Summary of this article
SEBI allows AIFs to retain liquidation proceeds for legal disputes.
Inoperative fund status reduces quarterly compliance and administrative overheads.
Retained cash must be invested in secure liquid instruments.
The Securities and Exchange Board of India (Sebi) has released guidelines for winding up of Alternative Investment Funds (AIFs). Sebi’s guidelines seek to regulate the retention of proceeds and ‘Inoperative Fund’ status.
Through the guidelines, the regulator seeks to address the operational gridlock and compliance burdens faced by fund managers when schemes cannot be fully closed down due to outstanding liabilities, pending tax demands, or active legal disputes. Notably, the guidelines have been released post-amendments to the central framework, which allowed flexibilities to fund managers during the liquidation process.
What Are Sebi's New Guidelines For AIFs?
Prior to the introduction of the new guidelines, AIFs were bound by rigid timelines to fully liquidate their portfolios, distribute all proceeds to investors, and immediately surrender their registration certificates once the fund term concluded.
The new guidelines introduced by Sebi seek to change this by introducing certain conditions under which an AIF can legally retain liquidation proceeds beyond the lifespan of the fund. The regulator has also clarified the conditions under which an AIF or a scheme of AIF can retain the funds.
"Demonstrable receipt of a litigation notice or demand by the AIF/scheme of AIF, which includes any official written communication from a tax authority, regulatory authority, law enforcement agency, court of law, or from an investor or counterparty in relation to litigation, which indicates a potential tax, regulatory or legal liability," Sebi said.
This, in turn, allows fund managers to hold funds if they demonstrate receipt of an official regulatory or litigation notice, obtain explicit consent from seventy-five per cent of investors by value for anticipated disputes, or provide documentary proof for residual operational costs, which are capped at a three-year retention period.
Additionally, the new guidelines also establish an entirely new regulatory mechanism called the ‘Inoperative Fund’ status. Previously, funds stuck in prolonged litigation had to continually meet extensive quarterly reporting, portfolio valuation, and mandatory compliance certification requirements to maintain their registration. However, under the new process, an eligible AIF can apply for an ‘Inoperative Fund’ status, which allows it to preserve its registration solely to wait out the conclusion of a legal dispute.
However, to ensure that funds do not misuse the ‘Inoperative Fund’ status, strict operational limits have been placed on the entities.
"No new scheme shall be launched under the AIF; and, no management fees shall be charged in respect of any of its scheme(s)," Sebi said.
How These Changes Impact the Broader Market
The changes introduced by the Sebi for AIFs in its latest circular aim to streamline the operational landscape of the private pool and venture capital ecosystem in India. The introduction of an institutional pathway for winding down inactive schemes removes a bottleneck which would have otherwise forced fund managers into compliance defaults during legal disputes.
The ‘Inoperative Fund’ designation exempts eligible funds from major administrative overheads, including providing quarterly activity updates, conducting portfolio valuation audits, hiring securities custodians, and maintaining specialised investment team certifications.For the investor, these rules can potentially increase transparency and standardisation.
By forcing funds to place all retained cash into highly secure, liquid instruments and submit annual retention status reports to the regulator, Sebi seeks to ensure that the players remain accountable and legally insulated without stopping the winding down of investment vehicles.
AIFs were introduced by Sebi in 2012 to create a structured regulatory environment for pooled private investment vehicles like venture capital funds, private equity funds, and hedge funds. The AIF category was positioned as an investment option for high-net-worth individuals and institutional players with a minimum investment amount of Rs 1 crore.
