This article is written by Gautam Badlani, a student at Chanakya National Law University, Patna. It provides an overview of the various provisions of Section 139 which deals with the qualifications, removal and functions of the auditors. The article also explains the procedure to be followed in the appointment of auditors and some landmark judgments. It also discusses the Rules under Companies (Audit and Auditors) Rules, 2014 which deal with the process of appointment and rotations of auditors.
It has been published by Rachit Garg.
Table of Contents
In the past few decades, there has been a significant increase in corporate-based financial transactions. Several new companies have been established. As a result, significant economic resources lie at the disposal of large corporations. It has become essential to monitor and review the manner in which the corporations use their financial resources. Thus, the Companies Act, 2013 lays down comprehensive provisions relating to the appointment of auditors. Auditors are not merely appointed for the purpose of ensuring the arithmetic accuracy of the financial statements. They monitor and scrutinise the entire internal control system of the company. This article provides a detailed analysis of Section 139 which deals with the appointment of auditors.
Appointment of auditors
An auditor is to be appointed by the company at its first annual general meeting. The annual general meeting is held every year and all the shareholders of the company are invited to attend the meeting. The directors of the company present the report about the annual performance of the company before the shareholders.
The auditor so appointed may be a firm or an individual. The auditor so appointed will continue to hold post till the conclusion of the sixth annual general meeting. Thus, the tenure of the auditors appointed under Section 139(1) is five years. An individual auditor who has completed 5 years in office cannot be re-appointed. However, an audit firm may be re-appointed for another 5 years.
It is essential to obtain the written consent of the auditor before making the appointment. A notice of the appointment has to be forwarded to the Registrar of Companies. Rule 4 of the Companies (Audit and Auditors) Rules, 2014 provides that a written consent and certificate must be obtained from the auditor prior to his appointment. The certificate should contain the following particulars:
- That the person or firm is not disqualified from being appointed as an auditor
- A list of proceedings, if any, against the person or firm
- The appointment is within the limits prescribed by the Act
Such notice must be communicated within 15 days of making the appointment. If no new auditor is appointed or re-appointed at the annual general meeting of the company, the existing auditor will continue to hold the post. The company will thereafter appoint an auditor at a subsequent meeting. This provision ensures that the office of the auditor does not fall vacant due to the failure of the company to appoint a new auditor.
The first auditor of any non-government company has to be appointed within 30 days of the registration of the company. If the Board of Directors fails to appoint the first auditor within the stipulated time, then the Board has to inform the members of the company about such failure. The members will then appoint the first auditors at an extraordinary general meeting within 90 days. The first auditor appointed at the extraordinary general meeting will continue in office till the conclusion of the annual general meeting.
In case of a company owned or controlled by the government, the auditor is to be appointed by the Comptroller and Auditor General of India (CAG). In case of a newly registered government company, the first auditor has to be appointed by the CAG within 60 days of the registration. If the CAG fails to fulfil his obligation, the Board of Directors will appoint the first auditor within the next 30 days. If the Board of Directors also fail to make the appointment, then they will inform the members of the company about such failure. The members will thereafter appoint the first auditors within the next 60 days at an extraordinary general meeting.
Section 139(2) provides the eligibility for re-appointment of auditors. A company cannot re-appoint an individual as an auditor after the completion of the 5-year term. Such an individual will be ineligible for re-appointment for the next 5 years after the expiry of his term.
On the other hand, an audit firm can be re-appointed for another five year term. However, companies cannot re-appoint an audit firm more than once. An audit firm will be ineligible after the completion of two consecutive terms.
However, this provision is only applicable in case of a listed company.
An auditor can be reappointed only if :
- He is not disqualified from being appointed as an auditor
- He has not communicated any written unwillingness to the company in respect to his re-appointment
- If a special resolution expressly barring the preceding author from appointment has not been passed at the meeting
Article 139(8) provides the procedure to be followed in case of a vacancy. Any casual vacancy arising in a company, other than a company where the auditors are appointed by the CAG, has to be intimated to the Board of Directors of the concerned company within 30 days. However, if such casual vacancy arises due to an auditor’s resignation, then such resignations will require the subsequent approval of the Board of Directors. The Board will approve the resignation at an annual general meeting which has to be held within 3 months of the submission of resignation by the auditor. The auditor resigning will continue to hold office till the conclusion of the annual general meeting.
The possible causes of a casual vacancy can be death of an auditor, disqualification of an auditor, etc.
