When Board Decisions Backfire: Case Studies on Ignoring Audit Committee Approvals

The Audit Committee is a vital organ of corporate governance, primarily established to ensure the integrity of financial reporting, risk management, internal control systems, and compliance mechanisms. Governed under Section 177 of the Companies Act, 2013 and SEBI (LODR) Regulations, 2015, the Audit Committee plays an oversight role that holds both management and statutory auditors accountable. In particular, there are specific transactions and actions where the Board of Directors is mandatorily required to obtain prior approval or recommendations from the Audit Committee. This article explores the key responsibilities of the Audit Committee, specific circumstances where its approval is essential, and important case laws where such roles were interpreted or relaxed.

Key Responsibilities of the Audit Committee

1. Review of Financial Statements:

   • Quarterly and annual financial statements before submission to the Board.

   • Accounting policies and practices, major judgmental areas, and audit qualifications.

2. Internal Controls and Risk Management:

   • Evaluation of the adequacy and effectiveness of internal controls and risk management systems.

3. Related Party Transactions (RPTs):

   • Approval or any subsequent modification of transactions with related parties.

4. Statutory and Internal Audit Oversight:

   • Review of the performance of statutory and internal auditors.

   • Discussion of audit findings and compliance with audit recommendations.

5. Whistleblower Mechanism:

   • Monitoring the functioning of the vigil mechanism as per Section 177(9) and (10).

Situations Where Board Needs Prior Approval

1. Related Party Transactions (Section 177(4)(iv), Companies Act 2013):

   • All RPTs require prior approval or omnibus approval by the Audit Committee.

   • Any material modification to an existing RPT also requires fresh approval.

   • SEBI LODR Regulation 23(2) mandates approval of all material RPTs by the Audit Committee and Board, followed by shareholder approval.

2. Appointment of Internal and Statutory Auditors:

   • Recommendations for appointment, re-appointment, and removal of auditors (Regulation 18(3), SEBI LODR).

3. Approval of Financial Statements:

   • The Audit Committee must review and recommend approval of financial results before they are considered by the Board.

4. Investments and Loans to Related Parties:

   • When a company proposes to give loans or guarantees to entities in which directors are interested, such transactions should be vetted by the Audit Committee.

5. Inter-Corporate Loans and Advances (If falling under RPTs):

   • If such loans qualify as related party transactions, prior approval is mandatory.

Case Laws Illustrating Audit Committee Oversight

1. Tata Sons Ltd. v. Cyrus Mistry (NCLAT, 2019; Supreme Court 2021)
   While not directly about audit committee permissions, the case underscored the importance of institutional structures and Board governance, particularly Audit Committee independence in protecting minority shareholders and ensuring checks on executive decisions.

2. SEBI v. Sun Infoways Ltd. [SAT Order, 2010]
   SEBI penalized the company for failing to obtain Audit Committee approval before entering into related party transactions. The SAT upheld SEBI's decision and emphasized that Audit Committees are not ornamental but functional decision-makers in corporate oversight.

3. JSW Steel Ltd. - SEBI Adjudication Order (2020)
   JSW had undertaken related party transactions without prior approval of the Audit Committee. However, SEBI considered the delay as procedural and imposed a nominal penalty, showing a relaxed view where the intention was not malafide and financial disclosure was otherwise proper.

4. PVR Ltd. and INOX Leisure Merger (2022)
   In this case, SEBI took cognizance of the role of Audit Committees in vetting and recommending the merger scheme, especially when interested directors were involved. This affirmed that such committees provide a layer of fairness and transparency in approval processes.

5. Apollo Tyres Ltd. v. SEBI [SEBI Adjudication Order, 2021]
   The Audit Committee's role in approving corporate guarantees to group entities was found deficient. The Board had acted without sufficient due diligence from the Audit Committee, which led to SEBI’s scrutiny and guidance on the matter.

When Permissions Are Relaxed

While the statutory requirement is strict, regulatory bodies and courts have occasionally relaxed enforcement in cases where:

• There was no mala fide intention or gain.

• The transaction was fully disclosed in the financials.

• The error was procedural in nature and subsequently rectified.

• The company voluntarily approached SEBI or the Ministry of Corporate Affairs (MCA) for clarification or compounding.

For example, SEBI's approach has evolved to penalize non-material violations with warnings or lower penalties, provided full disclosure is made and there is no suppression of material facts.

Conclusion

The Audit Committee is central to upholding financial integrity, compliance, and corporate accountability. Its recommendations are not merely advisory but statutorily binding in several matters—particularly related party transactions, auditor appointments, and approval of financials. Non-compliance can result in regulatory penalties and reputational risk. However, judicial and regulatory authorities have shown flexibility where procedural lapses occur without mala fide intent. Therefore, companies must not only constitute Audit Committees in form but ensure they function effectively and independently in substance.