IL and FS scam: Centre assails Bombay HC reading of Company Act's Sec 140-5

Both firms were former auditors of IL&FS Financial Services Ltd (IFIN).

"As per the interpretation provided by the High Court to Section 140(5) of the Companies Act, an auditor can escape legal liability and criminal sanctions arising out of aiding, abetting and designing a serious financial scam by merely tendering resignation as the statutory auditor from a company," said the Centre's petition.

Deloitte Haskins & Sells LLP (Deloitte) was the erstwhile statutory auditors of IL&FS Financial Services Ltd (IFIN) for the financial years 2007-18. Deloitte had rotated out as the auditor of IFIN in 2018 by operation of law. BSR & Associates LLP (BSR Associates) was appointed as the joint statutory auditors for IFIN for the financial years 2017-18 (jointly with Deloitte), continued as auditors of IFIN until June 10, 2019 and resigned.

"... interpretation and the resultant extinguishing of proceedings... if not stayed at this interim stage, would cause serious prejudice and would profoundly impact the functioning and the confidence around the reporting of financials of companies," said the Centre's petition.

In April, the High Court quashed all prosecution, pending before the National Company Law Tribunal and a special court in the city, against the two firms over the allegations of financial irregularities. BSR, which is part of KPMG India, and Deloitte, moved the High Court last year challenging the plea by the Centre before the tribunal seeking their removal as auditors of IL&FS. And, under section 140 (5) of the Companies Act, this kind of removal would also lead to a five year ban on the audit firms.

The High Court, however upheld the constitutional validity of Section 140 (5) stating that provisions only apply to existing auditors. The Ministry of Corporate Affairs moved the apex court challenging this order. On June 16, the Supreme Court issued notice on the matter.

Criticizing the High Court order, the Centre said it will result in a complete extinguishment of a criminal trial and further proceedings against the firms, "who have been found to have been involved in a serious financial scam  having repercussions on the national economy by an expert investigative agency upon conducting a detailed investigation".

The Centre claims as per the interpretation of Section 140(5) of the Act set forth by the High Court order, an auditor who has been proceeded against under Section 140 (5) of the Act can, by the mere stratagem of resigning as the auditor, stultify proceedings initiated against them. "Moreover, such an auditor could then negate the second proviso by continuing as the auditor of other companies," said the petition.

The Centre had argued that the High Court order does not take into consideration that Section 140(5) opens with the words "without prejudice to any action under the provisions of this Act" which would mean that Section 140(5) of the Act are not to be affected by other provisions under the Act including Section 132 (4B) of the Act.

The Supreme Court has continued the partial stay granted on the operation of the judgement of the Bombay High Court in the matter in connection with investigation into IFIN. The court further ordered that the order of the High Court cannot be used for the purpose of bail by the accused in the Serious Fraud Investigation Office (SFIO) complaint.