Corporate Law II

A PROJECT ON

Legal position of an Auditor in the

Company

SUBMITTED TO

Dr. Qazi Usman

BY: ZIAUL HAQ

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 ACKNOWLEDGEMENT

I owe my deep sense of gratitude to my respected teacher Dr. Qazi

Usman, who rendered his constructive and valuable guidance throughout
my work, without his perspicacious comments and scholarly guidance; I
would never have been able to complete this assignment. His patience to
go through the draft meticulously was incredible.

I also acknowledge the help provided to me by the staff members of the

library of faculty of law, JamiaMilliaIslamia.

I extend my gratitude to my friend Nouf Khan for her kind appreciation

and help.

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 INTRODUCTION
The auditors are important persons of the company who are responsible
for keeping and maintaining the accounts which are the reflection of the
state of affairs of company. The auditor occupies a position of trust and it
is his fundamental duty to keep up that trust by bieng outspoken with the
shareholders and provide them all material particulars in respect of the
state of affairs of the company. The auditor is under duty to examine the
affairs of the company. The Calcutta Hight Court in Deputy Secretary to
the Government of India v. Ministry of Finance 1 observed that the
examination by an agency such as auditor is practically the only
safeguard which the shareholders have against enterprise being carried on
in an un bussiness like way or their money being misssupplied without
their knowledge.

APPOINTMENT OF AUDITOR (SEC 139)

Every company at its first AGM, haas to ppoint an individual or a firm as

an auditor. Such appointte can hold office from the conclusion of the first
AGM till the cing to the appointmeny onclusion of its 5th and afterwards
till every 6th AGM. The manner and procedure of selection of Auditors
by the members of the company has too be according to what maybe
prescribed the company has to place the matter relating to the
apponytment for ratification by members every annual General meeting.
It ois necessary that written concent of the auditor is to be taken before he
is appointed as such. A certificate has also to be taken from him that his
appointed is in accordance with the presribed rules. The certificate has
also to indicate wether the auditor satisfies the criteria provided in section
141 (qualifiction of auditor) the company has to inform the auditor or the
firm of the fact of appointment. The notice of such appointment has also
to be sent to the registrar within 15 days of the meeting in the prescribed
manner.

1
A.I.R. 1956 Cal. 414.

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In case of a company that is required to constitute an Audit Committee
under section 177, such committee, and, in cases where such a committee
is not required to be constituted, the Board shall take into consideration
the qualifications and experience of the individual or the firm proposed to
be considered for appointment as auditor and whether such qualifications
and experience are commensurate with the size and requirements of the
company.
For the purpose of constitution of Audit Committee section 177 of the
Act read with Companies (Meetings of Board and its Powers) Rules,
2014 provides that:

The Board of directors of every listed companies and the following

classes of companies shall constitute an Audit Committee of the Board-
(i) all public companies with a paid up capital of ten crore
rupees or more;
(ii) all public companies having turnover of one hundred crore
rupees or more;
all public companies, having in aggregate, outstanding loans
or borrowings or debentures or deposits exceeding fifty
crore rupees or more.
Explanation.- The paid up share capital or turnover or outstanding loans,
or borrowings or debentures or deposits, as the case may be, as existing
on the date of last audited Financial Statements shall be taken into
account for the purposes of this rule.

Before considering the appointment of auditor, the Audit Committee or

the Board, as the case may be, shall consider any pending proceeding
relating to professional matters of conduct against the proposed auditor
before the ICAI or any competent authority or any Court. Further they
may call for such other information from the proposed auditor as it may
deem fit.

 Where a company is required to constitute the Audit Committee,

the committee shall recommend the name of an individual or a
firm as auditor to the Board for consideration and in other cases,
the Board shall consider and recommend an individual or a firm as

