New Delhi, June 19 -- The Securities and Exchange Board of India has allowed private equity, venture capital and other alternative investment funds (AIFs) that are looking to wind up to retain a part of their proceeds to meet any future litigation or tax demands.
The capital markets regulator has allowed this option even to venture capital funds that were regulated under the now-repealed Venture Capital Funds Regulations, 1996.
In a circular issued on June 16, the regulator said that such funds can apply for an "Inoperative Fund" and can apply to surrender their registration after all the liabilities and demands have been satisfied and any pending litigation has been resolved, and after the remaining money has been distributed to the investors.
The funds and lawyers who routinely advise them have largely welcomed this move by the regulator, but they also voiced an operational concern relating to securing investor consent. SEBI officials told VCCircle that the regulator is already working with the industry to address this concern.
Siddharth Pai, co-chair of the regulatory affairs committee at the Indian Venture and Alternate Capital Association (IVCA), said the guidelines "provide much needed regulatory clarity on winding up AIFs and on inoperative funds".
"A persistent issue faced by the industry is related to the status of a fund with no investments, but ongoing litigation," said Pai, who is also managing partner at VC firm 3one4 Capital.
Pratibha Jain, chairperson of the IVCA's regulatory affairs committee, said: "The framework provides much-needed flexibility and reduces the need to keep schemes alive solely because of unresolved obligations."
Jayesh H, co-founder at law firm Juris Corp, termed it "a significant step forward" and Anita Jain, founding partner at Aequitas Law Partners, said it rightly addresses a regulatory gap that had otherwise left general partners (GPs) in a "prolonged state of uncertainty, with investors waiting for closure".
The IVCA's Pai added that the industry sees this as a first step. "The interactions with SEBI have been positive and the industry hopes that any operational burdens during this period would be closely examined," he said.
New process, conditions
To initiate this new winding-up process, a fund will need to meet certain conditions.
It will have to submit the relevant documents such as a written communication from a regulatory or tax authority, a law enforcement agency, court of law, or an investor or counterparty in a litigation.
The regulator has expanded the list of eligible documents from what it had suggested in its consultation paper issued this February. In the final guidelines, the regulator has not just included the final demand notices but also the showcause notices, reassessment notices, investigation summons or similar communications.
The guidelines say that if the funds are being retained for meeting operating expenses, then the application should substantiate the demand with invoices or records of comparable expenses from previous years.
The funds will also need to get the consent of 75% of the investors by value of their investment in the scheme.
This last condition may prove challenging for GPs, according to lawyers.
Juris Corp's Jayesh said: "Unlike company law frameworks where voting thresholds apply to those present and voting, this requirement operates on the entire investor base, effectively treating non-participation as resistance. This makes the process inherently more rigid."
The IVCA's Pai said that 75% consent is in line with the threshold for other AIF matters as well, so it is not a key concern. But the industry has found securing that consent is not easy.
Pai said: "An issue faced by the industry has been to reach 75% when investors do not vote on such matters, an issue that has been highlighted to SEBI. We hope that this will be resolved in the near future."
Aequitas' Jain offers a slightly different opinion. She said: "If trust and confidence are built through transparent disclosures and periodical status updates during the life of the fund, securing 75% investor consent becomes a smoother, collaborative exercise rather than a procedural hurdle."
Exit complexities
According to Jayesh, funds will continue to face a fundamental challenge while winding up and this too is linked to securing investor consent. Therefore, the impact of SEBI's latest guidelines "may remain somewhat limited", he said.
"The reform primarily addresses post-exit complexities rather than the more fundamental challenge of exit feasibility itself particularly in India, where AIF portfolios are not always parked only in readily realizable assets," he said.
While SEBI allowed AIFs to enter into dissolution period to deal with unliquidated investments, Jayesh pointed out that this is procedurally difficult primarily on account of getting the necessary investor consent.
"Funds may need to prosecute investee companies to get their repayments and that could take a few years to resolve. But to do so, they need to enter the dissolution period and for that they need to obtain investor consent, which can be challenging. Therefore, funds may choose to liquidate their assets at a lower value to wind up the fund within set deadlines of the liquidation or dissolution period."
The IVCA's Jain also raised the problem of dealing with residual assets that cannot be exited immediately.
"Globally, mature fund jurisdictions often use a combination of contractual flexibility and structures to allow such assets to be moved to a standalone special purpose vehicle in which investors maintain a right. A similar evolution in India could help address these challenges and achieve more efficient fund closures without compromising investor protection," she said.
Published by HT Digital Content Services with permission from VC Circle.