SEBI Relaxes Rules: AIFs Can Now Retain Liquidation Proceeds

The Securities and Exchange Board of India (SEBI) has introduced significant regulatory shifts to provide Alternative Investment Funds (AIFs) with greater operational flexibility during the winding-up process. By allowing funds to hold onto liquidation proceeds beyond their official lifespan, the regulator aims to address the complex realities of legal and operational liabilities.

Flexibility Amidst Litigation and Liabilities

Under the new guidelines, AIFs or their specific schemes are now permitted to retain liquidation proceeds even after the formal dissolution period has ended. This concession is specifically designed to cover three critical scenarios: managing litigation notices or regulatory demands, meeting anticipated liabilities, and covering residual winding-up expenses.

SEBI has broadened the definition of litigation-related communications to include notices from tax authorities, law enforcement, courts, or even investors and counterparties. Notably, funds can retain money even if these potential tax, legal, or regulatory liabilities have not yet crystallized. If a fund manager intends to hold funds against anticipated liabilities, they must obtain consent from at least 75% of investors by value and must clearly disclose the proposed amount and the estimated duration of retention.

Managing Residual Expenses and the Three-Year Cap

For AIFs that need to retain capital to cover residual operational expenses related to the winding-up process, SEBI has set a strict temporal boundary. The retention period for these expenses cannot exceed three years from the end of the fund's permissible life.

To ensure transparency and standardized practices, the regulator has tasked the Standard Setting Forum for AIFs (SFA) to work alongside SEBI to formulate specific implementation standards for what qualifies as an eligible operational expense head.

Introduction of the 'Inoperative Fund' Framework

A major highlight of this circular is the introduction of the 'Inoperative Fund' status. This status is designed for AIFs that have successfully liquidated all their investments but must remain registered because they are holding retained proceeds or are awaiting the outcome of ongoing litigation.

Once a fund transitions to 'Inoperative' status, it faces strict limitations to protect investor interests:

To maintain oversight, SEBI has mandated that both AIFs retaining funds and those classified as 'Inoperative' must file annual reports detailing retained monies and outstanding liabilities within 30 days of the end of each financial year.

Key Takeaways