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 auditor to the members in the AGM for appointment.
 If the Board agrees with the recommendation of the Audit
Committee, it shall further recommend the appointment of auditor
to the members in the AGM otherwise, it shall refer back the
recommendation to the committee for reconsideration citing
reasons for such disagreement.
 Thereafter if the Audit Committee decides not to reconsider its
original recommendation, then Board shall record reasons for its
disagreement with the Audit committee and send its own
recommendation for consideration of the members in the AGM
and if the Board agrees with the recommendations of the Audit
Committee, it shall place the matter for consideration by members
in the AGM.
 The auditor appointed in the AGM meeting shall hold office from
the conclusion of that meeting till the conclusion of the sixth
annual general meeting, with the meeting wherein such
appointment has been made being counted as the first meeting.
 Such appointment shall be subject to ratification in every AGM till
the sixth AGM by way of passing of an ordinary resolution. If the
appointment is not ratified by the members of the company, the
Board of Directors shall appoint another individual or firm as its
auditor or auditors in this behalf under the Act.
Section 139(6) of the Act stipulated that first Auditor of the
Company other than Government Company, shall be appointed by the
Board within 30 days of its date of registration and in case of failure to
do so by Board of Directors, the members shall be informed and they
shall appoint the same within 90 days form incorporation, who shall hold
office till conclusion of first annual general meeting.

REMOVAL OF AUDITOR ( section 140)

The auditor appointed under section 139 may be removed from

office before expiry of his term only by a special resolution of the
company after obtaining prior approval of the Central Government in a

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prescribed manner. Before the removal, the auditor concerned shall be
given a reasonable opportunity to be heard.2
Sub-section (2) of Section 140 provides that an auditor may resign
from the company by filing a statement in the prescribed form with the
Registrar of Companies (ROC) within a period of thirty days indicating
reasons of resignation.
Sub-section (5) empowers the Tribunal that it can suo motu or on an
application made to it by the Central Government or by an aggrieved
person, if satisfied that the auditor of a company has acted in a fraudulent
manner or abetted or colluded in any fraud in connivance with company
or its directors or officers, may order or direct the company to change the
auditors.
Such removed auditors (by an order of the Tribunal) shall not be
elligible to be appointed an auditor of any company for the period of five
years from the date of Tribunal’s order and they shall also be liable for
action under Section 447 of the companies Act, 20133.
Where the auditor is a firm,the liability for collusion,fraud etc. shall
extend to every partner of such firm.4

Remuneration of Auditors [Section 142]

The remuneration of the first auditors appointed by the Board of
Directors shall be fixed by the Board and subject to this,the
remuneration of auditors of a company must always be fixed by the
company in general meeting or in such manner as the company in general
meeting may decide.
In the case of an auditor appointed under Section 139(5) by the
Comptroller and Auditor General of India,the remuneration shall be fixed
by the company in such meeting or in such manner as the company in
general meeting may determine.
The remuneration under Section 142(1) shall,in addition to the fee
payable to an auditor ,include the expenses incurred by the auditorin
connection with the audit of the company and facilities extended to him
but does not include any remuneration paid to him at any other service
2
Section 141(1)
3
Section 140(5) Second proviso
4
Section 140(5)

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rendered by him at the request of the company5.

Qualification of Auditors[Section 141(1)]

The person who may be appointed as auditor must be qualified

Chartered Accountants within the meaning of Chartered Accountants
Act,1949 or they must, for the time being, be authorised by the Central
Government to be appointed as having obtained similar qualification
outside India.
A firm whose all the partners practising in India are qualified
asChartered Accountants may also be appointed by its firm name to be
auditor of a company, and the partner so practising may act in the firm
name.

Disqualifications[Section 143(3)]

Aperson who is otherwise qualified to act as an auditor cannot act as

such if he is-
(a) A corporate body
(b) An officer or employee of the company
(c) A partner or employee of an officer or an employee of the
company
(d) A person whose relative is a director or is in employment as akey
managerial personnel
(e) A person who is in whole-time employment elsewhere or a
person or a partner of a firm holding appointed as its auditor.

Power and Duties of Auditors[Section 143]

Section 143 of the Companies Act,2013 contain provisions relating to

the powers and duties of auditors. The main powers vested in auditors
are:-

5
Section 142(2)

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 (1) Access to books accounts and vouchers: Every auditor of a
company has a right of access at all times to the books and
accounts and vouchers.

(2) To obtain information and explanations: He may require from any

officer of the company any information which he thinks necessary
for proper discharge of his duties as an auditor.In re Bhavnagar
Vegetable Products 6,the High Court of Gujrat held that this power
continues even after winding up of a company ahs commenced and
a liquidator has been appointed by the Court.The articles of a
company cannot preclude the auditor from exercising his power.7

(3) To sign the audit report: Section 145 of the Act provides that
onlythe person appointed as the auditor of the company,or where a
firm is so appointedonly a partner of a firm practising in India,may
sign the auditors report or authenticate any document of the
company required by law to be signed or authenticated by the
auditor.Thus an auditor has to check the accuracy of accounts.

