Amidst the vibrant tapestry of India’s economic landscape, Alternative Investment Funds (“AIFs”) have lately been at the helm of catalysing growth, innovation, and revolutionizing the financial fabric of India. These AIFs are established for a fixed period of time (“fund tenure”) in order to attain their investment objective and provide acceptable returns to their Limited Partners/contributors.
The Securities and Exchange Board of India (“SEBI”) has recently issued the SEBI (AIF) (Second Amendment) Regulations, 2023 (“Second Amendment”) that introduces the concept of ‘Liquidation Scheme’ and tries to redefine the regulatory landscape of the unliquidated investments of a scheme of an AIF after the expire of its fund tenure. Supplementing the Amendment, the SEBI has also issued a circular (“circular”) (“Second Amendment” and “circular” hereinafter collectively referred to as “Amendment”) clarifying the modalities for launching the Liquidation Scheme and for distributing the unliquidated investments of AIF in-specie. This article is an attempt to analyse the Amendment in light of the Liquidation Scheme and provide valuable insights on the same.
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Evergreening of fund tenure: Elephant in the room
Pursuant to Regulation 13(5) of the SEBI (AIF) Regulations, 2012 (“AIF Regulations”), a close ended AIF is allowed to extend its tenure upto two (02) years subject to approval of two-thirds (2/3) of unit holders by value of their investments in AIF. AIFs have lately resorted to a practice of extending the tenure of their fund beyond the prescribed tenure provided in the Private Placement Memorandum (“PPM”) by taking a consent of seventy five per cent (75%) of the investors in value of the investments. This evergreening of fund tenure had effectively afforded perpetuity to the AIFs whereby the tenure may go till a time which the manager with consent of the 75% of the investors in value would deem appropriate.
In the matter of Urban Infrastructure Venture Capital Fund, SEBI took a contrary view on these AIFs and held that such an extension is not in the interests of investors who had invested basis the tenure prescribed in the PPM and held that such an extension is not valid. In light of the same, SEBI introduced a consultation paper to hear the representation of the stakeholders and subsequently issued the concerned Amendment.
Options of Liquidation Scheme or In-Specie Distribution
The Amendment provides that during a period of one (01) year following the expiry of tenure or extended tenure of the scheme (“Liquidation Period”), an AIF has the option of either launching a new close-ended scheme meant only for liquidating those unliquidated investments (“Liquidation Scheme”) or distributing the unliquidated investments in-specie i.e., distributing the unliquidated investments themselves for fully liquidating the scheme of an Alternative Investment Fund. A Liquidation Scheme is exempted from various compliance requirements like minimum corpus requirement, minimum capital commitment, minimum tenure requirement among others. A Liquidation Scheme cannot accept fresh commitments or make any new investments and can have a maximum tenure equal to or less than the Original Scheme’s tenure.
For opting either of the aforementioned options, the manager has to obtain the consent of at least seventy five per cent (75%) of the investors by value of their investments in the expired scheme (“Original Scheme”). If the manager is not successful in obtaining the consent of minimum 75% of the investors, then the unliquidated investments will be distributed to the investors in-specie. If an investor, however, is not interested in taking these units in-specie, then the investments will be written off.
Provision for dissenting investors
The investors who do not consent for the launching of Liquidation Scheme or in-specie distribution of the unliquidated investments, as the case may be, will be provided an exit option by arranging a bid for atleast twenty five per cent (25%) of the unliquidated investments. These bids shall be for units representing the consolidated value of each unliquidated investments in Original Scheme’s investment portfolio. The dissenting investors will be given an exit option out of the proceeds of these bids and in case the bid amount is higher than the value of the unliquidated investments of the dissenting investors, then the unsubscribed portion of the bids would be used to provide a pro-rata exit option to the consenting investors.