The purpose behind these provisions is to avoid the possibility of the office of the auditor lying vacant. Sudden and unexplained resignations would have left the office of the auditor vacant till a new auditor is appointed by the Board at the next meeting. However, by virtue of Section 140, the resigning auditor continues till his resignation is approved. A new auditor can be appointed at the same general meeting in which the existing auditor resigns.
An offence under Section 139 is punishable under Section 147(1). Any company which is in violation of the provisions of Section 139 may be punished with a fine of up to Rs 5 lakhs. The minimum fine that the courts or tribunals may impose on the company is Rs. 25,000.
Any officer of the company who acts in violation of Section 139 is punishable with a fine of up to Rs. 1 lakh. The minimum fine that the courts of tribunal may impose on a defaulting officer is Rs. 10,000.
Earlier, the Section provided that a defaulting officer may also be punished with up to 1 year of imprisonment. However, by virtue of the Companies (Amendment) Act, 2020, Section 147 was amended and now a defaulting officer can only be punished with a fine.
A probable reason for this amendment can be that most of the courts were compounding an offence under Section 139. The defaulting companies and officers were usually filing an application for composition of the offence before the courts and tribunals. In most cases, the defaulters were able to establish some valid bona fide reasons for the delay and hence the courts were granting the relief of composition. The legislature may have taken note of the fact that in certain cases, the officers may default in making the statutory appointments for bona fide reasons. Thus, they should not be made liable to imprisonment.
Appointment of auditors under the Companies (Audit and Auditors) Rules, 2014
Rules 3 to 6 of the Companies (Audit and Auditors) Rules, 2014, deal with the appointment and rotations of auditors.
Rule 3 provides that if the company is required to constitute an Audit Committee, the committee will be responsible for recommending the appointment of the auditors. In such a case, the committee recommends the name to the Board of Directors. The Board of Directors, if they agree with the committee’s recommendation, recommends the name at the annual general meeting of the company.
However, if the Board does not agree with the recommendation made by the committee, it will return the recommendation to the committee. The Board has to provide the reasons for its disagreement. The committee will then consider the reasons for disagreements forwarded by the Board. If it does not agree with the reasons given, it will again forward the same recommendation. In such a case of conflict, the recommendation given by the committee is put forth before the shareholders at the annual general meeting. At the same time, the Board presents its own recommendation before the shareholders. The shareholders will then appoint the auditor they consider fit.
Where no such committee is to be constituted, the Board of Directors will determine the criteria for the appointment of the auditors.
Consideration has to be given to the qualifications and experience of the potential auditors. The committee or the Board has to determine whether the qualifications and experience of the candidate is in sync with the size of the company. Any pending proceedings against the proposed auditor in relation to alleged misconduct must also be taken into consideration.
Once an auditor is appointed, the appointment has to be ratified by an ordinary resolution at every annual general meeting of the company. Such ratification is required up till the 6th annual general meeting. The tenure of the auditor ends at the 6th annual general meeting.
Scope of Section 139(2)
Section 139(2) provides that all listed companies and other prescribed companies cannot re-appoint an individual auditor. An audit firm can be reappointed for a second term but not beyond that. Rule 5 of the Companies (Audit and Auditors) Rules, 2014 provides what classes of companies are covered within the scope of Article 139(2).
Article 139(2) applies to:
- All listed companies
- Unlisted companies having paid up share capital of Rs. 10 crores or more
- Private companies having paid up share capital of Rs. 20 crores or more
- All companies which have borrowed from banks or financial institutions an amount of Rs. 50 crores or more
- All companies which have accepted public deposits amounting to Rs. 50 crores or more.
Rule 6 deals with the manner in which the auditors are to be rotated. The Audit Committee recommends the name of the auditor who will replace the outgoing auditor. In the absence of the Audit Committee, the Board itself considers the rotations of auditors. A retiring auditor is ineligible to be re-appointed as an auditor till he completed a break for a continuous period of 5 years.
It is possible that the partner of the audit firm, who certifies the financial statements of the company, may resign from the firm and join another firm. In such a case, the latter firm will also be ineligible to be appointed as an auditor for a period of 5 years.
Removal of an auditor before expiry of term
Rule 7 provides the procedure to be followed for the removal of the auditors. An application has to be made to the central government for the removal of the auditor. Such an application has to be made within 30 days of the Board passing a resolution for the removal of the auditor. The company must also pay the prescribed fees for making an application to the central government for the removal of the auditor.
Once the approval of the central government is obtained, the company must hold a general meeting within 60 days and pass a special resolution for the removal of the auditor.
