Delhi High Court Upholds Validity Of S.132 Of Companies Act Establishing National Financial Reporting Authority, NFRA Rules

The Delhi High Court has upheld the constitutional validity of Section 132 of the Companies Act, 2013, and Rules 3, 8, 10 and 11 of the National Financial Reporting Authority Rules, 2018.Section 132 of the Companies Act states: (1) The Central Government may, by notification, constitute a National Financial Reporting Authority to provide for matters relating to accounting and auditing standards under this Act.A division bench comprising Justice Yashwant Varma and Justice Dharmesh Sharma rejected a batch of pleas moved by various Chartered Accountants as well as auditing firms challenging the constitutional validity of the provisions in question. In the alternative, the pleas sought a declaration to the effect that Section 132(4) of the Companies Act as well as Rules 3, 8 10 and 11 of the NFRA Rules be held not to apply to any audit completed before 01 October, 2018. They further sought reading down of the provisions as being inapplicable to audits that may have been completed prior to the introduction of Section 132 in the Companies Act.Section 132 of the Companies Act establishes the National Financial Reporting Authority (NFRA) which is responsible for financial reporting and auditing standards for companies in India. Section 132(4) gives the Authority the power to investigate and penalize misconduct by chartered accountants, either suo motu or on a reference made to it by the Central Government. The challenge to the constitutional invalidity was founded on a retroactive operation of Section 132, empowering the NFRA to initiate disciplinary proceedings not just against individual partners and CAs' but also against auditing firms in respect of any audit that may have been conducted, including those commenced and concluded prior to the introduction of the provision in question. Allowing the pleas, the Court held: “…..we uphold the validity of Section 132 and the NFRA Rules. We find no merit in the challenge based on the arguments of vicarious liability, retroactive operation and a violation of Article 20(1) of the Constitution.”The Court said that Section 132 is neither an overreach nor can it be said to be arbitrary, underscoring that the provision is a necessary mechanism to enforce professional accountability. It added that a firm's designation as an auditor inherently includes the collective responsibilities of its members, making the imposition of a vicarious liability a logical and justified extension of its statutory obligations. “Therefore, the contention that the provision is unconstitutional lacks merit and proceeds in ignorance of the operational and legal realities of an audit firm's engagement,” the Court said. It further held that Section 132 does not create a new species of misconduct nor does it create a liability which was otherwise not contemplated under a pre-existing legislation. The Court also observed that no auditor can claim or assert a vested right coming to be created in respect of professional misconduct that may have been committed prior to Section 132 coming into force. The bench said that the enactment of Section 132 represents a progressive regulatory shift aimed at reinforcing compliance, raising the bar for audit quality and ensuring that no aspect of professional misconduct or deficiency in service remains unchecked or unsupervised.It said that by instituting a more structured and stringent framework, Section 132 ensures that audit firms and professionals adhere to internationally recognized standards, thereby fostering greater transparency, accountability, and confidence in financial reporting.“This regulatory evolution does not operate retrospectively in a punitive sense but rather brings India's auditing and financial oversight framework in line with global standards, ensuring that all professional conduct meets the highest levels of scrutiny and quality assurance. The underlying objective is to create a more robust and reliable regulatory ecosystem, where professional standards are continuously refined to prevent any compromise in audit quality or integrity,” the Court said. With regard to NFRA, the Court said that the Authority itself initiates and undertakes the inquiry on the basis of the audit file and record which may have been gathered in the course of an audit quality review. It observed that such proceedings are not triggered or based upon the oral testimony of a complainant or person and therefore, the commencement of an inquiry by the NFRA is premised entirely on either a reference that may be made to it by the Union Government or where the it initiates an investigation suo motu.“We are also of the firm opinion that the proceedings which the NFRA would undertake are not liable to conform to the requirement of guilt being proved beyond reasonable doubt and which is a test which primarily applies to criminal trials. The proceedings under Section 132(4) are essentially disciplinary proceedings and which are governed and guided by the well- accepted principle of...

Delhi High Court Upholds Validity Of S.132 Of Companies Act Establishing National Financial Reporting Authority, NFRA Rules

Nupur Thapliyal

Tags