Introduction:
The provision for an audit committee is included in Section 177 of the Companies Act of 2013[1]. This section specifies the audit committee’s structure as well as its responsibilities. It is a very well-written provision that specifies how the company’s performance and efficiency would be improved. It is a crucial element that establishes an important committee that examines the financial information of the companies and ensures that it is correct and full. Whistle-blowing policies are now obligatory in India under this section. An audit committee was also included in the earlier company laws of 1996. The conditions for formation, composition, function, and penalty were spelled down in Section 292A. According to the old act, every public company with paid-up capital of at least five crores of rupees must form an audit committee consisting of at least three directors and as many other directors as the board determines, with two-thirds of the total number of members being directors other than managing or whole-time directors. The new act, on the other hand, mandates the formation of an audit committee by every listed business and any other company that may be prescribed.
Section 177[2]
This section is particularly essential since it establishes the structure of the audit committee for specified types of organizations. Any corporation that falls into the class defined by the act of 2013 and the further rules of 2014 must meet both requirements and form an audit committee. Any audit committee in a company must comply with this provision and be created in accordance with the provisions of this section. The newly formed audit committee will follow the procedures outlined in this section. The audit company was given the right to give omnibus approval for related party transactions by the 2015 amendment, as acquiring the approval letter was causing a lot of delays in operations. In 2017, the phrases ‘every public listed company’ were replaced with the terms ‘every listed company’ in section 177. (1). A proviso was also inserted to section 177(4) by this modification, indicating that if the audit committee does not approve a transaction that is not a section 188 transaction, the committee must submit such recommendations to the board.
Circumstances before the Implementation of Section 177
According to the former act[3], the committee must function in conformity with the Board’s written terms of reference. The old act also stated that the committee’s recommendations would be binding on the board, while the new act does not. For non-compliance with the requirement, the old legislation called for the imprisonment of up to one year and a fine, while the current act does not provide for imprisonment of the corporation, just the officers who are in contempt. Under the former legislation, the audit committee was required to meet with the auditors on a regular basis to examine internal control systems, audit scope, and other matters. However, under the amended law, the committee may now request the auditors’ opinions on internal control systems and other matters if it so wants. Another key point to remember is that the former act did not have any kind of vigil system. The former act required committee members to elect their chairman and also required the chairman to attend general meetings to provide clarity; however, under the new act, the chairman is only required to attend the annual general meeting.
Constitution of Audit Committees
The audit committee[4] must have a minimum of three directors, with the majority of them being independent. A majority of the audit committee members should be able to read and interpret financial statements, which is a requirement for the company’s smooth operation. Section 177 mandates the formation of an audit committee in every listed business, as well as additional categories of corporations as may be mandated later. The following are the additional types of businesses that are required to have an audit committee:
- Public corporations with a paid-up capital of at least ten crore rupees or more
- Public companies with a revenue of at least a hundred crore rupees or more
- Public companies with total outstanding debts, borrowings, debentures, or deposits of at least 50 crore rupees or more
Role of Audit Committees
The audit committee’s role has been expanded and refined, with specific obligations such as recommending auditors for an appointment and monitoring their independence and performance. The term “recommendation” is used since the audit committee does not have the jurisdiction to approve the appointment of auditors; stakeholders have the final say in the choice of auditor. The audit committee’s other responsibilities include reviewing financial statements and the auditors’ reports, as well as approving related party transactions. The Audit Committee has the authority to grant omnibus approval for related party transactions proposed by the firm, subject to any limitations that may be imposed. . The company’s auditors and top management people have a right to be heard in Audit Committee meetings when the committee reviews the auditor’s report, but they will not be able to vote. The composition of an audit committee must be revealed in the Board’s report of any company, and if the Board has not accepted any of the audit committee’s recommendations, the same must be disclosed in the Board’s report, along with the reasons for not accepting the recommendations.
Composition of Audit Committees
A business must have at least three directors, with two-thirds of them being independent directors. The audit committee’s members must all be financially literate, with at least one having accounting or equivalent financial management experience. (There are some minimum qualification requirements.) The chairman of the firm must be an independent director, and he or she must be present at the business’s annual general meeting. The audit firm’s secretary should be a corporate secretary. The committee may invite the financial director, the head of the finance department, or any other executive to its meetings at its discretion. According to this, the audit committee shall meet at least four times every year, with no more than one hundred and twenty days between meetings. With at least two independent directors, the quorum should be either two members or one-third of the members, whichever is greater.
Omnibus Approval[5]
The Audit Committee must first satisfy itself that omnibus approval is required for transactions of a repeated character and that such approval is in the best interests of the company, before giving this approval to the company in the best interests of the company and its shareholders. The omnibus approval shall be valid for not more than one financial year and will require new permission once that term has expired. For transactions involving the sale or disposal of the company’s undertaking, omnibus approval is not required.
Following approval by the board of directors, the audit committee shall outline the criteria for obtaining omnibus approval, which shall include:
- The total value of transactions that can be allowed on the omnibus route in a given year.
- The maximum transaction value that can be permitted
- The scope and style of the audit committee’s disclosures
- Transactions that are ineligible for omnibus approval.
