NCLT’s “Subjective Satisfaction”: An (Un)Constitutional interpretation of section 140(5) of the Companies Act, 2013
– Tanuj Agarwal & CA Kunal Agarwal
Statutory auditor (hereinafter ‘CA’) bears a significant role in corporate governance and protecting the interest of shareholders.[i]
Recently, in the case of N. Sampath Ganesh v. Union of India, the High Court of Bombay (hereinafter ‘HC’) analysed such subjective satisfaction of NCLT and upheld the constitutionality of section 140(5) of the Act. The case involved big auditing firms such as Deloitte Haskins and Sells LLP and BSR and Associates as petitioners. The constitutionality was challenged on the grounds of double jeopardy, due process, retrospective application, etc. Precisely, this post analyses NCLT’s subjective satisfaction concerning the due process of law while determining the constitutionality of the second proviso of section 140(5) of the Act.
Disciplinary action against CA in case of any default
Institute of Chartered Accountants of India (ICAI) is recognized as a disciplinary body to govern the conduct of CAs as per the Chartered Accountants Act, 1949.[ii] Further, the Act under section 132 also provides power to the National Financial Reporting Authority (NFRA) to proceed with specific cases and also to punish CA in the case of any professional misconduct. Additionally, criminal trial can also be pursued as per section 447 of the Act.
Accordingly, the HC observed that since Parliament cannot be presumed to have established manifold agencies with the same power, such punitive powers cannot be construed to be vested with NCLT under section 140(5) of the Act. The functions of NFRA are regulatory, since it is empowered to take punitive action in case of any fraud or professional misconduct. While the power of NCLT, as per section 140(5), is more curative in nature in the sense that it merely provides for the expedite change in CA, so that the company may function in an assured manner by having a new CA on board. Hence, NCLT has merely the power to change the suspected auditor by reaching its subjective satisfaction. Thereby, the consequences of the final order, i.e. debarment for five years and liability as per section 447, provided under the second proviso of section 140(5) are statutory mandate and not to be understood as a power of NCLT.
HC’s interpretation of NCLT’s subjective satisfaction
As per Rule 52 of National Company Law Tribunal Rules, 2016, NCLT is empowered to issue the summons, examine witnesses, etc. to inquire about the commission of fraud by CA. Notably, the HC stated that such inquiry is limited for the purpose of reaching its subjective satisfaction regarding the need to change the suspected auditor and not to punish him by way of debarment. Consequently, with reference to such subjective satisfaction, the HC noted that “[e]lement of subjective satisfaction rules out the need of a full-fledged inquiry or an exercise to prove it in each & every case.” The concept of subjective satisfaction exhibits that “Parliament has expected NCLT to change the doubtful CA who insists on continuing.”
The disqualification and liability of fraud under the second proviso is merely a threat to expedite the change of auditor. The intention of this scheme is not to punish but to restrict the suspected auditor from continuing his service. The HC stated that the purpose of this section is that, if the CA raises frivolous defence and does not resign, he has to bear the debarment of five years and liability under section 447. A self-respecting CA can safeguard himself from debarment and liability as per section 447 by accommodating the satisfaction of NCLT.. Conclusively, the HC stated that “[e]xtending the requirement of the standard of proof beyond reasonable doubt in the scheme of S. 140(5) where “satisfaction” of NCLT is envisaged, will result into a paradox.”
Nature of the Second proviso: Cautionary or Punitive
The HC interpreted the consequences of the second proviso as a threat or caution to the auditor if he does not voluntarily resign from his position. The HC stated that,
“This disqualification or debarment is [……] therefore a regulatory measure. No petitioner has attempted to urge that the need thereof as felt by the Parliament is bad.”
The concern here is that whether such a statutory mandate is just and proportionate for restricting CA to raise a defence against NCLT’s subjective satisfaction. Notably, The HC has not deliberated upon the unreasonableness of such provision (as the petitioners did not contend it). However, in the case of Modern Dental College and Research Centre and Ors. v. State of Madhya Pradesh and Ors., it was stated that the doctrine of proportionality is applicable is such cases which requires a balanced approach.