(4) To receive notice of and attent General Meetings: The auditor is

entitled to attend any part of business which concerns him as
auditor.8All notices of, and other communications relating to any
General Meeting of a company, which any member of the
company is entitled to have sent to him, shall also be forwarded to
the auditor of the company. Where the company fails to send the
notices and communications to its auditors, the official committing
this default may be fined which may extend to five thousand
rupees.

(5) To visit branch office of the company and have access to books
etc.: Where the accounts of any branch office are audited by a
person other than company’s auditor,the company’s auditor is shall
be entitled to visit the branch office,if he deems it necessary to do
so for proper discharge of his duties as auditor, and shall have
access at all times,to the books and accounts and vouchers of the

6
(1977) 47 Comp.Cas.128(Guj)
7
Newton v.Birmingham Small Arms Co.,(1906)2Ch.378
8
Section 146

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 company maintained in the branch office.

(6) To inspect minute books of the board: The auditors also have
power to go through the minute book of the Board meeting and
satisfy himself that necessary sanctions have been taken.

(7) To inform the Central Government about any fraud being

commited against the company: Where an auditor of a company
has reason to believe that an offence involving fraud has been
committed against the company by the officers or employees of
the company,he shall immediately report the matter to the Central
Government.

Duties of Auditors

The primary duty of an auditor is to protect the shareholders and

investors against any misrepresentation in the financial matters of the
company by making disclosures through their report. An auditor
is,therefore,under a statuatory obligation to make a report to members on
all the matters which he considers the members should be appraised.
Such matters are specified in Section 143(1) of the Companies Act,2013
and they require an auditor to enquire,--
(a) Whether loans and advances made by the company on the basis of
security have been properly secured and whether the terms on
which they have been made are not prejudicial to the intrests of
the company or its members;
(b) Whether book-entry transactions are prejudicial to the intrests of
the company;
(c) Where the company is not an investment or banking company
whether so much of the assets of the company as consist of
share,debentureand other securities have been sold at price less
than that at which they were purchased;
(d) Whether loans and advances made by the company have been
shown as deposits;
(e) Whether personal expenses have been charged to revenue account;
(f) Whether cash has actually been received in respect of any shares

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 shown in the books to have been allotted for cash and if no cash
has been received, whether the position as stated in the books is
correct,regular and not misleading.9

According to Section 142(2) of the Act,it is the dutyof the auditor

to make a report to the members of the company on the accounts
audited by him, and on every balance sheeet, profit and loss
account and on every document declared by the Act to be part of
or annexed to, the balance sheet or profit and loss account, which
are laid before the company in General Meeting during his tenure
of office. The report must expressly state-
(.) That, in his opinion and to the best of his information and according
to explanation given to him, the account gives the information required
by the Act in the manner as required;
(.)That the financial statement( balance sheet and the profit and loss
account) gives a true and fair view of company’s affairs at the end of
financial year.
(.)That he has obtained all necessary information and explanation
required by him for the purpose of audit;
(.)That, in his opinion, proper books of account as required by law have
been kept by the company and proper return for the purposes of his audit
have been made available from the branches not visited by him;
(.)That the company’s balance sheet and profit and loss account dealt
with by the reports are in conformity with the account standards as
reffered to in Section 133 of the Companies Act,2013.
(3) Section 143(4) of the Act,2013 further states that where any of the
above matters are answered in the negative or withqualification,the
auditor’s report must state the reasons for such answer.
(4) the comments or observations of the auditors on financial
transactions or matters which have an adverse effect on the functioning
of the company.
(5) whether any director of the company is disqualified from being
appointed as directors under Section 164(2) of the Act.
(6)whether the company has adequate internal financial control system
and about the operating efficiency of such controls.
(7) In case the company has any branch offices,the accounts of each
branch offices shall be audited by the company’s auditor or the
9
Section 143(1) (a) to (f) of the Companies Act,2013.

