Supreme Court Upholds Reopening of IL&FS Accounts: Hari Sankaran vs. Union of India (2019)

Introduction

Date of the Judgment: 4 June 2019
Citation: (2019) INSC 482
Judges: Indu Malhotra, J., M.R. Shah, J. (authored the judgment)

Can a company’s financial statements be reopened and recast if there are allegations of fraud or mismanagement? The Supreme Court of India recently addressed this crucial question in a case involving Infrastructure Leasing & Financial Services Limited (IL&FS). The court examined whether the National Company Law Tribunal (NCLT) was justified in ordering the reopening of accounts for IL&FS and its subsidiaries. This judgment clarifies the scope of Section 130 of the Companies Act, 2013, which allows for the re-examination of company accounts under certain conditions.

Case Background

The case revolves around Infrastructure Leasing & Financial Services Limited (IL&FS), a major infrastructure development and finance company with 348 group companies, including IL&FS Financial Services Limited (IFIN) and IL&FS Transportation Networks Limited (ITNL). IL&FS was promoted by Central Bank of India, HDFC Ltd., and the Union Trust of India. The company faced serious allegations of mismanagement and financial irregularities.

On 1 October 2018, the Central Government, through the Ministry of Corporate Affairs, filed a petition before the National Company Law Tribunal (NCLT) alleging mismanagement by the IL&FS board and that the company’s affairs were being conducted against public interest. The government sought the suspension of the existing board and the appointment of new directors. The Serious Fraud Investigation Office (SFIO) was also directed to investigate the company’s affairs under Section 212 of the Companies Act, 2013.

The Registrar of Companies also conducted an inquiry under Section 206 of the Companies Act and found evidence of mismanagement, compromised corporate governance, and risk management issues. It was observed that IL&FS had been presenting a misleading financial picture, concealing a mismatch between cash flows and payment obligations.

Timeline

Course of Proceedings

The NCLT, on 1 October 2018, suspended the existing Board of Directors of IL&FS and appointed a new board, finding that the affairs of IL&FS were being conducted in a manner prejudicial to public interest. Following this, the Union of India sought permission from the NCLT under Section 130(1) of the Companies Act to reopen and recast the financial statements of IL&FS, IFIN, and ITNL for the last five years (2012-2013 to 2017-2018). The NCLT issued notices to various parties, including the Income Tax Authorities and SEBI.

On 1 January 2019, the NCLT allowed the application under Section 130, permitting the reopening of accounts. The appellant, a suspended director of IL&FS, appealed this order before the National Company Law Appellate Tribunal (NCLAT), which dismissed the appeal on 31 January 2019, upholding the NCLT’s decision.

Legal Framework

The case primarily involves the interpretation and application of the following sections of the Companies Act, 2013:

• Section 130: This section deals with the reopening of books of accounts and recasting of financial statements of a company. It states that a company can reopen its accounts if the earlier accounts were prepared in a fraudulent manner or if the company’s affairs were mismanaged, casting doubt on the reliability of the financial statements. The section reads:
  
  “130. Re-opening of accounts on Court’s or Tribunal’s orders.—(1) A company may, subject to such conditions as may be prescribed, re-open its books of account and re-cast its financial statements, and also re-cast its reports for any of the three preceding financial years, if—
  (i) the relevant earlier accounts were prepared in a fraudulent manner; or
  (ii) the affairs of the company were mismanaged during the relevant period, casting a doubt on the reliability of financial statements.”
• Section 211: This section provides for the establishment of the Serious Fraud Investigation Office (SFIO) to investigate corporate frauds.
• Section 212: This section empowers the SFIO to investigate the affairs of a company if the Central Government deems it necessary in the public interest or upon request from a government department.
• Section 241: This section allows the Central Government to apply to the Tribunal if it believes a company’s affairs are being conducted in a manner prejudicial to public interest.
• Section 242: This section empowers the Tribunal to make orders, including suspending the board of directors and appointing new directors, to manage the company’s affairs.

