Author: Khyati Maurya & Saransh Sood
Third year students at Gujarat National Law University, Gandhinagar
I. Introduction
The division bench of the Delhi High Court, in the recent case of Deloitte Haskins v Union of India upheld the constitutional validity of section 132 of the Companies Act 2013, which established the National Financial Reporting Authority (“NFRA”) along with Rule 3, 8, 10 and 11 of the National Financial Reporting Authority Rules 2018. The question before the Delhi High Court arose while hearing a set of petitions challenging the orders passed by the NFRA imposing penalties on the auditors and partnership firms for the alleged non-compliance with the accounting standards and professional misconduct. The petitioners, inter-alia, challenged the validity of section 132 of the Companies Act and the NFRA rules 2018. The validity of section 132 was assailed primarily on three grounds: first, the imposition of the vicarious liability on the firms for the acts of its partners; second, the retrospective effect of the provision; and third, the lack of procedural safeguards in NFRA’s investigation process.
While the court upheld the validity of section 132 of the Companies Act, it ruled that NFRA must maintain a clear separation of functions in its operations. Specifically, there must not be any overlap between the unit of NFRA conducting the review process and the one initiating disciplinary proceeding. NFRA challenged this ruling before the Supreme Court, arguing that NFRA is a composite body that cannot work in watertight divisions. This appeal is currently pending before the division bench of the Supreme Court.
While the court has noted the lack of separate divisions in the NFRA, a significant concern remains unaddressed, that is, the absence of adequate procedural safeguards, particularly the right to legal representation in the NFRA proceedings. Given the serious consequences of NFRA’s inquiries on auditors and firms, and the power of NFRA to attach vicarious liability on firms for partners' actions, it is imperative to re-examine this issue through a “due process” lens. This piece argues that the right to legal representation must be explicitly recognized in NFRA rules to uphold fairness and prevent any miscarriage of justice.
II. Background
The NFRA is an independent regulatory body, set up in 2018, tasked with monitoring and ensuring compliance with accounting and auditing standards. It has the power to conduct an investigation, either suo moto or upon a complaint in the cases of professional misconduct, negligence and fraud by auditing and accounting firms or individuals, and impose penalties. Although the provision regarding establishing the NFRA was introduced in 2013, its implementation was delayed due to opposition from various stakeholders, including Institute of Chartered Accountants of India (“ICAI”). Before the establishment of the NFRA, the auditors were regulated by the ICAI. However, as a self-regulatory body comprising of all the chartered accountants in the country, it lacked an independent oversight mechanism. This self-regulatory mechanism was insufficient and a need for an independent regulatory body was felt in light of various financial frauds and corporate scandals, one prominent being the 2009 Satyam Scam. Therefore, the 37th Report of the Standing Committee of Finance in 2016 highlighted the need for such an independent body to regulate the country's auditing practices. This was further recommended by the apex court in 2018 in the case of S. Sukumar v. The Secretary, Institute of Chartered Accountants of India, where the apex court underscored the need to have an independent body other than the ICAI to regulate the conduct of the professional auditors. Therefore, following these developments, the central government finally notified section 132 and established the NFRA in October 2018. The rules in this regard were then notified in November 2018.
The NFRA has a dual mandate: overseeing the audit process, and adjudicating cases of professional misconduct. This involves both investigating potential violations and imposing penalties when misconduct is proven. Notably, NFRA is empowered to penalize accounting firms for the actions of their constituent partners, thereby holding partners in Limited Liability Partnerships (“LLP”) vicariously liable for the misconduct of other partners.
III. The Deloitte Judgement
In the context of a broader discussion on legal representation in NFRA proceedings, it is crucial to briefly examine two significant points the court addresses: the vicarious liability of auditors and the separation of functions within the NFRA.
First, regarding the challenge on the ground of vicarious liability, it was challenged by the petitioners that imposing liability on LLP for the misconduct of an individual partner, regardless of their involvement in the audit function is arbitrary and is impermissible under Section 28 of the Limited Liability Partnership Act, 2008. Rejecting this, the court concluded that the liability of the firm and its partners is indeed unified and indivisible under the Partnership Act 1932. The same is provided for in section 27(2) of the LLP Act, 2008. Therefore, the firm (other partners) can be held vicariously liable for the act of any one of its partners.
Second, it was ruled that NFRA must maintain a clear separation of functions among its divisions, as mandated by legislative intent. Specifically, the court emphasized that divisions responsible for audit reviews should not also conduct disciplinary proceedings against auditors. It noted that if the division is ignored, the principle that “no man can be a judge in his case” shall be violated, leading to the violation of principles of natural justice. Since this separation was ignored in cases before the court, with the same officers handling both the audit reviews and disciplinary actions, the court struck down the orders passed by NFRA. An appeal in this regard remains pending before the Supreme Court.
Turning to the main focus of the discussion, it was the submission of the petitioners that the procedure prescribed for the adjudication under the NFRA rules lacks adequate procedural safeguards, which is evident from several instances, such as the lack of right to cross-examination of the witness or the complainant and the sole reliance on the audit reports as evidence to contest the allegations along with the denial of right to legal representation.
