Section 177: Audit Committee

This article discusses about the composition of the audit committee as well as the functions of the committee under section 177 of the companies act, 2013 along with the penalty for violation under section 178 of the companies act, 2013.
Estimated Reading Time: 9 minutes

Introduction

Section 177 of Companies Act, 2013 lay down the provision for audit Committee. This section lays down the composition of the audit committee as well as the functions of the committee. It is a provision very well laid down as it is detailed and provides for improving the effectiveness and efficiency of the company. It is a very important section, laying down an important committee, which assesses the companies’ financial information and makes sure that the information is accurate and complete. This section has also made whistle-blowing policy mandatory in India. This analysis is done to get a better understanding of this important section and to look at the provision in whole with other relevant prescribed rules/regulations.

Purpose of Section 177

This section is very important as it the nitty gritties of the audit committee of a company. The section lays down the following:

  • Constitution of audit committee: According to this section every listed company and such other classes of companies as prescribed later on have to constitute an audit committee in their company. According to rule 6[14], following are the other classes of companies who shall constitute an audit committee:
  • Public companies with a paid-up capital of ten crore rupees or more
  • Public companies having turnover of 100 crore rupees or more
  • Public companies, having in aggregate, outstanding loans or borrowings or debentures or deposits exceeding 50 crore rupees or more.
  • The audit committee has to consist of minimum of three directors with majority being independent directors. Member of the audit committee in majority should be able to read and understand financial statement, a requirement necessary for smooth functioning of the company. 
  • Role of audit committee: Role of audit committee has been increased and made more qualitative with specific responsibilities including the recommendation for appointment of auditors and monitoring their independence and performance. The term used is recommendation and not having the authority to approve appointment of auditors the audit committee can only recommend; the final say for the choice of auditor rests with shareholders. The other role of audit committee includes examination of the financial statement and the auditors’ report thereon, approval of related party transactions, etc. In case of approval of related party transactions, the Audit Committee may make omnibus approval for related party transactions proposed to be entered into by the company subject to such conditions as may be prescribed.
  • The auditors of a company and the key managerial personnel have a right to be heard in the meetings of the Audit Committee when it considers the auditor’s report, but they will not have a right to make a vote.
  • The Board’s report of any company has to disclose the composition of an audit committee and where the Board has not accepted any recommendations of the audit committee, the same have to be disclosed in the Board’s report with their reasons for not accepting the recommendations.
  • Vigil Mechanism:  The companies’ act, 2013 lay down provision for vigil mechanism. Section 177(9) of the act, 2013 along with regulation 22 of SEBI listing Obligation Regulation, 2015 deals with whistleblowing provisions. This mechanism enables a company to set up a process which encourages and promotes ethical corporate behaviour by rewarding employees for their integrity and for providing valuable information to the management on deviant practices being adopted in the company. The success and efficient results of such systems in western countries, lead to India adopting them. Now all the companies listed under section 177 of the act, 2013 have to establish a vigil mechanism wherein directors and employees can report apprehension about the conduct of the business, its accounting methods or any other aspects, to the chairperson of the audit committee. The third party has been kept outside this mechanism. The vigil mechanism has to provide for adequate safeguards against victimization of persons who use such mechanisms. The details of such establishment have to be disclosed by the company on its online web site and in the Board’s report. Further it is the duty of the independent director to ascertain and ensure that the company has an adequate and functional vigil mechanism and to ensure that the interests of a person who uses such mechanism are not prejudicially affected on account of such use.
  • Penalty: Section 178(8) of the act, 2013 gives punishment and penalty for contravention of this section. According to the section, the company will be punishable with fine and every officer of the company who is in default will be punishable with imprisonment or fine or with both.
  • Section 177 have to be read with SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, which lays down following requirements:
  • A company needs to have a minimum three directors as members and two-thirds members shall be independent directors.
  • All members of the audit committee must be financially literate and at least one member should have accounting or related financial management expertise. (Certain minimum qualification limits).
  • Independent director shall be chairman of the company and should be present at the annual general meeting of the company.
  • Secretary of the audit company should be a company secretary.
  • The committee shall on its discretion invite the financial director or head of finance function or any other executive to its meetings. The audit committee according to this has to meet at least four times in a year and not more than one hundred and twenty days must elapse between two meetings.
  • The quorum should be either two members or one third of the members; whichever is greater with at least two independent directors.
  • The audit committee shall have powers to investigate any activity within its terms of reference, seek information from any employee, obtain outside legal or other professional advice and secure attendance of outsiders with relevant expertise.
  • The SEBI regulation also provides for a vigilance committee by all listed companies, on the same lines as the act, 2013.
  • Further section 177 also have to read with the Companies (Meetings of board and its power) Rules, 2014, which lay down the following provisions mainly with respect to omnibus approval (Rule 6A) and vigilant mechanism (Rule 7), in addition what is already stated under SEBI regulations and Companies act, 2013:
  • Omnibus approval shall be required of the audit committee for all related party transaction; the approval shall be made subject to prescribed conditions.
  • Audit committee, after approval by board of directors shall specify the criteria for making the omnibus approval which shall include: (1) maximum value of the transactions, in aggregate, which can be allowed under the omnibus route in a year (2) maximum value which can be allowed per transaction (3) extent and manner of disclosures to be made to audit committee (4) transactions which cannot be subject of omnibus approval.
  • The audit committee while giving the approval has to consider (1) repetitiveness of the transaction (past or future) (2) justification of the need of omnibus approval.
  • The Audit Committee has to mandatorily satisfy itself on the need for omnibus approval for transactions of repetitive nature and that such approval is in the interest of the company and only then gives this approval to the company, in the interest of the company and the shareholder.
  • The omnibus approval shall contain the following: (1) name of the parties (2) nature and duration of transaction (3) indicative base price or current contracted price and the formula for variation in the price, if any (4) maximum amount of transaction that can be entered into (5) any other information relevant. If theses information is not available, the committee can still give approval if the transaction amount does not increase rupee one crore per transaction.
  • Omnibus approval shall be valid for a period not exceeding one financial year and shall require fresh approval after the expiry of such financial year.
  • Omnibus approval shall not be made for transactions in respect of selling or disposing of the undertaking of the company.
  • These rules also provide for a vigilant mechanism, overseen by the audit committee. The companies, which do not have to constitute audit committee, there the board of directors shall nominate a director to play the role of audit committee for the purpose of a vigil mechanism to whom other directors and employees may report their concerns.
  • In case of repeated frivolous complaints being filed by a director or an employee, the audit committee or the director nominated to play the role of audit committee may take suitable action against the concerned director or employee including reprimand.

