The Article has been drafted by Suman Kumar Jha (Founder & Managing Partner), Afnaan Siddiqui (Co-Founder & Partner), Visakha Raghuram (Associate) and Ankit Abhishek Jha.
The Delhi High Court in its recent judgement, in the matter of Deloitte Haskins & Sells LLP vs. Union of India & Anr, W.P.(C) 1065/2021 dated 7th February upheld the validity of Section 132(4) of the Companies Act, 2013, along with Rules 3, 8, 10, and 11 of the National Financial Reporting Authority (“NFRA”) Rules, 2018. The retroactive operation of Section 132 and the vicarious liability imposable on entire audit firms and not just individual partners and CAs was challenged. The judgment merged group of petitions which was filed by Audit firms and Chartered Accountants challenging the validity of Section 132(4) of the Companies Act, 2013 on grounds of unconstitutionality, arbitrariness, and ultra vires.
Challenging the action initiated by the NFRA and the constitutional validity of Section 132 of the Companies Act, the petitioners primarily contended that the provision is liable to be struck down as it imposes vicarious liability on audit firms and their constituent partners, regardless of their direct involvement in the audit process. It was further argued that Section 132 unfairly extends liability to Limited Liability Partnerships (LLPs), which may consist of numerous partners and employees, thereby subjecting individuals to penalties despite their lack of direct participation in the alleged misconduct. They also challenged the retrospective application of Section 132, which empowers NFRA to initiate disciplinary proceedings against Chartered Accountants and auditing firms for audits conducted prior to the provision’s introduction. The petitioners argue that this retroactive enforcement breaches principles of fairness and due process, as it imposes penalties and disciplinary actions under a regulatory framework that was not in place at the time of the audits. The petitioners argued that NFRA’s disciplinary procedures lack the procedural safeguards and fairness provided under the Chartered Accountants Act, 1949. They contended that NFRA’s dual role—both overseeing audits and initiating disciplinary proceedings, creates a conflict of interest, effectively making it both prosecutor and judge. This, they claimed, violates Article 14 by depriving them of fair and impartial proceedings.
The Court observed that auditing services involve a fully integrated relationship between a firm and its members, with overlapping roles and responsibilities to uphold professional standards. Given this integration, a firm cannot dissociate itself from the actions of its partners, particularly when those actions are carried out in fulfilment of the firm’s obligations. Consequently, the Court rejected the argument that Section 132 of the Companies Act should be deemed unconstitutional on the grounds of vicarious liability for audit firms or their members. It held that Section 132 is neither excessive nor unjust but rather a necessary mechanism to ensure professional accountability.
The Court noted that the Explanation to Section 132(4) clearly states that ‘professional or other misconduct’ carries the same meaning as defined under Section 22 of the Chartered Accountants Act. Therefore, Section 132 does not introduce a new category of misconduct or impose liabilities beyond those already established under existing law. Since the definition of misconduct was already in place, auditors and Chartered Accountants were always subject to scrutiny based on these standards. The Court rejected the argument that Section 132 retroactively creates new liabilities, emphasizing that no auditor can claim a vested right in relation to professional misconduct committed before the provision came into effect in October 2018.
The Court reaffirmed that Article 20(1) applies strictly to crimes and punishments in the conventional sense. It noted that professional misconduct had already been subject to penalties under existing laws long before the introduction of Section 132 in the Companies Act. Since Section 132 merely incorporates the definition of misconduct from the Chartered Accountants Act for the purpose of proceedings under its purview, the argument based on Article 20(1) was deemed baseless and rejected. While upholding the validity of Section 132 and the NFRA Rules, the Court pointed out that NFRA had acted contrary to legislative intent by failing to maintain a clear separation of roles as mandated under the Companies Act and the NFRA Rules.