Written by Porus Confectioner, a career banker with 25 years experience in banking/ financial services and has completed the DEABL from NUJS Kolkata.
Experiences of the past few years have reinforced the need for strengthening of Corporate Governance globally and in India for companies and institutions. The audit function remains one of the pillars of Corporate Governance in companies and auditors remain the keystone in enforcement and maintenance of standards of Governance.
The most critical purpose of an audit is to provide company stakeholders as an expert, independent and true and fair view of the financial affairs of a company. Auditor independence is, therefore, the central critical element for auditors to perform their role “ freely, fearlessly and objectively” to protect the larger interests of all stakeholders.
While the previous Companies Act 1956 had codified the auditor requirements, the Companies Act 2013 has set out in greater detail the law with regard to appointment, retirement, removal and other requirements for independence of the audit function by subjecting auditor decisions to more scrutiny by appropriate authorities. The set up of National Financial Reporting Authority to oversee audit performance is also an effort to cover the question “ who audits the auditors.”
In this paper, we explain relevant Companies Act 2013 legislation on audit including the rights of a Retiring Auditor.
The law relating to Audit in India is covered under the following Acts and Rules :
- Companies Act 2013 – Sections 139 to 148 and amendments 2017
- Companies ( Audit and Auditors Rules ) 2014
- Companies ( Management and Administration Rules ) 2014
- Audit Standards – Issued by Central Government, Institute of Chartered Accountants of India and requirements of +National Financial Reporting Authority.
Section 139 states that in following cases a company would require to constitute an Audit Committee which would recommend to the Board the individual or firm for audit purposes after taking in to account relevant experience and qualification of auditor :
- Companies with Paid-up Capital of INR 10 Crores or more
- Public Companies with turnover of INR 100 Crores or more
- Public companies with any outstanding borrowings of INR 50 crores or more
( Sec 139 ) – First Auditors to be appointed By Board of Directors within 30 days of Registration of company and they will hold office till first AGM. The same auditor may be reappointed up to the 6th AGM or new audit firm appointed at Sixth AGM subject to shareholder approvals. The same auditor appointment to be ratified at every AGM. This requirement for ratification by shareholders, which also came under scrutiny in SPC & Associates Vs. DVAK and Co & Anr by NCLT Hyderabad has since been removed by Amendment to Companies Act in 2017. Henceforth, auditor re-appointment will not require shareholder ratification at each Annual General Meeting. The eligibility, qualifications, and disqualifications for an auditor appointment are set out in Section 141.
The procedures and requirements for Removal, retiring and the resignation of auditors is encoded in Sections 139 and 140. Section 139 restricts individual auditor appointment for a maximum term of 5 years and a firm for 2 terms of 5 years. Thereafter, they may be reappointed after a cooling off period of 5 years. Let us understand who is a “Retiring “ auditor.
A Retiring Auditor – retires at the first AGM of the company and holds office till next AGM of the company. At every AGM thereafter, the same auditor would be reappointed unless:
- He is not qualified for reappointment ( Disqualification )
- Has given the company notice of his unwillingness to continue ( Resignation )
- A Special Resolution is passed at AGM for non-reappointment of retiring auditor ( Removal ).
Section 139 (10 ) states that where at any Annual General Meeting, no auditor is appointed or re-appointed, the existing auditor shall continue as the auditor of the company.
Where an Auditor, being a firm, retires, on completion of a 5-year tenure, his appointment may continue for another 5-year tenure. In such a case, the auditor’s tenure may be extended for another 5 years by Ordinary Resolution passed at the Annual General Meeting each year. However, where the auditor is not to be reappointed, there would be a requirement for a *Special Notice procedure under Section 115, which would require to be moved, for subsequent Resolution to be placed at the next Annual General Meeting, in such a case.
Special Notice Procedure: Where a Special Notice is required to be given, the Special Notice of intention to move such Special Resolution later, must be :
- moved by members holding not less than One Percent of the total voting power or holding shares of not less than five lakhs value of paid-up equity capital as on the date of moving of the Special Notice.
- the Special Notice must be sent between 3 months and 14 days prior to the date that the Resolution has to be moved so that sufficient time is available for the company to inform auditors and for the company for further action
- the company shall give its members notice of the resolution at least 7 days before the meeting as per Rule 23 of Companies ( Management and Administration ) Rules, 2014.
In such a case, the following Rights would be available to the retiring auditor – Sec 140 (4) (iii) :
- Right to receive a copy of Special Notice: Copy of Special Notice to be sent to the auditor immediately by Registered A/D. The contents of the notification must be clearly stated or given to the auditor.
- Right to make representation in writing and request notification to members: auditor may make a representation in writing to members of the company
- Right to have the representation circulated to members – the company is obligated to forward the representation to all members unless it is received too late. In the representation is too late, the representation must be filed by the company with the registrar
- Right to have representation read out at the meeting – if the above representation is late auditor has right to get the representation read out at The General Meeting.
- Right to be heard orally at the meeting – it is imperative that the auditor is given audience to state his viewpoint which may be considered.
The following points may be noted :
- Where the Auditors have requested for representation at the meeting, their representation may be read out to the members of the company. The company is bound to represent only if requested for by the auditor.
- In such a case the Auditor should be given “ Reasonable opportunity to be heard “ before any action is taken by shareholders or Central Government. In Basant Ram & Anrs.vs Union of India & Ors* it was held that “ there is considerable merit, as there is no statutory bar on a prior meeting held, wherein the shareholders or the members approve the resolution for making the application to seek the previous consent of the Central Government.” Hence, any action would be operative only after the approvals of shareholders. “
Principles of Natural Justice demand that an auditor is given an opportunity to state his case before retiring or being removed from office. The auditor is a critical functionary in the in the corporate eco-system and it would be inappropriate to remove them without giving ear to their viewpoints and comments. Accordingly, the requirement of intimating the members about representations being made in the notice to members and the right of auditor being heard at the meeting may not be dispensed with in any circumstances.
The company, which has concerns on the continuation of the auditors’ services, may apply to the NCLT with a request to avoid the requirement of sending of the representation or having the same read out in the meeting on the ground that the rights conferred by the section are being misused by the auditor.
The High Court, in the case of SPC & Associates, Chartered Accountants Vs DVAK & Co., observed that the provisions of the Companies Act 2013 underscore that the statutory auditor cannot arbitrarily be removed and the statutory procedure has to be followed. Auditors are expected to function as independent professionals and not simply toe the line of the management of the concerned company.
Removal of an auditor prior to the expiry of his term, under Sec 140 (1), requires the company to obtain Shareholders approval, Central Government approvals and reasonable opportunity of being heard before any action is taken. The Removal of Auditor is Special business and requires a Special Resolution for the purpose.
The Companies Act 2013 has laid out comprehensively the law with regard to audit and auditors from Sections 139 to 148. The Act has also allowed for protection of auditors rights through various safeguards including shareholder approvals, central government approvals and opportunity of being heard before any action lies which may be prejudicial to their rights as auditors. This three-tier audit protection structure has been brought in to ensure that the auditors’ act “freely, fearlessly, objectively and independently” and without any influence from the companies they audit, in pursuit of high Corporate Governance standards.
*Special Notice – Explanation: Resolutions requiring Special Notice and Special Resolutions. The former is the procedure that precedes the placement of Resolution proposed by certain members for approvals of members at General Meeting whereas the latter is a resolution passed under Section 114 of the Companies Act 2013. In general, matters which require special notice under Companies Act 2013 are Ordinary Resolutions.