SEBI Overhauls AIF Rules to Allow Retention of Liquidation Proceeds

In a significant move to enhance operational flexibility, market regulator SEBI has introduced new guidelines allowing Alternative Investment Funds (AIFs) to hold onto liquidation proceeds even after their official fund life has ended. This regulatory shift addresses the practical complexities faced by fund managers during the winding-up process and the settlement of unforeseen liabilities.

Flexibility Amidst Litigation and Residual Liabilities

Under the newly amended SEBI (Alternative Investment Funds) Regulations, AIFs or their specific schemes can now retain funds beyond the mandatory dissolution period under three specific conditions. First, if the fund has received litigation notices or regulatory demands—including notices from tax authorities, law enforcement, or courts—even if the liabilities have not yet crystallized.

Second, fund managers can retain money to meet anticipated liabilities if they secure consent from at least 75 per cent of investors by value. In such cases, managers must explicitly disclose the amount to be held and the estimated duration of retention. Lastly, funds may retain proceeds to cover residual operational expenses related to the winding-up process, though this retention period is strictly capped at three years from the end of the fund's permissible life.

The Introduction of the 'Inoperative Fund' Framework

To streamline the management of wound-up funds that still have outstanding obligations, SEBI has introduced a new 'Inoperative Fund' status. This category is designed for AIFs that have successfully liquidated all their investments but must remain registered due to ongoing litigation or the need to hold retained proceeds.

An AIF intending to surrender its registration while still holding such monies can apply for this status. To prevent misuse, SEBI has imposed strict limitations on Inoperative Funds: they are prohibited from making any new investments, launching new schemes, or charging management fees. Any retained money held by these funds can only be invested in instruments that are specifically permitted under the existing AIF Regulations.

Regulatory Relief and Compliance Mandates

While the 'Inoperative Fund' status provides relief, it also brings a reduction in the administrative burden. SEBI has exempted these funds from several heavy compliance requirements, such as quarterly and annual activity reports, performance benchmarking disclosures, and certain audit requirements for Private Placement Memorandum (PPM) terms.

However, transparency remains a priority. SEBI has mandated that all AIFs retaining funds, as well as those classified as Inoperative Funds, must file an annual report regarding retained money and outstanding liabilities. This report must be submitted to both SEBI and the investors within 30 days of the end of each financial year. Notably, these new rules also extend to Venture Capital Funds registered under the older 1996 regulations.

Key Takeaways