2025 (12) TMI 1485 - HC - Companies Law

External forensic audit for bank lender action under RBI directions-consultant conflict and unsigned FAR led to invalidation.

Appointment of an external forensic auditor to support lender-bank action, including show-cause notices based on a forensic audit report (FAR), was ... Eligibility of Auditors to conduct Audit under relevant statutes - applicability of Clause 4.1 of 2024 RBI Master Directions and Footnote 14 therein - HELD THAT:- Defendant No. 2 was already engaged with the Lender Banks as Consultant all throughout. A Forensic Auditor’s independentness is extremely crucial for objectivity, ensuring that he is free from bias and external influence to investigate fraud impartially acting as a credible, unbiased expert for courts, boards, and all stakeholders and most importantly not advocating for any specific party but for the truth and for upholding professional standards. He must be free from obligations, interests, or relationship with the client or else it could impair his objectivity. He cannot support a client's predetermined position. In the present case, association of Defendant No. 2 with the Lender Banks as Consultant clearly creates a conflicting position as an independent External Forensic Auditor. In essence, the Forensic Auditor serves as an independent truth seeker providing reliable financial analysis for legal or decision making purposes, making independence the bedrock of his professional role. It is seen that the timeline for completing the Forensic Audit stipulated in the Appointment order was 2 months. FAR was submitted to Lead Banks on 15.10.2020 i.e. after 1 year, 5 months and 8 days later. This erosion of the stipulated timeline on the face of record itself proves the above issue and clearly shows how Banks have treated the statutory Master Directions and the timeline of six (6) months stated therein for completion of the External Audit process with disdain. In the present case, it is an admitted position by Defendant No. 2 in its Affidavit-in-Reply that Defendant No. 2 though being appointed as statutory External Forensic Auditor is not the signatory of the Report whereas FAR is signed by Defendant No. 3 being one of its then Partner. Most crucial fact is that Defendant No. 3 is admittedly not a qualified Chartered Accountant either which is also admitted by him. It is also an admitted fact that none of the Chartered Accountant Partners of Defendant No. 2 at the then time were registered with ICAI. This position is undisputed - It is seen that by virtue of enactment of 2024 RBI Master Directions the earlier Directions stood superseded which effectively means that in place of earlier Directions the new 2024 RBI Master Directions would now apply. It cannot be argued by Banks that it is only in 2024 that Footnote 14 giving effective direction for Auditors who are qualified under relevant statutes to conduct Audit is reflected for the first time and thus it would be applicable prospectively. It is seen that Forensic Audit involves a detailed examination and evaluation of firms or individuals financial records. In Forensic Audit, the goal is to derive evidence that can be used in Court of Law and other proceedings. A Forensic Audit is a specialized accounting field focused on investigating financial records for fraud, embezzlement or other financial crimes. It is seen that Forensic Audit covers a wide range of investigation activities and is often conducted to prosecute a party for fraud, embezzlement and other financial crimes. It is also seen that in the process of Forensic Audit the Auditor may be called to serve as an expert witness during the trial proceedings. In the present case, in this regard say of Defendant No. 2 in the Audit Report and its Affidavit-in-Reply becomes very relevant for adjudicating grant of interim relief. In the present case in 2019 the External Auditor is appointed to investigate the accounts pertaining to the period between 2013 and 2017. The RBI Master Directions are rendered completely redundant if this timeline is seen. It is seen that under the 2016 RBI Master Directions or even the 2024 RBI Master Directions once the Auditor is appointed he has to submit his Report within three months but in the present case it has taken an invariably long time of 17 months for submitting the FAR - The Master Directions of RBI are not a mere paper tiger to enable the Banks to wake up from their deep slumber and initiate action according to their convenience. Had the concerned accounts of Plaintiff being Red Flagged on account of one or two EWS in the year 2013 itself or even thereafter and had the Banks acted strictly in consonance with the prevailing Master Directions, the present situation would not have arisen. It is preposterous to accept the argument of Banks that an External Auditor not having Chartered Accountant qualifications could be validly appointed under the 2016 RBI Master Directions for External Audit. Banks’ case that interfering with the Show Cause Notices and further consequential action will derail investigation cannot be countenanced if the edifice on which it is based is itself palpably dubitable. Allowing the impugned action to proceed will lead to disastrous consequences in such cases where it leads to a certain civil death without trial. Hence on the parameter of grave and irreparable harm / loss, Plaintiff’s case deserves to be accepted for grant of interim relief for all the above reasons, legal and factual, and in accordance with the principles of natural justice. Principles of natural justice is based on the maxim – “Justice should not only be done but should manifestly be seen to be done”. It provides for a fair hearing, unbiased decision-making and presenting proper evidence before taking any action. Suit allowed. 1. ISSUES PRESENTED AND CONSIDERED (i) Whether interim injunctive relief should be granted to stay and restrain bank actions founded on a forensic audit report, where the report's author/signatory and the auditing entity are asserted to be not 'auditors qualified to conduct audit under relevant statutes'. (ii) Whether the qualification requirement reflected in Clause 4.1 read with Footnote 14 of the 2024 RBI Master Directions operates only prospectively, or whether it is to be read harmoniously into the earlier regime governing the impugned bank action. (iii) Whether, on the facts, the forensic auditor's independence was compromised so as to materially undermine the report's reliability for initiating and sustaining fraud-related action. (iv) Whether the suits/interim claims are prima facie barred by limitation, waiver, or estoppel, given the timing of disclosure of the forensic audit report and prior participation in bank processes. (v) Whether the established standards for interim injunction (prima facie case, balance of convenience, irreparable harm) justified staying all actions taken and restraining further action in reliance upon the report/show-cause notices (and, where applicable, the fraud declaration order). 