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 company may appoint any other auditor for the purpose.
(8) He must be honest and exercise reasonable skills,care and caution
keeping in view the circumstances of the case.
(9) Auditor’s report has to be read before the companyin General
Meeting and is open to inspection for any member of the
company.Section 146 of the Act provides that an auditor is entitled to
attend any General Meeting and isto be heard on any part of the
business in the meeting which concerns him as auditor.
Auditor is not bound to give advice nor is he concerned with how
business of the company is being carried on.

Audit of Accounts Pertaining to the Branch

Office of Company[Section 143]

The auditor appointed by the company under Section 141 of the

Companies Act,2013 may audit the accounts of the branch office of the
company. If the branch office is located in a foreign country ,then on
that case the auditor of the company or a person who is eligible to be
appointed as auditor according to the laws of the country in which the
branch office is situated, may audit the account of branch office.
In Deputy sectratary v S.N. Das Gupta,10the High Court of Calcutt
held that the auditor of a banking company was guilty of neglect of
duty because he failed to verify the cash balance claimed by the
company and the actual cash in hand turned out to be much less than
what was shown in the account books. The Court further held that the
“whole object of audit is an examination of what the management have
done and if the statement of management even in matters capable
ofdirect verification,were to be accepted,an audit would be an idle
farce”.
Lopes LJ in Re Kingston Cotton Mill Co.,11 held that “an auditor is a
watch-dog but not a bloodhound”. He is not required to approach his
work with suspiction or with a foregone conclusion that something is
wrong. In certain technical matters such as valuation of stock-in-

10
AIR 1956 Cal. 414.
11
(1896)2 Ch 279.

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 trade,an auditor has to rely on some skilled person. Therefore he cannot
be held guilty of breach of duty when in absence of suspicious
circumstances, he relied on the version of the manager of a cotton mill.
In Re London & General Bank Ltd.(No.2)12,it was held that the duty of
the auditor is to convey true financial position of the company to the
members in direct terms and not merely to indicate the means of
acquiring the information and arouse their suspicion.
In S. Ganeshan v. A.K. joscelyne,13 the Court expressed its view that
auditor is appointed by theshareholders to look into the account of the
company and to report them about the true condition of itf affairs and
whether that condition is correctly reflected in the accounts submitted
by it. If he is to accept whatever the directors say is final, his
appointment as auditor serves no purpose at all.
The Supreme Court in Institute of Chartered Accountants v. P.K.
Mukherjee,14 observed:
“The auditor is intended for the protection of shareholders and the
auditor is expected to examine the accounts maintained by the directors
with a view to inform the shareholders of the true financial position of
the company. The directors occupy a fiduciary position in relation to
the shareholders and in auditing the accounts maintained by the
directors,the auditors act in interest of the shareholders who are in
position of beneficiaries”.
In Formento (Sterling Area) Ltd. v. Selsdon Fountain Co. Ltd., 15 the
house of Lords underlined the duties of an auditor and observed that his
duty is not confined merely to the mechanics of checking the vouchers
and making arithmatical computations. His vital work is to see that
errors are not made.In order to perform his job properly, “he must come
with an inquiring mind-not suspicions of dishonesty but suspecting that
someone might have made a mistake somewhere and that a check must
be made to ensure that there has been none”.
In discharging his duties as an auditor,he has to exercise that skill,care
and caution which a reasonably competent, careful and cautious auditor
would use. What is reasonable care, skill and caution would depend on
partucular circumstances of each case. Reffering to the extent of care

12
(1895) 2 Ch 673 (CA)
13
AIR 1957 Cal. 33.
14
(1968) 2 Comp. LJ 211 (SC).
15
(1958) 1 All ER 11(HL).