Arguments

Appellant’s Arguments (Hari Sankaran):

• The appellant argued that the NCLT’s order under Section 130 of the Companies Act was illegal because the preconditions for reopening accounts were not met. Specifically, the appellant contended that the NCLT did not find that the accounts were prepared fraudulently or that the company’s affairs were mismanaged.
• The appellant submitted that the NCLT’s order was in breach of natural justice because he was not given sufficient opportunity to file a reply before the order was passed. The notice for the application under Section 130 was issued on 27 December 2018, and the order was passed on 1 January 2019, without granting him time to respond.
• The appellant argued that the NCLT’s reliance on the earlier order dated 1 October 2018 (passed under Sections 241/242 of the Companies Act) was incorrect as it was an interim order and not a final finding of mismanagement.
• The appellant contended that Section 130, Sections 211/212, and Sections 241/242 of the Companies Act operate in different fields, and observations made under one provision cannot be applied to another.
• The appellant relied on the decisions of Mannalal Khetan v. Kedar Nath Khetan [ (1977) 2 SCC 424] and Swadeshi Cotton Mills v. Union of India [(1981) 1 SCC 664], arguing that when a statute provides a specific manner for doing something, it must be done in that manner only.
• The appellant cited Calcutta Discount Company v. Income Tax Officer [AIR 1961 SC 372] to argue that the conditions precedent for invoking Section 130 were not satisfied.
• The appellant cited Mohinder Singh Gill v. Chief Election Commissioner, New Delhi [(1978) 1 SCC 405] and T.P. Senkumar v. Union of India [(2017) 6 SCC 801] to argue that the respondents cannot rely on subsequent events to support the order under Section 130.

Respondents’ Arguments (Union of India):

• The respondents argued that the NCLT’s order was in the larger public interest and in accordance with Section 130 of the Companies Act. They highlighted serious allegations of fraudulent accounts and mismanagement of IL&FS.
• The respondents pointed out that the NCLT, in its order dated 1 October 2018, had already found that the affairs of IL&FS were being conducted in a manner prejudicial to public interest.
• The respondents emphasized the investigations by the SFIO and the Registrar of Companies, which revealed significant financial irregularities and mismanagement.
• The respondents argued that all three provisions—Sections 211/212, 241/242, and 130—should be read conjointly, and the order under Section 130 would aid the ongoing investigations.
• The respondents submitted that the powers under Section 130 are less stringent than those under Sections 241/242 and 211/212. They argued that the NCLT only needed to be satisfied that either the accounts were prepared fraudulently or the company was mismanaged.
• The respondents argued that the appellant was given a sufficient hearing, as the erstwhile directors opposed the application under Section 130 and were heard by the NCLT.
• The respondents relied on the subsequent interim investigation reports by the Reserve Bank of India (RBI) to support the validity of the order under Section 130.
• The respondents cited Chairman, All India Railway Recruitment Board v. K. Shyam Kumar [(2010) 6 SCC 614] to argue that subsequent events can be considered while determining the legality of an order in public interest.

Submissions

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

1. Whether the order passed by the NCLT under Section 130 of the Companies Act, 2013, allowing the reopening of accounts of IL&FS and its subsidiaries, was illegal and/or contrary to the provisions of Section 130 of the Companies Act?

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered the following authorities:

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• The Court distinguished the cases cited by the appellant, stating that they were not applicable to the facts of this case.
• The Court agreed with the ratio of the case cited by the respondents, Chairman, All India Railway Recruitment Board v. K. Shyam Kumar [(2010) 6 SCC 614], that subsequent events could be considered in the public interest.
• The Court interpreted Section 130 of the Companies Act, 2013, to mean that either of the conditions (fraudulent accounts or mismanagement) being satisfied is sufficient for the Tribunal to order the reopening of accounts.

What weighed in the mind of the Court?

The Supreme Court’s decision was heavily influenced by the need to protect public interest and ensure corporate accountability. The Court emphasized the seriousness of the allegations against IL&FS, the involvement of substantial public funds, and the need for a thorough investigation. The Court was also persuaded by the preliminary findings of the SFIO, ICAI, and RBI, which indicated significant financial irregularities and mismanagement. The Court’s reasoning focused on the following key points:

• Public Interest: The Court repeatedly highlighted the larger public interest involved, emphasizing the need to uncover the truth and protect public funds.
• Seriousness of Allegations: The Court acknowledged the gravity of the allegations of fraud and mismanagement against IL&FS and its group companies.
• Preliminary Reports: The Court relied on the preliminary reports of SFIO, ICAI, and RBI, which indicated that there were significant financial irregularities and mismanagement.
• Compliance with Section 130: The Court found that the conditions precedent to invoke Section 130 were satisfied.
• Need for Investigation: The Court recognized the need for a thorough investigation to determine the extent of the irregularities and take appropriate action.