While approving the transaction, the audit committee must evaluate both the transaction’s repetitive nature (past or future) and the explanation for the necessity for omnibus approval.
The following items must be included in the omnibus approval:
- The parties’ names
- Transaction type and duration
- An indication of the base price or the current contracted price, as well as the formula for price variation, if any
- The maximum number of transactions that can be made
- Any other pertinent information
If these documents are not accessible, the committee can nonetheless approve the transaction if the total value does not exceed one crore rupees per transaction.
Vigil Mechanism[6]
The Companies Act of 2013 establishes a vigil system. Whistle blowing provisions are covered by section 177(9) of the act, as well as rule 22 of the SEBI Listing Obligation Regulation, 2015. This method allows a corporation to build up a process that motivates and promotes ethical business practices by paying employees for their integrity and for providing vital information to management about the company’s deviant activities. Because of the success and efficiency of such systems in Western countries, India has decided to embrace them. All organizations listed under section 177 of the act of 2013 must now establish a monitoring mechanism via which directors and workers can report concerns about the business’s conduct, accounting methods, or any other element to the audit committee’s chairman. The third-party has been excluded from this system. The vigil mechanism includes enough controls to protect anyone who utilizes it from being victimized. The corporation must disclose the specifics of such an institution on its website and in the Board’s report. Furthermore, it is the independent director’s responsibility to determine and guarantee that the company has an adequate and working vigil mechanism, as well as to ensure that the interests of anybody who utilizes the mechanism are not harmed as a result of their use. For the sake of the Vigil Mechanism for reporting purposes, the Board of Directors shall nominate a director to serve as the Audit Committee. The person who has been wronged shall have direct contact with the Audit Committee’s Chairperson/Nominated Director. In the event of repeated frivolous allegations, the audit committee or the director nominated can take appropriate measures, including reprimand, against the concerned director or employee. The facts of the mechanism’s creation will be made public on the company’s website and in the Board’s report.
Audit Committee Authority
The Audit Committee is in charge over:
- To seek the auditors’ comments on internal control systems, the scope of the audit, including the auditors’ observations, and the evaluation of financial statements prior to their submission to the Board.
- To discuss any connected issues with the company’s internal and statutory auditors, as well as the management.
- To look into any issue relating to the goods or matters brought to it by the Board.
- Obtaining expert guidance from outside sources
- To have complete access to all information contained in the company’s records.
Penalties for Violation
If a company violates Section 177 of the Companies Act 2013, the company will be fined between Rs. 1 lakh and Rs. 5 lakhs, and officers who are in violation would be fined between Rs. 25,000 and Rs. 1, 00,000 or imprisoned for up to one year, or both.
Case Laws
RE vs. Sand Land Real Estates Private Limited[7]
It was a compounding application made by a corporation that had violated section 177 of the Companies act 2013. The corporation missed the deadline for forming the audit committee by 337 days, as required under section 177. The company claimed that due to a large outstanding loan, it was unable to appoint an independent director as required by section 149 and that this caused a delay in the formation of the audit committee. They informed the ROC and should not be held accountable because they had no malicious intent. They were found guilty by the court and were assessed compounding fees to prevent them from defaulting again.
Shruti Power Projects Private Ltd. & Ors[8]
It is a public company that was not required to have an audit committee under the Act of 1956, but after the Act of 2013, and Rule 6 of the Companies (Meetings of Boards and Their Powers) Rules, 2014, it was required to form the committee within a year of the rules’ implementation. This was not done, and the company was in violation. They created a committee and filed this application after that. It’s worth noting that the court in this case explicitly stated that the violation could only be compounded against the company, not the defaulting officers. Both will be prosecuted under Section 178.
Conclusion
The audit committee is a crucial aspect of any organization, as it oversees the firm’s finances, which are the company’s backbone. An audit committee was also included in the previous act, which was enacted in 1956. We can see how the new act of 2013 has made significant adjustments to the old legislation and added new inputs to improve the committee’s efficiency. The preceding study depicts the significant changes and their consequences, allowing one to comprehend the genuine significance of this committee in a business.
References:
[1]Companies act 2013 [https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf]
[2]Audit committee, on 1st April 2014 [http://ebook.mca.gov.in/Actpagedisplay.aspx?PAGENAME=17561]
[3] Companies act, 1956 [https://www.mca.gov.in/Ministry/pdf/Companies_Act_1956_13jun2011.pdf]
[4] Akash Surani, Applicability of audit committee under SEBI and company law on 15th April 2020 [https://taxguru.in/company-law/applicability-audit-committee-sebi-company-law.html]
[5] CS Divesh Goyal, Omnibus Approval For Related Party Transaction under Companies Act, 2013 on 30th December 2015 [https://taxguru.in/company-law/omnibus-approval-related-party-transaction-companies-act-2013.html]
[6] KAS, Vigil Mechanism/ Whistle Blower Policy under Company Act, 2013 [http://kritiadvisory.com/vigil-mechanism-whistle-blower-policy-under-company-act-2013/]
[7] RE vs. Sand Land Real Estates private limited on 10 August 2017 [LAWS (NCLT)-2017-8-502]
[8] RE vs. Shruti power project private limited on 13 April 2017 [C.P. No.5/441/NCLT/AHM/2017]
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