Appointment of auditors under the Companies Act, 1956
Under the Companies Act, 1956, Section 224 dealt with the appointment of auditors. Under Section 224, every company was required to appoint an auditor at every annual general meeting. Thus, the tenure of an auditor was only 1 year. The auditor held the office till the conclusion of the subsequent annual general meeting.
The appointed auditor was required to inform the Registrar of his appointment within 30 days of the appointment. The Section also provided that an individual or firm can be an auditor only for a prescribed number of companies.
An auditor, under the 1956 Act, could be removed from office before the expiry of his term, only after obtaining the prior approval of the Central Government. However, the company may remove an auditor and replace him by a new auditor at the general meeting, if the notice of such appointment is given to the members of the company 14 days prior to the general meeting.
Section 224A provided that in case of certain companies, an auditor could be appointed or reappointed only after the passing of a special resolution at the annual general meeting of the company. These companies included companies where 25% or more of the subscribed share capital was held by
- Central or state government
- Public financial institution
- Financial institution established by any State Act in which the government hold 51% or more subscribed share capital
- Nationalised bank
- Insurance Company
Section 619 of the 1956 Act provides that the auditor of a government company would be appointed by the CAG. Moreover, the CAG had the power to prescribe the procedure in which the accounts of a government company were to be audited. Moreover, the CAG could authorise a test audit of the company. Section 619B provided that Section 619 would cover such companies in which 51% or more of the subscribed share capital was held by:
- A combination of central government and one or more government companies
- One or more state governments and one or more government companies
- A combination of central government with one or more state government and one or more government companies
- Any combination of the central government and/or one or more state governments and/or one or more corporations owned or controlled by the central government.
Qualifications and remuneration
Section 141 enunciates the qualifications and disqualifications of the auditors. Only a Chartered Accountant (CA) is authorised to be appointed as an auditor. Where an audit firm is appointed, only those partners of the firm who are CAs and the majority of partners practising in India will be qualified to sign the company’s financial statements.
The following persons are disqualified from being appointed as auditors:
- An employee of the company is disqualified. Moreover, any person who is an employee or officer of the company’s employee is also disqualified from being appointed as an auditor. An employee of the company will not be able to provide a fair and independent view of the financial statements. Thus, the employees and officers are ineligible to be appointed as auditors.
- A person who holds any interest in the company or any of its associated companies
- A person who owes a debt to the company or has given any guarantee in respect of the company
- A person or firm having direct business relations with the company
- A person who is the relative of a director of the firm
- Person convicted of fraud
Moreover, a body corporate is also ineligible from being appointed as an auditor. The reason for this may be that the members of a body corporate share limited liability. Thus, if the CAs form a body corporate and then act as auditors through the corporate, then they could not be made individually liable.
If a person who was working as an auditor incurs any disqualification, he will be removed from the office and such removal will give rise to a casual vacancy.
Section 142 provides that the remuneration of the auditors will be determined by the members of the company at the general meeting. However, the remuneration of the first editor will be determined by the Board of Directors. It must be noted that the law does not specify the procedure for determining the remuneration of an auditor who is appointed to fill a casual vacancy. In such a case, the remuneration of such an auditor may be determined by the Board of Directors.
Section 177 of the Act stipulates the setting up of an audit committee. Such a committee will be responsible for recommending the appointment and remuneration of auditors. Rule 3 of the Companies (Audit and Auditors) Rules, 2014 provides that the auditors have to be appointed in accordance with the recommendations of the Committee.
Article 139(10) provides that where the company is required to appoint an audit committee under Section 177, the recommendations of the committee must be taken into consideration before making the appointment.
The Audit Committee also reviews the report submitted by the company’s auditors. The auditors can also appear before the committee to defend their report. The committee supervises the use of funds by the company. The committee monitors the overall financial system of the company.
Removal of an auditor
It is possible that some differences may arise between the Board of Directors and the auditors of the company. In such a scenario, the Board of Directors may try to remove the auditors from office before the expiry of the tenure of the auditors. There may be several reasons due to which the Board or the members of the company may want to remove the auditors. For instance, the auditors may act negligently or the company may find that the performance of the auditors is not upto the mark.
The law has to ensure that there is no friction between the Board and the auditors. At the same time, the auditors must have the independence to discharge their duties efficiently. Thus, the Companies Act clearly lays down the procedure for the removal of an auditor.
