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The authors are Shriya Chakravarthy, Advocate, High Court of Karnataka, and Mrigank Pathak, Advocate, Supreme Court of India.
The National Financial Reporting Authority (NFRA) was established on 01 October, 2018, by the Government of India, in exercise of its power under Section 132 (1) of the (the Act). The need for establishment of an audit watchdog such as the NFRA, so as to increase the regulatory gaze inter-alia upon auditors and Chartered Accountants (CAs) and audit firms was recognized in the aftermath of the Satyam scandal which brought to light the limitations of the Institute of Chartered Accountant of India (ICAI) in professional self-regulation. The NFRA has been recognized by the National Company Law Appellate Tribunal (NCLAT) to have overriding powers in accounting regulation, as against the ICAI. This view has also been affirmed by the Hon’ble Supreme Court of India in CA Sam Varghese v. National Financial Reporting Authority.
The specific powers of the NFRA have been enumerated under Section 132 (4) of the Act. While Section 132 (4)(a) provides that the NFRA shall have the power to investigate matters of professional or other misconduct by any member or firm of CAs, Section 132 (4)(c) empowers the NFRA to make an order imposing penalty where professional or other misconduct is proved. Section 132 (4)(c) permits imposition of monetary penalty, as well as the penalty of debarment from being appointed as an auditor/performing valuation for a period ranging between six months and ten years. The monetary penalty to be imposed is to be quantified in terms of the fees received by the individual CA or the Firm, as the case may be, and a penalty of up to five times of the fees received may be levied as against an individual CA, while in respect of a Firm the amount of penalty may be up to ten times the fees received.
The NFRA, in exercise of such power, has been routinely imposing penalty simultaneously on the audit Firm, as well as on the individual CAs that are designated as partners in such Firms, notwithstanding the fact that it was only the Firm and not the individual CA that was engaged as an ‘Auditor’ in a given case and was remunerated in this behalf. Against the aforesaid backdrop, this article seeks to evaluate: (a) whether such duality of penalty is statutorily contemplated under Section 132 (4)(c) of the Act, and (b) whether imposition of penalty on a Firm as well as on its Partners is in the teeth of Article 20(2) of the Constitution. For the reasons detailed in the following portions of the article, the authors have answered question (a) in the negative, and (b) in the affirmative. The article concludes that in order to save Section 132 (4)(c) of the Act from being declared as unconstitutional, Courts must interpret the same to hold that imposition of dual penalty is not contemplated under Section 132(4)(c) of the Act, lest, they would be opening up the provision to challenge as being violative of Article 20(2) of the Constitution.
Imposition of dual penalty by the NFRA: Whether statutorily contemplated under Section 132 (4)(c) of the Act?
As discussed hereinabove, the NFRA has on various occasions imposed a penalty simultaneously on the audit Firm, as well as on the individual CAs that are designated as partners in such Firms, in respect of a given instance of misconduct. In the opinion of the authors, such duality of penalty is not statutorily contemplated, for two reasons which are set out hereunder:
First, a pre-requisite under Section 132(4)(c), for imposition of monetary penalty is receipt of fee by the individual or Firm. This may be inferred from the fact that quantification of penalty under the said provision, is in terms of fees received by an individual (CA or Auditor as defined under Section 141 of the Act) or Firm. However, where it is a Firm that is appointed as the auditor, partners do not receive any fee in their individual capacity. Therefore, it would be artificial to axiomatically apply the fee received by the Firm as a whole, to quantify the penalty to be imposed on each partner. It is hence opined that where it is a Firm that is appointed as the auditor, penalty for any misconduct, may only be imposed on the Firm as a whole, and not on a partner individually.
Second, as regards the penalty of debarment, the same may be imposed either as against the Firm or an individual CA (member), but not against both simultaneously. This aspect is explicit from a bare perusal of Section 132(4)(c)(B) of the Act which pertains to the authority of “debarring the member or the firm”. The use of the word “or” in the said provision would indicate that the penalty of debarment may be imposed, in respect of a single act of misconduct, either against the Firm or an individual CA (member), and not against both simultaneously.
