Rotation of auditors: Inconsistency between new Companies Act and Draft Rules

The new Companies Act has enhanced scope of auditors by mandating internal audit for such class of companies as may be specified, while by imposing civil liability on the auditors, the Act requires auditors to be more cautious and careful while auditing
 

Following the trend in the US, which replaced its 37 year old Companies Act in 2006, India is also replacing its nearly six decades old law (Companies Act, 1956) with the new Companies Act, 2013 (the Act). The New Act has already been assented by Lok Sabha and Rajya Sabha on 18 December 2012 and 8 August 2013, respectively. It received the nod from the President on 29 August 2013. The Companies Bill, which was in pipeline since five years, has now been enacted as Act no: 18 of 2013 that will replace the 1956 Act.

 

 The 1956 Act had some 658 sections and 14 schedules and the new Act has 470 sections and 7 schedules. This does not mean that the Act has now been made smaller or simpler. The words ‘as may be prescribed’ is appearing at 416 places in the Act, which means a huge amount of law will be enacted by way of rules to be issued by the government in process.

As the Act has already got the assent of the President last month, the Ministry of Corporate Affairs (MCA) has placed on its portal, the draft rules for public comments on 6 September 2013 (Draft Rules) inviting comments till 8 October 2013.

Here are some conflicting provisions in the Draft Rules and the Act relating to rotation of auditors in listed and in certain class of companies to be specified.

 

Provision under the Act

Among others, one of the major changes, which the new Act is proposing, is that it has now put a restraint on the terms of the auditors. Under the 1956 Act, statutory auditors were to be appointed by companies annually. However, section 139 of the new Act now requires appointment (which has been defined by way of an explanation under sub-section (1) to include re-appointments also) of auditors at every sixth annual general meeting (AGM) and the appointment is to be ratified at every AGM.

On the sixth AGM, the auditor is eligible for reappointment, in terms of section 139 (9), subject, however, to the mandatory retirement provisions of sub-section (2) of the said section.

Additionally, in terms of sub-section (2), in case of listed companies or companies of a class to be notified, there is a bar on reappointment of an auditor, if he has already held: (a) one term of 5 years in case of an individual; or (b) two consecutive terms of 5 years in case of a firm. Once the bar on reappointment applies, there is a mandatory cooling-off period of 5 years.

On one hand, where the Act has enhanced the scope of auditors by mandating internal audit for such class of companies as may be specified, on the other hand, by imposing civil liability on the auditors, the Act now requires auditors to be more cautious and careful while auditing.

Provisions under the Companies Rules, 2013

After the new and strict provisions relating to audit and auditors in the Act, the Draft Rules seems to be another challenge for the chartered accountants. Rule 10 of the Draft Rules deals with provisions relating to audit and auditors.

 

Rule 10.4 (4) of the Draft Rules reads as:

 

“For the purpose of the rotation of auditors:

(i) In case of an auditor (whether an individual or audit firm), the period for which he or it has been holding office as auditor prior to the commencement of the Act shall be taken into account in calculating the period of five consecutive years or ten consecutive years, as the case may be.

(ii) The incoming auditor or audit firm shall not be eligible if such auditor or audit firm is associated with the outgoing auditor or audit firm under the same network of audit firms or is operating under the same trade mark or brand.”

 

Para (i) above says that for the purpose of rotation of auditors under section 139 (4) (applicable to listed and other to be specified class of companies), the existing term of auditors shall also be taken into account. This is clearly contrary to the language of section 139(2) of the Act, which refers to "one term of 5 years" or "two terms of 5 years each".

Prior to the commencement of the Act, there may be no appointment of auditor for a term of five years at all. Even if an auditor has been holding his office for 5 years under the 1956 Act, it is not one term of 5 years, but 5 terms of one year each. If an auditor gets reappointed, it does not mean the term is any longer than annual. However, under the Act, before issue of Draft Rules, it was predicted that the ‘term’ will be new term starting after notification of the Act. The Draft Rules have, though divergent with the Act, made it clear, the existing term under the 1956 Act will also be counted for calculating the 5 years or 10 years term. It would mean that if the tenure of appointment of auditors under the Act will effectively be 4 years or 9 years and all related conditions are to be read with such term only.

As the Draft Rules are open for public comments till 8 October 2013 only, the chartered accountants should raise objection/ concern over this particular point to MCA.

 

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