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 and caution to be exercised by an auditor Romer J., In RE City
Equitable Fire Insurance Co.,16 observed:
“He (i.e.., auditor) must be honest, that is, he must not certify what he
does not believe to be true and he must take reasonable care and skill
before he believes that wht he certifies is true.”
Auditors are not concerned with the policy of the company nor are
theyunder a duty to advice the directors or shareholders about the
prudence or imprudence ofmaking loans with or without security or
whether the business of the company is being conducted profitably or
improfitably. His duty is to ascertain and state the true financial
position of the company at the time of audit and no more.17
The Canadian Court in Haig v. Bamford18 held that where an auditor
issues a certificate without actual verification,he would be liable to a
person who was misled bysuch certificate. Likewise, the auditor who
participated in the negotiations for sale on company’s shares on the
balance sheet audited and certified by him., the value of which turned
out to be unreal,was held liable. The Court pointed out that “results
would have been different had the auditor not participated in the
negotiations”.19
In Caparo Industries v Dickson,20 the court of appeal in England laid
down the guiding principles for determining the liability of an auditor
towards the investors. The liability may be imposed on auditor if it is
shown that:-
(1) He could forsee that the person relying on the accounts would suffer
harm if the auditor was negligent;
(2) The auditor and user of accounts stood in fiduciary relationship;
and
(3) It was just and reasonable to impose duty on the auditor in view of
the circumstances of the case.
Describing the nature of duties of an auditor, Chakravarti, C.J., in
Deputy Secretary, Finance, Government of India v. S.N. Das
Gupta21 observed:
“………………vis-à-vis the shareholders,the auditor holds a

16
(1925) Ch. 407 (481)
17
Lindley,LJ, In Re London &General Bank(No.2),(1895)2 Ch 673(682)
18
(1973)32 DLR (3rd) 67.
19
Diamond Mfg Co.Ltd. v. Hamilton (1968) NZLR 5
20
(1990)1 All ER 568
21
AIR 1956 Cal. 414(420)

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 position of trust and it is his bounden duty to honour that trustby
being candid with the shareholders and telling them frankly and
fully everything with regard to the affairs of the company which
has come to his knowledge and which it is material for the
shareholders to know……his duty is to make a full, carefull and
truthful report in default of which he must be held to have failed in
discharge of his obligations.”
In yet another case, namely, Controller of Insurance v. H.C.
Das22, the learned Chief Justice warned against the danger likely to
be posed to the shareholders due to lack of care and caution by the
auditors. The learned Judge , inter alia , observed:
“An auditor wwho construes his duties to the shareholders or
policy holders too narrowly and he passes and approves of whatever
is stated to him by the management of the company , does not serve
the shareholder with loyalty and efficiency expected of him and
constitutes , instead of source of security to the shareholders, a
positive danger to them.”
The auditors were held liable for the negligence in Leads Estate
Building & Investment Co. v. Shepherd, 23 for not raising any
objection to the distribution of dividend from the share capital of the
company. In this case the company showedexaggerated profits by
including several imaginary items. The auditors neither tried to
ensure whether the company had compiled with the provisions of
its articles nor objected to distribution of dividend from company’s
capital. They were therefore held liable for damages.
Where the auditors submitted their audit report duly signed by
them to the secretaryof the company but the same was not placed
before the general meeting as the meeting was not called,the
auditors were not held liable for the breach of duty24. Instead the
directors were held liable for not calling the General Meeting.

Protection against breach of Duty

Earlier, the companies usually provided in their articles that the

22
AIR 1957 Cal.387.
23
(1887) 36 Ch D 787 (802)
24
In Re Alen Gaig &Co. Ltd.,(1934) Ch 483.

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 auditors should not be held liable for damages except in case of
wilful negligence or default This is well illustrated in the case of
City Equitable Fire Insurance Co. Ltd.,25 wherein the auditors were
held guilty of breach of negligence but as their negligence did not
amount to willful negligence they were protected by the articles and
thus escaped liability.
The Indian Company Law, however, provides that any provision
in the articles of a company or any contract which exempts the
auditor from liability for negligence, default, misfeasance, breach of
duty or breach of trust in relation to the company, shall be void.
Section 463 of the Companies Act, 2013 provides that the Court
may grant relief to officers of the company including the auditors in
cases where there is no suggestion 0f dishonesty or unreasonable
conduct. The onus of proving honesty and reasonable conduct,
however, shall be on the auditor against whom allegations are made.

Auditor’s liability to Third Parties

It was generally accepted that in absence of fraud, an auditor

cannot be liable to third parties for damages suffered by them even
though he had been negligent. This view finds support in the
English decision Le Lievre v. Gould26 wherein owner of the property
engaged an architect so that payment could be made to the builder
as the construction work progressed. The advances to the builder
were actually made by a mortgagee who, unknown to the architect,
had relied on his certificates. On an action being brought by the
mortgagee against the architect for loss sustained by him, the Court
held that the latter was not liable in the absence of any fraud or
contract. Though in this case the liability of an architect was in
question, but the same principal would apply in the case of an
auditor also.
The question of auditor’s liability to third parties for negligence
came up for decision in the well known case of Candler v. Crane,

25
(1925) 1 Ch 407.
26
(1893) 1 QB 491.