The petitioners underscored the difference between Rule 14 and Rule 18 of the Chartered Accountants (Procedure of Investigations of Professional and Other Misconduct and Conduct of Cases) Rules 2007 (hereinafter the Misconduct Rules 2007), which provided the procedure to be followed in cases of disciplinary proceedings by the Board of Discipline and the Disciplinary Committee of the ICAI respectively, and Rule 10 of the NFRA rules, which provides for the procedure to be followed by the NFRA in case of its proceedings. It was highlighted that the NFRA rules, in contrast to the ICAI Rules, do not provide for the right to be represented by an advocate or an authorized representative; rather, they only mandate an ‘in-person’ hearing. The petitioners drew the attention of the court to the letter dated 10th June 2020 issued by the NFRA, which interpreted Rule 11(5) of the NFRA rules to mean that the “opportunity for being heard in person” shall mean the opportunity to present the case by the person himself or herself, thereby effectively denying the right to be represented by an authorized representative or a lawyer [1].
It was further emphasized that while an opportunity for a personal hearing was a right under the ICAI rules, the same was the discretion of the NFRA under Rule 11 of the NFRA Rules.
The respondents submitted that the NFRA had permitted the petitioners to be represented by the lawyers and legal practitioners in the present petitions. Further, relying on the case of Hyderabad Vanaspati Limited v. A.P State Electricity Board, the respondents submitted that the right to be represented by a legal practitioner is not an inviolable part of principles of natural justice and the same has to be decided on a case to basis, depending on the facts of each case [2].
Having heard both parties, the court ruled that the NFRA Rules cannot be struck down for the lack of procedural safeguards or the lack of right to legal representation. The court noted that the principles of natural justice are not unalterable principles and are to be followed according to the given facts and circumstances of each case. However, the court did not extensively deal with the issue of the right to legal representation since, in the present case the petitioners were indeed allowed to be represented by a legal counsel during the proceedings before NFRA [3].
IV. Right to Legal Representation
In the authors' view, the right to legal representation must be explicitly recognised under the NFRA rules to prevent any abuse of the process and ensure a fair trial while deciding upon auditors' liability for professional misconduct. While the authors acknowledge the settled legal principle that the right to legal representation is a qualified and not an absolute right that must be decided based on the facts of each case, there does exist strong grounds for its explicit inclusion in the NFRA rules.
Notably, the apex court in the case of J.K. Aggarwal v. Haryana Seeds Development Corporation Ltd. and Ors., explicitly stated that the right to be represented by a lawyer should be allowed in cases where the “presiding officer in charge of the disciplinary proceedings is a person of legal mind and experience.” This precedent becomes of particular importance in the light of section 132(3) of the Companies Act 2013, which provides for the composition of NFRA, it states that the NFRA shall consist of individuals having expertise in auditing, accountancy, finance or law. Hence, the auditors and firms acing disciplinary action may find themselves appearing before a panel that includes legal professionals, leading to a bias against them in cases where they are denied the right to legal representation. Furthermore, it must be noted here that the NFRA under section 132(4) is empowered to debar the member or the firm from “being appointed as an auditor or undertaking any audit in respect of financial statements or internal audit of the functions and activities of any company or body corporate”, for a period ranging between 6 months to 10 years. Such penalties impact an individual’s professional standing and directly affect their right to livelihood. Given the gravity of these potential penalties and sanctions, it is essential to ensure that accused individuals have the right to adequate legal representation. Denying the same may amount to procedural ambiguities and lead to biased or arbitrary decisions against the auditors or firms. While the NFRA may allow legal representation on a case basis, as was considered in the present case, to avoid any ambiguities. In the interest of fairness, the right to be represented by a legal representative must be codified in the NFRA Rules itself. Such a right becomes even more important as the NFRA possesses the power to impose vicarious liability on the firms for the acts of its partners. Sans such a recognition of the right, the NFRA may deny the same in some cases, leading to writ litigation before the constitutional courts and lengthening of the disciplinary proceedings.
IV. Conclusion
In sum, it can be concluded that the right to legal representation under the NFRA proceedings is an important procedural safeguard to ensure fairness and avoid ambiguities. While the court has rightly recognized that NFRA must function in strictly separate units to ensure that the process does not violate the principles of natural justice, the issue of the right to legal representation remains unresolved.
The court must also recognize the right to be represented by a legal representative to ensure fairness and due process. Given the serious consequences of NFRA’s decisions, such as the vicarious liability, long-term debarment the right to legal representation must be explicitly recognised. Recognizing this right in the NFRA rules not only aligns with the principles of natural justice but also prevents unnecessary litigation and delays. As the Supreme Court prepares to hear the appeal by NFRA, it should also address the critical issue of the right to legal representation. A well-defined framework for legal representation would enhance transparency, ensure fair hearings, and strengthen confidence in NFRA’s disciplinary process.
Note: This article has been reviewed by Mr. Vinod Kothari (Managing Partner, Vinod Kothari and Company) at the Tier II Stage.
[1] Deloitte Haskins v Union of India (2025) SCC Online Del 641, para 231.
[2] Ibid, para 252.
[3] Id., para 336.