Auditor and Corporate Governance: Analyzing the Deloitte Haskins Judgement

[Anubhav and Rishi are students at Christ (Deemed to be University).]

Followed by a batch of petitions filed by Chartered Accountants and Accounting firms, the Delhi High Court in Deloitte Haskins & Sells LLP v. Union of India decided on the constitutional validity of Section 132(4) of the Companies Act 2013 (Act) that deals with the National Financial Reporting Authority (NFRA) and its exclusive powers to investigate professional misconduct by chartered accountants, overriding other bodies. It holds civil court powers for inquiries and can impose monetary penalties and debarment. Misconduct is defined under the Chartered Accountants Act 1949 (CA Act). The petitioners also challenged Rules 3, 8, 10 and 11 of the National Financial Reporting Authority Rules 2018. 

The petitioners argued the concerned provisions are unconstitutional on the grounds of being arbitrary and ultra vires. The petitioners prayed for the non-enactment of the said provisions to audits before 1 October 2018. They have impugned notices issued by the NFRA over disciplinary proceedings alleging ‘professional and other misconduct’. 

The High Court upheld the said provision while also emphasizing a lack of separate division of the NFRA to uphold the procedural fairness during the whole proceedings. An appeal on the judgement is pending before the Supreme Court. The piece analyses the judgement from the perspective of procedural standards and how NFRA should amend to ensure justice and fairness. 

Legal Framework

The NFRA was set up with the purpose to ensure compliance to accounting standards. Prior to 2018, the CA Act read with its 1988 regulations and the Misconduct Rules 2007 was tasked with legal authority to conduct investigations and impose penalties for actions leading to misconduct and non-compliance. The CA Act laid down eligibility criteria, procedure, designated acts of misconduct under the Schedule and penalties, therefore upholding “due process” and “procedural fairness”, something that is lacking with NFRA. 

Rule 11 of the NFRA Rules mandate that disciplinary proceedings should happen in accordance with principles of natural justice and wherever deemed necessary, provide an opportunity for hearing the charged person/entity. The said rule lays down an order to be passed after considering all submissions made and material taken into account. The Act along with NFRA Rules fails to put any legal obligation on the NFRA to follow any set procedure, contrary to the CA Act that allowed cross-examinations, lead examinations etc. 

The respondents contended that a partner in an audit firm appointed under Section 139 of the Act, acts as the firm’s representative, with their role tied directly to the firm's appointment. Citing the Standards on Auditing, they emphasized that the appointed firm maintains oversight over its partners’ audit functions.

The Vicarious Liability Argument

The doctrine of vicarious liability is a legal principle where parties in positions of control and authority, benefiting from the actions of the wrong-doer, are also held to be legally responsible. Traditionally applied in employer-employee relationships, Indian courts have extended the principle to principal-agent relations and partnerships, and the doctrine has also been acknowledged, with regards to the vicarious liability of a legal person. Under Indian law, this doctrine is rooted in common law principles and its central feature is that the wrong must have been committed within the course of the employment. While the statutes do not explicitly contain the doctrine, in India, it has primarily evolved through judicial interpretations, and the court has consistently ensured corporate accountability for the wrongful actions of both employees and agents.

The petitioner in the instant case argued that Section 132 of the Act, imposes unreasonable liability and restrictions upon limited liability partnerships, as it creates vicarious liability on audit firms as well and its constituent partners even when they are unconnected with the audit. On the basis of the Limited Liability Partnership Act 2008 (LLP Act), the petitioners argued that it does not envisage such vicarious liability, as partners are not liable for other partners' acts. Furthermore, the intent of the Parliament on such liability was argued upon, stating that since the LLP Act was enacted before the Section 132, it cannot be read in a manner which diminishes the protections made available to the petitioners by the LLP Act, specifically the protection against actions the LLP has no knowledge about. Relying on the US Supreme Court, it was submitted that placing a blanket ban on association with groups which have both legal and illegal aims would impair the freedom of expression and associations and a similar view was taken by the Indian Supreme Court. 