As per Section 140, an auditor can be removed by the members of the company by passing a special resolution to this effect. The concerned auditor must be provided a fair opportunity of hearing before the members. Thus, the auditor must be given a chance to defend his performance. The principles of natural justice have to be observed even during the proceedings of the removal of the auditor. This also ensures that if the removal order is challenged before any court of law, the court will have a record of the statements made by the auditor in his defence. Prior approval of the Central Government is also required to remove an auditor from office.
CDK Global India Private Limited, In Re (2017)
In the case of CDK Global India Private Limited, In Re (2017), the applicants were a company incorporated in August 2014, its directors and the Company Secretary. However, they had failed to appoint the first auditor within 30 days of incorporation. No auditor was appointed at the extraordinary general meeting either. Thus, they violated the statutory time limit provided under Section 139 for the appointment of the first auditors.
Subsequently, the first auditors were appointed in August 2015. The applicants pleaded for the compounding of the offence. The Registrar had no objection to the plea of the company.
The Court held that an offence under Section 139 is compoundable. If the company is able to establish bona fide reasons to justify the delay, then the Court may compound the offence. Thus, the Court compounded the offence and imposed a fine of Rs. 25000 on the company and a fine of Rs. 1000 on every defaulting member.
Graco India Private Limited, In Re (2017)
The petitioner company, in this case, was involved in the business of fluid handling equipment. It was incorporated in November, 2015. The company had defaulted in appointing the statutory auditors for 6 months.
The Tribunal pointed out that no notice had been issued to the petitioners by the Registrar of Companies. The petitioners had themselves suo motu prayed for the composition of the offence. Even though there was a delay of 6 months in appointing the statutory auditors, the offence was made good when the auditors were appointed on August, 2016. The Court thus compounded the offence and imposed a penalty of Rs. 2.5 lakhs on the petitioner company and Rs. 50, 000/- on the other petitioners.
Pipara v. Tourism Corporation of Gujarat (2021)
Section 140 does not provide the procedure for the removal of an auditor who is appointed by the CAG under Section 139. In Pipara v. Tourism Corporation of Gujarat (2021), the issue before the High Court was whether the CAG can remove an auditor appointed by him under Section 139. The applicant had been appointed as a statutory auditor for the respondent firm. The appointment was done by the CAG.
The applicant was approached by the respondent for several works However, after some time, the respondent firm stopped responding to any calls or other communication from the applicant auditor. The applicant later discovered that he had been terminated by the respondent firm without any prior notice. The removal was done with the prior approval of the CAG.
Issues and Arguments
The petitioners contended that the removal of the applicant auditor without any prior notice was a violation of the principles of natural justice. The CAG could not act arbitrarily and remove the applicant auditor.
The respondent pleaded that since the removal of the auditor appointed by the CAG is not governed by Section 139, thus there is no obligation on the CAG to hear the side of the auditor before arriving at a decision. The respondents submitted that the applicant had not performed any audit work for the respondent company despite being appointed as an auditor. The auditor company had subsequently appointed another company who had commenced with the audit work. The argument of the respondents was that the CAG is only concerned with the fact that the subsequent auditor was undertaking the audit work.
The Court held that while the CAG can remove the auditor, such removal will be guided by principles of natural justice. Thus, an opportunity of being heard has to be provided to the auditor.
The Court observed that even if the auditor is to be removed by the company, with the prior approval of the Central Government, and even if there is no role of the CAG in the removal process, also the principles of natural justice have to be observed. The auditor has to perform a statutory duty and thus he is entitled to a right to be heard before his removal from office.
Auditors play a vital role in maintaining transparency in the financial affairs of the company. They mention any irregularity in the financial dealings in their report and thus supervise the functions of the top management. Their report is presented to the members of the company in the general meeting. The report provides shareholders with a financial overview of the company.
The Companies Act, 2013 contains detailed provisions regarding the appointment of auditors. The Act also prescribed the qualifications, disqualifications, remuneration and functions of the auditors. Section 139 is an important provision which mandates the appointment of an auditor within 30 days of the registration of a company.
The procedure for the appointment of an auditor depends on the nature of the company. Section 139 makes a distinction between the procedure to be followed by a government company and a non-government company. Thus, the procedure will depend on the type of business.
Frequently Asked Questions
Which form is to be filled at the appointment of the first auditor?
E-form ADT-1 must be filled at the appointment of the first auditor. This form has to be filled within 15 days of the appointment.
Can the company appoint its director as an auditor?
The officers and employees of the company cannot be appointed as an auditor. Director, whether executive or not, will fall within the category of officer of the company. Thus, directors are not eligible to be appointed as auditors of the company.
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