IL&FS Case: High Court Quashes SFIO’s Criminal Complaint Against Deloitte, BSR

The Bombay High Court quashed criminal complaints filed by the Serious Fraud Investigation Office against the erstwhile auditors of Infrastructure Leasing and Financial Services Ltd. and its non-bank lending arm for alleged collusion in falsifying books.

A division bench of Chief Justice Bhushan Dharmadhikari and Justice Nitin Borkar, while upholding the constitutional validity of Section 140(5) of the Companies Act, observed that the provision applies only to existing auditors. But the high court, on the government’s plea, stayed the part of its order where it held prosecution against auditors as unsustainable.

Deloitte Haskins and Sells and BSR & Associates LLP., an Indian affiliate of KPMG, had moved the high court after the National Company Law Tribunal denied relief. They had challenged the central government’s move to bar them for five years, and the SFIO’s decision to initiate criminal proceedings invoking Section 447 of the Companies Act, among others. The two firms, which were auditors for IL&FS for different periods till March 2018, had argued that the provision can be used only against existing auditors.

What The Court Said

The high court said:

• Section 140(5) is constitutional and does not suffer from double jeopardy or any procedural discrimination as argued by the auditors.
• SFIO’s argument on the status of its investigation report itself demonstrates “absence of application of mind: to relevant facets which have a bearing on the investigation.
• The government’s report should have showed whether even one instance of financial bungling was fully investigated and if it showed whether any offence was committed by the auditors. The SFIO report itself indicates the need for further investigation into certain matters.
• The sanction issued by the government for initiating prosecution against BSR, its audit partner N Sampath Ganesh, and Deloitte Haskins and its audit partners Udayan Sen and Kalpesh Mehta is untenable in law and is thus set aside. Similarly, the resultant proceedings at the NCLT and the sessions court are quashed.
• Prosecution against Hari Sankaran, former vice chairman of IL&FS, is also quashed as it was initiated pursuant to the government’s sanction order.

The Backstory

The case stems from a string of surprise defaults by IL&FS in 2018, sparking a liquidity crisis in the Indian financial markets. That prompted the government to take over the beleaguered infrastructure conglomerate to avoid a contagion. The government then directed the SFIO, Registrar of Companies, the Ministry of Corporate Affairs and the Institute of Chartered Accountants to investigate the alleged involvement of the auditors.

The accounting regulator ICAI said in its December interim report that the auditors failed to report the serious mismatch between assets and liabilities as well as key indicators which pointed to liquidity concern in its balance sheet. Deloitte was the statutory auditor of IL&FS Finance Services Ltd. between FY07 and FY17, while BSR was appointed as a joint auditor for FY18.

SFIO, after a nine-month probe, concluded that the auditors allegedly colluded with the management of IL&FS Financial Services and falsified the books of accounts and the financial statements between 2013 and 2018. It filed a criminal complaint against certain partners and officials of the audit firms, alleging fraud under the company law and criminal conspiracy under the Indian Penal Code.

The government moved the NCLT on June 10 seeking a five-year ban on the auditors under Section 140 (5) of the Companies Act. It also sought to implead the auditors in the oppression and mismanagement case against the management of IL&FS and its non-bank lending arm.

Deloitte Haskins and BSR challenged the government’s move, arguing the law permitted removal of an “existing” auditor only after a final order establishing a fraud is passed and the NCLT lacked jurisdiction as the firms had already resigned. The tribunal dismissed the challenge in August last year.

BSR then moved Bombay High Court, challenging the constitutional validity of Section 140 (5) and seeking that all proceedings against them be quashed. The high court granted interim relief to the firm and Deloitte Haskins and its audit partners.

Auditors’ Arguments

Seeking to quash proceedings, the auditors argued:

• SFIO’s started proceedings on the basis of a 32,000-page interim report; and the Ministry of Corporate Affairs granted permission just a day after it was submitted. This indicates that the government proceeded “hastily”.
• Section 140(5) is unconstitutional on various grounds as it does not make an “intelligible differentiation” between existing and previous auditors. The provision does not provide procedural safeguards to an auditor. While the government can initiate prosecution under several provisions, an auditor is left defenceless.
• The NCLT allowed initiation of proceedings against auditors even when they had already resigned on basis of a “deeming fiction”. The NCLT lacked jurisdiction to exercise such powers which can be only exercised by high courts.

Government’s View

The government and SFIO had argued:

• Section 140(5) is constitutionally valid and provides adequate procedural safeguards.
• The word ‘interim’ does not affect the finality of investigation report, which was prepared after a detailed probe.
• Provisions for debarring an auditor are preventive in nature and have proper procedural safeguards.
• Initiation of process to remove auditors was necessary considering the widespread impact caused by the alleged fraud at IL&FS group entities.