On the other hand, the respondents sought to argue that the appointed auditor acts as the agent of the firm as they are appointed by the partners under Section 139 of the Act, and various accounting standards. Furthermore, the quality control standards and policies of the auditing firm establish that there is a definite link between the actions of the partners of the firm and these policies, and thus when members discharge their functions it cannot be viewed as a separate action removed or separate from the engagement of the firm as an auditor itself. Most importantly, it was submitted that the general concept of a partnership firm is an association of persons rather than an entity in law, and since the established position is that a partnership is not liable to be construed as a separate juristic entity, the audit firm is to be vicariously liable for the actions of the auditors.

Court’s Findings

The Delhi High Court noted that the Act makes provisions in terms of which both the firm as well as its partners are held liable, especially since a firm is expected to act through its members. The court observed that this liability stems from Section 147 of the Act, which existed before the NFRA and the validity of the same was not questioned before the bench. Moreover, it was observed that it is incorrect to hold that the liability under Section 132 is unforeseeable as the Act clearly contemplates a firm suffering a liability as a consequence of the action of its constituents who may be involved in the conduct of the audit. Aligning with the organic theory that a firm is a single legal unit, the court reasoned that the designation of an audit firm extends to its members, who act on its behalf, making the firm liable for the actions of its partners engaged in the audit.

The court also emphasized that the LLP Act was not intended to override the Act, and both statutes must be construed harmoniously. It was further noted that under Section 27(2) LLP Act holds the LLP liable as a result of a wrongful act or omission of the partner in the course of the business of the LLP or with its authority. Therefore, the court concluded that Section 132 of the Act is not an overreach and by the firm’s appointment as an auditor, both the firm and its members undertake responsibilities that come with a clear expectation of compliance with accounting standards  and thus the argument on vicarious liability on behalf of the petitioners fails.

Implications for Corporate Governance

The Delhi High Court's judgment firmly establishes the NFRA as a powerful independent regulator with retrospective jurisdiction over audit misconduct, fundamentally reshaping the accountability landscape for auditing professionals and firms.

At the heart of this ruling is the validation of NFRA's authority to investigate and penalize auditors for professional misconduct. The court systematically dismantled constitutional challenges, clarifying that NFRA's disciplinary framework simply adopts existing misconduct standards from the CA Act rather than creating new liabilities. By endorsing NFRA's independent oversight model, the court has moved India closer to global best practices seen in jurisdiction, where independent audit regulators have significantly improved financial reporting quality. 

Perhaps most significantly, the ruling clarifies the division of regulatory responsibilities between NFRA and ICAI. NFRA now has clear jurisdiction over audits of listed companies, large unlisted entities, and financial institutions, while ICAI maintains oversight of smaller firms. This delineation eliminates the conflicts of interest inherent in self-regulation while ensuring comprehensive coverage across all company types.

By establishing NFRA as a credible enforcement body with teeth, the judgment addresses long-standing concerns about audit quality that came to the fore in high-profile cases like the Punjab National Bank fraud. As the implications of this judgment unfold, it promises to usher in a new era of accountability and transparency in India's financial reporting ecosystem.

Conclusion

The judgment of the Delhi High Court marks an important order in India’s audit regulatory landscape as it cements the validity of the NFRA under Section 132 of the Act and its powers to hold audit firms and auditors accountable. With regards to vicarious liability, the judgment advanced the position that both audit firms and the partners have a shared level of responsibility for meeting the accounting standards. The court also clears the air around the jurisdiction of the NFRA, with the judgment emphasizing that the authority’s jurisdiction extends to large and listed companies and it also fosters a greater transparency in financial reporting. Moreover, the court observed that the NFRA must enact disciplinary protocols while keeping in mind the principles of natural justice.. The Delhi High Court brings integrity and confidence in the procedures, and facilitates corporate accountability in the context of India's legal landscape.