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 Christmas & Co., 27 in which accountants were alleged to be
negligent in preparing draft accounts on the instructions of the
managing director of the company. The accountants knew that the
accounts were to be used for the information of an intending
investor. The draft accounts were subsequently certified by the
accountants as auditors. The investors sued the auditors for loss
sustained by him but it was held that he could not claim against the
auditor since they were employed by the company and not by him
and also because there was no liability in torts for negligent mis-
statements relying on Derry v. Peek, 28 rule. Justice Denning,
however, gave a dissenting judgment. To quote his own words, he
said:
“Accountants owe a duty, of course to their employee or client
and also, I think, to any third person whom they themselves show
the accounts or to whom they know their employer is going to show
the accounts so as to induce him to invest money or take some other
action on them.”
Lord Denning’s view found support in Hedley Byre & Co. Ltd. v.
Heller & Partners Ltd.,29 which sought to extend auditor’s liability
to third parties if they were known and recognized to be relying
upon the work of the auditor. The auditor’s liability is further
extended even to someone of whom he knew nothing at the time of
audit.30 Therefore, the law, as it stands today, is that liability of an
auditor extends not only to persons to whom he knew the company
would show the accounts but also to those persons whom he ought
reasonably to have foreseen at the time the accounts were audited
might rely on the accounts. An auditor, however, owes no
responsibility or duty to the Income-tax Department.31

Criminal Liability of Auditors

The auditors may be held criminally liable for the acts done by them
27
(1951) All ER 426
28
(1889) 14 AC 337
29
(1963) 2 All ER 575
30
(1981) 3 All ER 283.
31
(1952) 22 Comp. Cas. 356.

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 during audit of accounts . Their criminal liability extends to the
following matters:-
1. Where auditor’s report is made or any document of the company
is signed or authenticated otherwise than in conformity with the
requirements of section 143 and 145, the auditor concerned shall
be punished if the default is willful.32Similarly , auditor being an
officer of the company for the purpose of sections 299,
300,336,340 and 342of the Companies Act, 2013, he may be
held criminally liable under any of these sections.33

2. Where the auditor fails to produce relevant accounts,

documents and books before the Inspector appointed for
investigating the affairs of the company, he may be punished
with imprisonment of a term which may extend to six months
and fine shall not be less than twenty five thousand rupees but
which may extend to one lakh rupees, and also with a further
fine which may extend to two thousand rupees for every day
after the first during which the failure or refusal continues.34

3. Where any auditor makes a false report, certificate or balance

sheet required for the purpose of any of the provisions of the
Act or omits any material fact knowingly,35 he shall be liable to
punishment as provided under section 477 of the Companies
Act , 2013.

4. Where an auditor intentionally gives false evidence on

examination upon oath or in any affidavit etc. he shall be
punishable with imprisonment for a term which shall not be
less than three years but which may extend to five years and
with fine which shall not be les than one lakh rupees but which
may extend to three lakh rupees36

5. Where the official liquidator has made a report to the Court

32
Section 147 Companies Act,2013
33
In re London &General Bank, (1895)2 Ch 673
34
Section 217 (8)
35
Section 488
36
Section 336

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 station that in his opinion a fraud has been committed by any
officer of the company including an auditor, the court may
direct his public examination under section 300 of the
Companies Act, 2013.

6. If in the event of winding up of a company, any officer of the

company including the auditor, with the intention of defraud or
deceive, destroys, alters mutilates, falsifies or secrets any
books, accounts, papers, etc, he shall be punishable with
imprisonment shall not be less than three years but which may
extend to five years and with fine which shall not be less than
one lakh rupees but which may extent to three lakh rupees.

7. Where in course of winding up of a company, it appears that

the auditor has been guilty of any misfeasance or breach of trust
in relation to the company, the Court ( now Tribunal ) may
examine into his conduct and compel him to repay or restore
the papers, etc37

The company cannot provide in its articles any clause which

seeks to exempt auditors from criminal liability in any of the
aforesaid matters. The auditor, may, however, approach the
Court for grant of relief in such cases under section 463 of the
companies Act, 2013.

37
Section 340

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 BIBLIOGRAPHY

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