IL&FS Crisis: NCLAT Rejects Deloitte, BSR Plea Seeking Exclusion From Mismanagement Case

The appellate tribunal dismissed the appeals by former auditors and independent directors of Infrastructure Leasing and Financial Services Ltd. and its non-bank lending arm challenging their inclusion as a party to the ongoing case of oppression and mismanagement.

Deloitte Haskins & Sells and BSR & Associates., along with their audit partners, had challenged the maintainability of the National Company Law Tribunal’s order allowing to implead them in the lawsuit alleging oppression and mismanagement that brought the infrastructure conglomerate to the brink of collapse. They argued that they weren’t the necessary party to the case.

The National Company Law Appellate Tribunal said in its order that various acts at IL&FS were prejudicial to public interest and were likely to have cascading impact on the economy. In such circumstances, the NCLT’s opinion can’t be held to be illegal, the appellate tribunal said.

A Deloitte spokesperson said it will review the order before taking a decision on its future course of action, which may include an appeal. BSR, too, said it’s reviewing the order.

The probe stems from the Ministry and Corporate Affairs takeover of the IL&FS group to prevent a contagion in credit markets after surprise defaults by the AAA-rate conglomerate. The ministry and the Serious Fraud Investigation Office initiated separate probes into alleged collusion between the erstwhile auditors and the management in the falsification of books. The Bombay High Court stayed the proceedings in September last year after the auditors challenged its constitutional validity.

The NCLAT, however, denied relief. Here are the key arguments of all the parties:

Auditors, Partners, Directors

Deloitte Haskins and Sells challenged impleadment on the grounds:

• NCLT did not make a specific finding in its order that its impleadment was necessary in the case for mismanagement. The MCA’s petition did not contain any allegations against it or its employees.
• The mismanagement case pertained to IL&FS and IL&FS Financial Services Ltd.’s management. Deloitte was not involved in the management of the affairs of the company.
• The NCLT lacked jurisdiction to pass an order against the auditors under Sections 241 and 242 of the Companies Act.
• Section 241 indicates that a case for oppression and mismanagement can be initiated only for present actions, while Deloitte ceased to be an auditor due to rotation at the end of annual general meeting for 2017-18.
• The central government sought impleadment on the basis of interim, not final, report by the SFIO.

Impleaded partners of the audit firms cited that no action can be initiated against them in their personal capacity and they were not a necessary party to the case.

Government

The Ministry of Corporate Affairs, SFIO and the central government argued:

• The NCLT is vested with wide powers under Sections 241 or 242 to implead the auditors.
• The central government did not solely rely on the SFIO report. It also considered inspection report by the Reserve Bank as well as the Institute of Chartered Accountants.
• The auditors failed to fulfill their statutory duties and did not report fraudulent accounts of IFIN.
• Independent directors failed to fulfill their statutory duties. They did not report acts of fraud which was their statutory obligation.
• Directors, auditors were privy to the inner working of IL&FS and its non-bank lending arm. Therefore, they cannot evade responsibility for misfeasance, persistent negligence in carrying out their duty.

NCLAT’s Reasons To Dismiss Plea

The appellate tribunal relied on its past orders on oppression and mismanagement cases. While dismissing the auditor’s plea, it said:

• The NCLT has to follow the principle of natural justice. If it orders investigation against any party, it can also seek impleadment of connected parties.
• The tribunal can pass any order as it deems fit after forming an opinion that the affairs of a company are conducted in a manner prejudicial to the public interest.
• The NCLAT relied on the Supreme Court’s 2018 decision in the Gitanjali Gems case. The apex court had said that an interim order by the tribunal cannot be restrictive in nature. The NCLTcan pass an order against a company or any individual.

Auditors’ Reaction

“We will review the written order before determining our further course of action, which may include an appeal,” said an emailed statement by a spokesperson of Deloitte.

“In the matter of impleadment under Sec. 241 and 242, we continue to believe that auditors cannot be treated as part of the management which is responsible for managing the affairs of the company and therefore should not be charged as per the said section,” it said. “We will continue to present and protect our position, supported by the facts, to the relevant authorities. The firm remains committed to high standards of audit quality and ethical conduct in its professional practice.”

A spokesperson for BSR said in an emailed statement to BloombergQuint that it’s reviewing the order and will explore appropriate steps as required. “We do not anticipate this order impacting our ability to continue providing high quality audit services to our clients. BSR is committed to, and bears responsibility and accountability for, the highest ethical and quality standards in its audits. BSR reaffirms its commitment to all our stakeholders.”