Third, the proviso to Rule 11(4) of the National Financial Reporting Authority Rules, 2018 (NFRA Rules) clarifies that a notice to a Firm shall be deemed to be a notice to all partners thereof, and that all partners shall only be collectively responsible for the acts of the Firm, and no one Partner shall own individual responsibility unless the Firm so discloses. It also emerges from a close reading of the said proviso that the statutory scheme does not contemplate imposition of penalty on the Partners for the acts of the Firm, more so, when penalty has already been imposed on the Firm as a collectivity.
There is yet another aspect that would fortify the authors’ view that duality of penalty cannot be sustained- this prong of reasoning transcends the realm of statutory interpretation and ventures into the area governed by the Constitutional protection against double jeopardy. This aspect shall be addressed in the following section of this article.
(a) Imposition of penalty on a Firm as well as on its Partners: Whether violative of Article 20(2) of the Constitution of India?
The NFRA has sought to justify simultaneous penalties on the Firm as well as the Partners thereof in respect of the same act of misconduct by rejecting claims of double jeopardy. However, in the opinion of the authors such a view fails to recognize that a Firm is not a separate legal entity, meaning thereby that when a penalty is imposed on a Firm, it would essentially be tantamount to penalty being imposed on every partner thereof. Therefore, imposition of penalty, once again on each of the partners is unwarranted and impermissible under Article 20(2) of the Constitution of India.
The decision of a Full Bench of the Hon’ble High Court of Judicature at Bombay in M/s Amritlakshmi Machine Works v. The Commissioner of Customs, may be instructive on the issue as to when simultaneous penalty on a Firm and its partners may be sustained. In the said case, albeit in the context of Section 112 of the Customs Act, 1962, the Hon’ble Court highlighted that so as to sustain simultaneous penalties of such nature, the statute must specifically penalise even abetment of the offence/transgression in question. In such a case, the Firm may be penalised for the offence per se, while the individual partners may be penalised for abetment thereof, which would constitute a distinct offence, thereby saving the penalty from being rendered violative of Article 20(2). It was further cautioned that penalty could not be ipso facto imposed on the Partner(s), in respect of all transgressions of the Firm, unless it is made out that penalty is imposable on the partner for abetment, which is an offence independently punishable under the Statute concerned. However, when the aforesaid principle is considered in the context of Section 132(4)(c) of the Act, read with NFRA Rules, it would emerge that the statutory scheme under consideration does not provide for the independent offence of abetment of misconduct. Therefore, in effect, the Firm and the Partners are being penalised for the very same offence. Such penalty, would therefore, be in the teeth of Article 20(2) of the Constitution of India.
In fact, prima-facie noticing that Orders of the NFRA imposing simultaneous penalty on the Firm as well as its Partners involve elements of “dual penalty in its generic sense”, the Hon’ble High Court of Karnataka, has granted an interim stay on one such Order of the NFRA in W.P. No. 10123 of 2023, captioned CA C. Ramesh v. NFRA. The final judgement in the said case is, however, awaited.
Conclusion
For the reasons cited hereinabove, it may be necessary for the NFRA to revisit its approach of imposing penalty simultaneously on the audit Firm, as well as on the individual CAs that are designated as partners in such Firms. Perhaps, it would be prudent for the NFRA to acknowledge that imposition of dual penalty is not contemplated under Section 132(4)(c) of the Act. Since it is trite that a provision ought to be interpreted in a manner as would save it from being declared unconstitutional, perhaps, the Courts would deem it appropriate to hold that imposition of dual penalty is not contemplated under Section 132(4)(c) of the Act. Should the NFRA continue to maintain the stance that imposition of dual penalty is, in fact, contemplated under Section 132(4)(c) of the Act, it would potentially place the powers of the watchdog on rather shaky grounds, as, such an understanding would throw Section 132(4)(c) open to challenge as being violative of Article 20(2) of the Constitution.
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