Situation Before the Enactment of Section 177

The previous company act of 1996 also had had provision for an audit committee. Section 292A laid down the requirements for formation, composition, function and penalty. The old act provides that every public company having paid-up capital of not less than five crores of rupees must constitute an audit committee consisting of not less than three directors and such number of other directors as the board may determine of which two-thirds of the total number of members shall be directors, other than managing or whole-time directors. The new act, on the other hand, states that every listed company and such other company as may be prescribed, shall constitute an audit committee. The criterions are different, new act also provides for independent directors, increasing the efficiency of the company.

The old act says that the committee should act in accordance with terms of reference to be specified in writing by the Board. The old also held that the recommendations of the committee would be binding on the board, the new act provides for no such thing. The old act provided imprisonment up to one year and fine, for non-compliance of the provision, but the new act does not provide for imprisonment for company but the officers in default. Under the old act, there was a compulsion on audit committee to have discussions with the auditors periodically about internal control systems, scope of audit etc., however, under the new act, now the committee may call for the comments of the auditors about internal control systems etc., if it so desires.

Further another important thing to note is that the old act did not provide for any vigil system. The old act provided that the members of the committee shall elect their chairman and also provided that the chairman shall attend the general meetings to provide clarification, under new act the chairman only has to attend the annual general meeting. The above clearly shows that the situation under the old act was quite different, and many new inputs are there in the act, 2013 for the provision of an audit committee. The new provision increases the efficiency and effectiveness of the committee.

Application of Section 177

This section is a very important section laying down the constitution of the audit committee for prescribed classes of companies. Any company that falls under the class prescribed by the act, 2013 and further rules, 2014 have to fulfil the requirements of both, and constitute an audit committee. Any audit committee in a company has to compile with this provision and have to be formed in lines of this section. The constituted audit committee will also work in the way provided under this section.

Amendments

By the way of the 2015 amendment, the audit company was given the power to give omnibus approval for related party transactions, as getting the approval letter was creating a lot of hindrances in business. By way of amendment in 2017, ‘every public listed company’ substituted the words ‘every listed company’ in section 177(1).  Further by this amendment, a proviso was also added to section 177(4), stating that if the audit committee does not approve a transaction other than a section 188 transaction, then the committee has to make such recommendations to the board. 

Following the insertion of rule 6 Companies (Meetings of Boards and Its Powers) Rules, 2014, MCA vide a notification dated 12/06/2014 provided the public companies which did not have to form audit committee under 1956 act, but now have to as per above stated rule, then that shall do it within one year of the commencement of these rules or appointment of independent director, whichever is earlier.

By the way of MCA notification, exemption has been carved out for section 8 companies. They are not required to have independent directors as majority, in their audit committee. This exemption will be applicable to those companies, which have not committed default in filing financial statements and annual returns.

Cases at a Glance

  • M/s Sand Land Real Estates Private Limited case: It was an application for compounding, filed by the company who was in violation of section 177 of the cat 2013. The company was late by 337 days in the constitution of the audit committee as per the provision of section 177.  The company contended that it was in delay in appointing independent director as per section 149, due to huge outstanding loan, and hence they incurred delay in constitution of audit committee. The informed the ROC and thus should not be held liable as they did not have any mala fide intention. They were held to be liable by the court and were charged compounding fees to defer them from repeating the default. This case shows how important it is to comply with the conditions of section 177.
  • Shruti Power Projects Private Ltd. & Ors: In this case, the company has filed an application for compounding the violation of section 177(1). It is a public company which did not require an audit committee under the act, 1956 but after the act 2013, and rule 6 of Companies (Meetings of boards and its Powers) Rules, 2014, it had to constitute the committee within a year of commencement of rules. The company did not do so and was in violation. They later formed the committee and filed this application. What is interesting is to note that the court in this case clearly held that the violation could be compounded only against the company and not against the officers in default. Both are to be punished under section 178. This again outlines the serious nature of conditions of section 177.

Concluding Summary

Audit committee is a very important part of any company, looking after the financials of the company, which forms the backbone of a company. The old act, 1956 also had a provision for an audit committee. We see how the new act, 2013 have brought major changes in the old act and brought in new inputs to increase the efficiency of the committee. The above analysis shows the major changes and their effects and helps one understand the true importance of this committee in a company.

Also read, the concept of corporate veil explaining history of the concept of lifting of corporate veil.