Sentiment Analysis of Reasons Given by the Supreme Court:

Fact:Law Ratio:

Logical Reasoning

The Court considered alternative interpretations, such as the argument that the conditions under Section 130 were not met. However, the Court rejected these interpretations, noting that the NCLT had sufficient evidence of mismanagement and potential fraud to justify reopening the accounts. The Court emphasized that the word “OR” in Section 130(1) means that either of the two conditions being satisfied is sufficient. The final decision was reached by balancing the need for a fair process with the larger public interest and the need for accountability in corporate governance.

The Supreme Court held that the NCLT’s order was justified given the serious allegations of mismanagement and fraudulent accounts. The Court emphasized that the NCLT had considered the preliminary reports of SFIO and ICAI. The Court also noted that the NCLT’s earlier order under Sections 241/242 had found the company’s affairs to be prejudicial to public interest. The Court held that either of the conditions under Section 130(1)(i) or (ii) being satisfied is sufficient for the NCLT to pass an order under Section 130.

The Court quoted from the judgment:

• “Therefore, if either of the conditions precedent is satisfied, the Tribunal would be justified in passing the order under Section 130 of the Act.”
• “While passing an order in a particular provision, the endeavour should be to see that the order/orders passed under other provisions of the Companies Act are given effect to, and/or in furtherance of the order/orders passed under other Sections.”
• “In the facts and circumstances of the case, we are of the opinion that the order passed by the learned Tribunal passed under Section 130 of the Companies Act, confirmed by the learned Appellate Tribunal, is not required to be interfered with.”

There were no dissenting opinions in this judgment. The bench consisted of two judges, both of whom concurred with the final decision.

Key Takeaways

• The Supreme Court upheld the NCLT’s order to reopen the accounts of IL&FS and its subsidiaries, emphasizing the importance of public interest and corporate accountability.
• The judgment clarifies that under Section 130 of the Companies Act, 2013, a company’s accounts can be reopened if either the accounts were prepared fraudulently or the company was mismanaged, casting doubt on the reliability of financial statements.
• The Court emphasized that preliminary reports by investigating agencies like SFIO and ICAI can be considered sufficient grounds for ordering the reopening of accounts.
• The Court held that the principles of natural justice are deemed to be complied with if the concerned parties have been given a chance to be heard.
• The judgment underscores the importance of a holistic reading of the Companies Act, where different provisions are interpreted to achieve the overall objective of corporate governance and public interest.

Directions

The Supreme Court did not issue any specific directions other than dismissing the appeal and upholding the order of the NCLT.

Impact

This judgment has significant implications for corporate governance in India:

• Strengthened Corporate Accountability: The ruling reinforces the principle that companies must maintain accurate and transparent financial records. It sends a strong message that corporate misconduct will not be tolerated and that regulatory bodies have the power to take corrective action.
• Enhanced Public Trust: By upholding the reopening of accounts, the Supreme Court has boosted public confidence in the regulatory mechanisms designed to protect public interest. It demonstrates that the judiciary is committed to ensuring corporate accountability.
• Deterrent Effect: The judgment acts as a deterrent against financial mismanagement and fraudulent accounting practices. Companies are now more likely to adhere to accounting standards and maintain ethical business practices.
• Clarification of Section 130: The judgment provides clarity on the interpretation of Section 130 of the Companies Act, 2013. It establishes that either of the two conditions (fraudulent accounts or mismanagement) being satisfied is sufficient for the Tribunal to order the reopening of accounts.
• Increased Scrutiny: Companies are now subject to increased scrutiny from regulatory bodies, and there is a greater likelihood of intervention if financial irregularities are suspected.
• Precedent for Future Cases: This judgment serves as a precedent for future cases involving similar issues. It provides guidance on how to interpret and apply Section 130 of the Companies Act, 2013.

Conclusion

The Supreme Court’s decision in Hari Sankaran vs. Union of India is a landmark judgment that reinforces the importance of corporate accountability and public interest. By upholding the NCLT’s order to reopen the accounts of IL&FS and its subsidiaries, the Court has sent a clear message that financial irregularities and mismanagement will not be tolerated. The judgment has clarified the scope of Section 130 of the Companies Act, 2013, and has provided a framework for future cases involving similar issues. The case highlights the critical role of regulatory bodies and the judiciary in ensuring that companies operate ethically and transparently, thereby protecting the interests of the public and the economy.