SEBI Reforms: AIFs Can Now Retain Liquidation Proceeds Post-Fund Life

The Securities and Exchange Board of India (SEBI) has introduced significant regulatory flexibility for Alternative Investment Funds (AIFs), allowing them to hold onto liquidation proceeds even after their official fund life has ended. This strategic move aims to provide a structured way for funds to manage unforeseen liabilities and operational costs during the winding-up process.

New Flexibility for Managing Residual Liabilities

Under the revised SEBI (Alternative Investment Funds) Regulations, AIFs or their individual schemes can now retain liquidation proceeds beyond the standard dissolution period under specific conditions. This is particularly crucial for funds facing legal or regulatory uncertainty.

According to the new guidelines, funds may retain money if they have received litigation notices or regulatory demands from tax authorities, law enforcement, or courts—even if these liabilities have not yet crystallized. Additionally, funds can retain capital to meet anticipated liabilities if they secure consent from at least 75 per cent of investors by value. In such cases, fund managers are strictly required to disclose the specific amount to be retained and the estimated duration of this retention to the investors.

The 'Inoperative Fund' Framework and Operational Expenses

To streamline the exit process, SEBI has introduced a new 'Inoperative Fund' status. This status is designed for AIFs that have already liquidated all their investments but must continue to hold retained proceeds or remain registered while pending the outcome of litigation.

For funds needing to cover residual winding-up operational expenses, SEBI has set a clear ceiling: the retention period cannot exceed three years from the end of the permissible fund life. To ensure consistency, the Standard Setting Forum for AIFs (SFA) will work with SEBI to formulate implementation standards for which specific operational expense heads are eligible for such retention.

Compliance and Restrictions for Inoperative Funds

While the new framework offers relief, it comes with stringent prohibitions to protect investor interests. Once a fund is classified as 'Inoperative,' it is strictly prohibited from making any new investments, launching new schemes, or charging management fees. Any retained monies must be kept in instruments permitted under existing AIF Regulations.

To reduce the administrative burden on these closing entities, SEBI has exempted Inoperative Funds from several reporting requirements, including:

However, accountability remains high. AIFs and Inoperative Funds must file an annual report detailing retained money and outstanding liabilities with both SEBI and their investors within 30 days of the end of each financial year. This framework is effective immediately and extends to Venture Capital Funds registered under the 1996 regulations.

Key Takeaways