HC quashes prosecution against 2 former IL&FS audit firms

Granting relief to audit firms BSR and Associates, and Deloitte Haskins and Sells, both former auditors of IL&FS Financial Services, the Bombay High Court on Tuesday quashed all prosecution against the two firms that had been pending before the National Company Law Tribunal and a special court in the city, over alleged financial irregularities. 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.

The section 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". While the Bombay High Court on Tuesday 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.

On Tuesday, a bench of Chief Justice BP Dharmadhikari and Justice NR Borkar quashed the prosecution of both firms before the NCLT. The bench 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 bench pronounced its judgement following petitions filed by both firms and other former ILFS auditors, N Ganesh Sampath, Kalpesh Mehta, and Udayan Sen. The petitioners had challenged the Union government's plea before the NCLT seeking that they be prosecuted under section 140 (5) of the Companies Act and, thus, be banned from auditing for five years.

They had challenged the constitutional validity of the above section. The petitioners also challenged criminal proceedings initiated against them by the Union Ministry of Corporate Affairs following an investigation report filed by the Serious Fraud Investigation Office (SFIO) before a special court.

In June last year, Union Ministry of Corporate Affairs had sought such removal and also initiated criminal proceedings against the firms for their role in alleged financial irregularities at the now bankrupt IL&FS Group. In August last year, the NCLT had found merit in the Union government's plea, and subsequently approved the proposed removal of both firms.

At the time, it had also directed the SFIO to initiate a probe and disciplinary action against such audit firms. SFIO had subsequently claimed that BSR and some other audit firms had acted in breach of auditing standards and that they had failed to detect financial inconsistencies at IL&FS.

The petitioners challenged the criminal proceedings arguing that the same was based on the SFIO report, which was inconclusive and ran into over 32,000 pages with annexures. This report, therefore, could not be the basis for their prosecution.

The bench agreed with the above arguments. It said that the plea filed by the ministry before the NCLT was "non tenable" since the petitioners had resigned by then.

It said that the NCLT order rejecting relief to the petitioners on August 9, last year was, therefore, "quashed". "Section 140(5) of the Companies Act, 2013 is not unconstitutional," it said, but "NCLT proceeding as if the debarment is the object behind section 140(5) and using the theory of deemed continuation of the CA (petitioners) though he had been rotated out or resigned, therefore, is an error apparent which must be corrected in exercise of its extraordinary jurisdiction by this Court," it said.

The High Court also quashed the criminal proceedings based on the SFIO report after ruling that it was humanly impossible for one to come to conclusions after reading such a lengthy report. Besides, the SFIO report itself said it needed to make further cross examinations to provide adequate evidence, the HC said while quashing the criminal proceedings against the audit firms that had been pending hearing before a special court in the city.