Act constitutional; 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