2. ISSUE-WISE DETAILED ANALYSIS (i) Interim restraint against actions based solely on the forensic audit report Legal framework: The Court evaluated interim relief under Order XXXIX Rules 1-2 CPC by applying the tests of prima facie case, balance of convenience, and irreparable harm, additionally considering equitable considerations including the parties' conduct. The Court treated the RBI Master Directions as having statutory force (issued under Section 35A of the Banking Regulation Act, 1949) and assessed whether the impugned bank actions complied with the governing Directions and 'relevant statutes'. Interpretation and reasoning: The Court found that the forensic audit report was the sole basis and foundation for the show-cause notices issued by the banks and for consequential steps, including a fraud classification order in one matter. It held that where the foundational report is prima facie legally infirm and itself disclaims audit/attestation character and responsibility, bank action built upon it cannot be permitted to proceed at the interim stage, particularly given the drastic civil consequences of fraud classification. Conclusion: Interim relief was granted staying all actions already taken under or in reliance upon the report and the relevant show-cause notices (and, where applicable, the fraud declaration order), and restraining further action in reliance on them pending trial. (ii) Applicability and meaning of Clause 4.1 and Footnote 14 of the 2024 RBI Master Directions; 'relevant statutes' and auditor qualification Legal framework: The Court considered Clause 4.1 of the 2024 RBI Master Directions and Footnote 14 ('Auditors who are qualified to conduct audit under relevant statutes'), and harmonised them with the Companies Act, 2013 provisions reproduced and applied in the judgment (Sections 141(1), 141(2), and 145) and the Chartered Accountants Act, 1949 provisions reproduced (including Section 6 on certificate of practice). Interpretation and reasoning: The Court rejected the banks' submission that no Chartered Accountant qualification was contemplated under the earlier regime and that Footnote 14 introduced a new, purely prospective requirement. It held that an 'external auditor' under the fraud framework must conform to the qualification standards under the 'relevant statutes', which the Court held to be the Companies Act, 2013 for this purpose. It reasoned that accepting a dual-standard-one for statutory/internal auditors and another for external forensic auditors-would create an impermissible dichotomy and allow appointment of unqualified persons at bank discretion. The Court treated Footnote 14 as clarificatory, supplying an omission and making explicit what was implicit, and thus not merely prospective in the manner argued by the banks. Conclusion: The Court held that the forensic audit, to be valid for reliance in fraud proceedings, required an auditor qualified under the relevant statutes; consequently, a report authored and signed by a non-Chartered Accountant partner, with the auditing entity not being an ICAI-registered CA firm, was prima facie non-compliant and could not sustain the impugned bank action. (iii) Independence and propriety of appointment of the forensic auditor Legal framework: The Court examined the factual record concerning the appointment and prior engagement of the forensic auditor with lender banks, treating independence as intrinsic to the role of an 'external' forensic auditor within the fraud risk framework. Interpretation and reasoning: The Court found that the auditor had been engaged as a consultant and had presented and discussed fund-flow issues with the lenders before its formal appointment as forensic auditor, and had suggested/solicited its own appointment in lender meetings. This, in the Court's view, compromised the auditor's independence and objectivity. The Court further noted material deviations from the appointment terms and timelines (including delay far beyond stipulated periods) as reinforcing that the process did not reflect due adherence to the framework's checks and balances. Conclusion: The Court concluded that the auditor's independence was prima facie compromised, further weakening the report as a lawful and reliable foundation for fraud-related action. (iv) Limitation, waiver, and estoppel Legal framework: The Court assessed limitation with reference to accrual of the cause of action upon receipt of the complete report and applied Article 58 of the Limitation Act as expressly adopted in the judgment's reasoning for maintainability. Interpretation and reasoning: The Court held that, although the report was prepared earlier, it was not shared with the claimant until 2024 (and in some cases later), and therefore the cause of action to challenge the report and consequent notices arose upon disclosure. It rejected the banks' limitation argument at the interim stage. The Court also declined to hold that participation in hearings or prior litigation amounted to waiver/estoppel, emphasizing that the specific challenge to the report's legality and the author's/signatory's qualification had not been previously adjudicated, and denying the challenge would render the claimant remediless. Conclusion: The suits/interim claims were held prima facie within limitation and not barred by waiver or estoppel so as to deny interim protection. (v) Natural justice, adequacy of material, and irreparable harm Legal framework: The Court evaluated the grave civil consequences of fraud classification and underscored the need for procedurally fair action, including disclosure of foundational material enabling an effective response. Interpretation and reasoning: The Court found that the report itself contained extensive disclaimers (including that it was not an audit/attestation engagement and that findings were based on incomplete information) and noted documentary material indicating that the auditor did not conclude fraud as defined in the fraud framework. Given that the show-cause notices and consequential actions rested solely on such a report, and given the severe consequences amounting to near 'civil death' in economic terms, the Court held irreparable harm was established and that banks' 'derail investigation' argument could not prevail where the foundation was prima facie doubtful. Conclusion: The Court held the claimant satisfied the requirements for interim injunction; interim relief was granted, and the request to stay the operation of the interim relief order was refused.