As per the Standards on Auditing-700, the audit report is just an opinion of a CA to the best of his knowledge. It indeed provides a reasonable assurance, but not a guarantee that it always identify a material misstatement. The duty imposed on CA is not that stringent to embrace strict certification, thereby the corrective action in case of default should also be proportionate. Accordingly, there may be a situation where there is misconduct in the company even after an appropriate audit. In such suspected cases, CA should be given a prospect to raise his concern.
Notably, the said debarment of five years and liability as per section 447 lead to irreparable harm to the suspected CA. Such eventual consequences are not proportionate to the object of this section. Since the purpose of this section is merely to change CA even in doubtful cases, the irreparable harm is not a balanced approach. Even the doubtful CA can be debarred for five years and made liable for fraud under section 447, if he questions NCLT’s subjective satisfaction by not resigning as an auditor, on an application under section 140(5) of the Act. Thereby, the scheme of the second proviso seems to be punitive rather than regulatory and cautionary.
Subjective satisfaction of NCLT and Due process: A critique of HC’s approach
A corporate cannot be held criminally liable unless the guilt is proven beyond a reasonable doubt.[iii] The determination of the guilt without giving an opportunity of being heard would deter the test of due process.[iv] In the case of the Union of India v. Tulsi Ram, the Supreme Court stated that,
“The principles of natural justice constitute the basic elements of a fair hearing, having their roots in the innate sense of man for fair play and justice, which is not the preserve of any particular race or country but is shared in common by all men.”
The scheme of section 140(5) of the Act provides for the summary procedure of 15 days. Such a summary procedure is to reach its satisfaction for any fraud being committed for the removal of CA. The observation of HC is that this provision was merely intended to change the suspected CA is very much conceived on the basis that the Parliament would not make multiple mechanisms to deal with professional misconduct. However, the consequences of debarment for five years and liability of fraud under section 447 is quite unjust and manifest unreasonableness. As established, the nature of such consequences is more punitive than cautionary. Notably, “fraud” under section 140(5) shall be determined by referring to section 447, and consequently, the concurrent process should also be the same to discern any guilt. The eventual consequence of section 140(5) is a criminal liability as per section 447; thereby, the guilt must be proved beyond a reasonable doubt by giving the right of being heard to the suspected CA. A summary procedure cannot be just for establishing the liability of punitive nature.[v] Remarkably, HC opted for an opposite view that in case CA has not resigned voluntarily and wants to interrogate his liability, then NCLT has the power to directly make him liable pursuant to 140(5), the consequence of which is punitive in nature.
Moreover, the trial under section 447 of the Act is conducted by applying the Criminal Procedure Code[vi] and giving a full opportunity of being heard. Even when the consequences that follow are the same, the scheme of section 140(5) does not provide for the same. Such a statutory mandate which imposes criminal liability, even in suspected cases where the guilt is not proved beyond reasonable doubt, should not be held as constitutionally valid. A provision that empowers NCLT to change CA (even suspected) by reaching subjective satisfaction, without any punitive statutory mandate, would remarkably suffice the interests of shareholders and ensure healthy corporate governance.
[i] Marianne Ojo D Delaney, Auditor Independence-Its Importance to the External Auditor’s Role in Banking Regulation and Supervision, Conference Proceedings of the IBFR Conference, Costa Rica and Elsevier Journals (2006).
[ii] The Chartered Accountants Act 1949, ch V.
[iii] Pamela H. Bucy, Corporate Ethos: A Standard for Imposing Corporate Criminal Liability, 75 Minn. L. Rev. 1095 (1990-1991).
[iv] Zahira Habibullah Sheikh & Anr v. State of Gujarat & Ors, Criminal Appeal No. 446-449 of 2004.
[v] Jyotsna K. Valia v. T.S. Parekh & Co., 2007 (3) BomCR 772.
[vi] Siddharth Chauhan v. Serious Fraud Investigation Officer, CRM-M No. 38926 of 2019.
Tanuj is a student of law at Institute of Law Nirma University, Ahmedabad and Kunal is a Partner at Baweja & Kaul Chartered Accountants.