Swap of AIF Units
The Amendment envisages a swap of AIF units whereby the units of Liquidation Scheme shall be allotted to the Original Scheme in lieu of the unliquidated investments of the Original Scheme sold to the Liquidation Scheme. Subsequently, the Original Scheme will distribute the units of Liquidation Scheme that it holds in-specie in return of the units that it had previously issued to its investors and would eventually be wound up. The Original Scheme has to complete this swap and be wound up before the completion of the Liquidation Period.
Analysis of the Amendment
The Amendment attempts to provide a modality for carrying forward of unliquidated investments of a scheme even after the expiry of the tenure. This is categorically beneficial in cases where the investments are stuck in short-term litigations or unforseen temporary circumstances. The Amendment provides leeway to a manager to not undergo distressed sale of the unliquidated investments at a loss when there is a reasonable anticipation of an increase in the value of the investments in the near future. This Amendment tries to curb the evergreening of fund tenure which was considered as the elephant in the room contrary to the interest of the investors. Additionally, the launch of the Liquidation Scheme is expected to provide the true asset value and the true disclosure of the fund performance.
However, the Amendment is marred with certain interpretational and regulatory issues that are highlighted hereunder:
> Real problem remains unaddressed: The main rationale why a regulatory framework on unliquidated investments was sought from the SEBI was concerning the investments that do not have any buyers. The Amendment does not clear the manager’s agony of the treatment of investments that do not have any bidders / buyers in the interest of the investors. The Amendment only provides that a mandatory in-specie distribution of the investments will be done for such investments. However, such a compulsory distribution is not in the interest of investors who invest in anticipation of a reasonable return on their investments.
> Grey area on the purpose of bids: The Amendment prescribes that the dissenting investors will be provided an exit out of the proceeds of bids for a minimum twenty five per cent (25%) of the unliquidated investments. However, the Amendment does not specify whether these bids will be required even when there are no dissenting investors. That is to say, whether the purpose of bids is to only give an exit option to the dissenting investors or is a matter of procedure is yet unclear.
> Increased time and costs of AIF: The AIF will be required to pay an amount of one (01) lakh as scheme fees in order to launch the Liquidation Scheme. Furthermore, the operations and the compliance of the Liquidation Scheme shall further increase the costs of the fund which was already suffering because of lack of liquidity. Not only that, the launching of a Liquidation Scheme shall require a considerable amount of time and effort in order to draft the fund documents and comply with other ancillary legal requirements. These costs shall eventually be paid off by the investors thereby contradicting their own interests.
> Host of foreign exchange issues: The swap of AIF units for Liquidation Scheme and the in-specie distribution in case of a non-resident beneficiary will crop up a host of foreign exchange issues with regard to the fair market value, pricing guidelines, and sectoral caps among others. Such a swap may also require approval from the Reserve Bank of India in case the present foreign exchange regime does not allow it without approval.
> Lack of clarity on already expired schemes: The Amendment does not clarify whether the changes brought will be applicable even on the schemes which are already expired or about to expire. Such an unclarity leaves compliance at grey for the already expired schemes which are not wound up.
Concluding Remarks
The Amendment tries to bring a fundamental change in the treatment of unliquidated investments of an already expired scheme by carrying them forward to a new Liquidation Scheme which is dedicatedly launched for liquidating those investments. This Amendment, though, curbs the evergreening of fund tenure, however, is marred with lack of clarity on numerous accounts. The Amendment does not address the real problem of giving a solution to the agonised managers for those investments which do not have any buyer. Though the Liquidation Scheme allows for increased disclosure and better picture of the fund performance, it will, however, increase the time and costs of the fund which would eventually be a burden on the investors’ pocket. In such a scenario, what is evident is that the Amendment may bring a paradigm shift in the treatment of the unliquidated investments and the fund management and vocally calls for more clarity with regard to the misty areas.
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Authors: Parv Pancholi (4th Year student at National Law University Odisha), and Ishita Khandelwal (4th Year student at National Law University Odisha)
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