On April 25, 2024, the Securities and Exchange Board of India (“SEBI”) notified certain significant amendments to the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”).

These amendments, read with a circular issued by SEBI on April 26, 2024, are meant to, inter alia, provide flexibility to alternative investment funds (“AIFs”) and their investors to deal with unliquidated investments of their schemes by: (a) permitting AIFs to enter into a dissolution period (subject to conditions); and (b) prohibiting AIFs from launching new liquidation schemes from the date of notification of the amendments i.e., April 25, 2024.

As a result of these amendments, during the ‘liquidation period’, an AIF can distribute investments of a scheme which are unsold due to lack of liquidity, in-specie to the investors, or enter into dissolution period, after obtaining approval of at least 75% of the investors by value of their investment in the AIF scheme. The existing framework of launching liquidation schemes which would acquire the unliquidated investments of the AIF scheme whose tenure was expiring, will no longer be available.

Conditions prescribed by SEBI for availing this flexibility are:

• the AIF/manager being required to arrange bids for a minimum of 25% of the value of unliquidated investments of the scheme, to provide an exit option to the dissenting investors, before seeking investors’ consent;
• specified disclosures by the AIF to investors before seeking their consent;
• the AIF/manager being required to intimate SEBI about obtaining the investors’ consent and the investors’ decision to enter into a dissolution period, prior to expiry of the liquidation period;
• in case the AIF/manager is able to arrange bid for a minimum of 25% of the value of unliquidated investments of the scheme, the dissenting investors need to be offered an option to exit through the arranged bids. After exercise of the exit option by dissenting investors, if any portion of the bid is left unsubscribed, such portion can be used to provide pro-rata exit to the non-dissenting investors, in case they choose to do so;
• however, if the AIF/manager fails to arrange bid for a minimum of 25% of the value of unliquidated investments of the scheme, the AIF can still opt for dissolution period provided approval of at least 75% of the investors by value of their investment in the AIF scheme is obtained; and
• restriction on providing exit to an investor which is the bidder or a related party of the bidder, out of the arranged bids.

Importantly, the dissolution period of an AIF scheme cannot be more than the original tenure of the AIF scheme and is further non-extendable. Further, the AIF scheme cannot accept any fresh commitment from any investor and cannot make any new investment during the dissolution period.

Mandatory in-specie distribution has also been prescribed if during the liquidation period, the requisite investor consent is not obtained for: (a) entering into dissolution period; or (b) in-specie distribution. In case any investor is not willing to take in-specie distribution, such investment is to be written off.

As a measure of providing one-time flexibility to certain AIFs, the SEBI has allowed extension of liquidation period till April 24, 2025, in cases where the liquidation period for an AIF scheme has expired or is expiring by July 24, 2024, and if such AIF scheme does not have any pending investor complaint on non-receipt of funds/securities as on April 25, 2024. On the other hand, if an AIF scheme has pending investor complaints on non-receipt of funds/securities as on April 25, 2024, it can avail the additional liquidation period upon resolution of the investor complaint(s), from the date of resolution of the complaint till April 24, 2025.

Amongst other amendments, SEBI has imposed a general obligation on the AIFs, their managers and key management personnel of such managers and the AIFs to exercise specific due diligence, with respect to their investors and investments, to prevent facilitation of circumvention of the laws. This amendment is in line with the consultation paper issued by the SEBI in January 2024, whereby the SEBI had inter alia observed that since classification of indirect foreign investment in case of investment vehicles (including AIFs) was based on domicile of ownership and control of manager/sponsor of the AIF under the Indian foreign exchange control laws, AIFs were being set up with domestic managers/sponsors to contravene the Indian foreign exchange control laws, such as, to invest: (a) in sectors prohibited for foreign investment; (b) beyond the permissible sectoral limits; and (c) in debt/debt securities, by-passing the foreign portfolio investment (FPI)/external commercial borrowing (ECB) route.

Additionally, SEBI has permitted (subject to conditions) Category I and Category II AIFs to create encumbrance on equity of investee company, which are in the business of development, operation or management of projects in the infrastructure sub-sectors listed in the Harmonised Master List of Infrastructure issued by the Central Government, only for the purpose of borrowing by such investee company. Notably, encumbrance cannot be created on the investments in foreign investee companies.

Significantly, SEBI has specified that Category I or Category II AIFs with more than 50% foreign investment or with foreign sponsor/manager or with persons other than resident Indian citizens as external members in its investment committee which is set up to approve its decisions, need to comply with the requirements under Indian exchange control regulations with respect to pledge of shares of Indian investee companies by non-residents, effectively taking the position, in this context, that such AIFs are persons resident outside India. It will be important to see what further changes in the regulations (including in the exchange control regulations) are brought about in future to emphasize this position.