Pro-rata and pari-passu rights of investors of AIFs
Summary
This circular amends the AIF Regulations to mandate pro-rata and pari-passu rights for investors in Alternative Investment Funds. It outlines specific exemptions for pro-rata rights regarding defaults, carried interest, and certain institutional investors. Additionally, it establishes a framework for offering differential pari-passu rights through implementation standards formulated by the Standard Setting Forum for AIFs.
Text
The investors of a scheme of an Alternative Investment Fund shall have rights, pro-rata to their commitment to the scheme, in each investment of the scheme and in the distribution of proceeds of such investment, except as may be specified by the Board from time to time: Provided that the rights of the investors of a scheme of Alternative Investment Fund issued prior to the notification of the Securities and Exchange Board of India (Alternative Investment Funds) (Fifth Amendment) Regulations, 2024, which are not pro-rata to their commitment to the scheme and not exempted by the Board, shall be dealt with in the manner specified by the Board.
In this regard, it is specified that the requirement of maintaining investors’ rights pro-rata to their commitment to the scheme, shall not be applicable in an investment of a scheme and distribution of proceeds of the investment to the extent – 3.1. an investor has been excused or excluded from participating in the said investment; or, 3.2. an investor has defaulted on providing his/her pro-rata contribution for the said investment.
Further, the requirement of maintaining pro-rata rights of investors in distribution of proceeds of investments of a scheme, shall not be applicable to the extent returns or profit on the investments is shared by an investor with the manager or sponsor of the AIF (by whatever name it is called, such as carried interest/additional return), in terms of contribution agreement executed between them.
Additionally, to provide flexibility in fund raising from investors with varied risk appetite, the following entities may accept returns lesser or share losses more than their pro-rata rights in investments of an AIF/scheme of an AIF, i.e., may subscribe to classes of units which are junior/subordinate to other class(es) of units of the AIF/scheme of AIF - a. Manager or sponsor of the AIF; b. Multilateral or Bilateral Development Financial Institutions; c. State Industrial Development Corporations; d. Entities established or owned or controlled by the Central Government or a State Government or the Government of a foreign country, including Central Banks and Sovereign Wealth Funds.
In case manager or sponsor of an AIF subscribes to junior / subordinate class(es) of units of the AIF/scheme of the AIF, it shall be ensured that the amount invested by the AIF/scheme of the AIF is not utilized by an investee company, directly or indirectly, to repay any of its obligations or liabilities towards the manager or sponsor of the AIF or their associates.
Accordingly, it is hereby specified that existing AIFs/schemes of AIFs that have adopted priority distribution model and not falling under the exemption at para 5 above, shall neither accept any fresh commitment nor make investment in a new investee company, directly or indirectly.
As a consequence of compliance with the clause at para 9 above or the SEBI circular dated November 23, 2022 as mentioned in para 7 above, if the investment limits specified under AIF Regulations are breached by any AIF/scheme of AIF, such breach may not be considered as non-compliance with applicable provisions of AIF Regulations or circulars issued thereunder, to that extent. However, the same shall be recorded in writing in the ‘Compliance Test Report’ prepared by the manager in terms of Chapter 15 of SEBI Master Circular for AIFs dated May 07, 2024.
Regulation 20(22) of AIF Regulations states as under – “The rights of investors of a scheme of an Alternative Investment Fund, other than that specified in sub-regulation (21) of this regulation, shall be pari- passu in all aspects: Provided that differential rights may be offered to select investors of a scheme of an Alternative Investment Fund, in the manner as may be specified by the Board, without affecting the interest of other investors of the scheme: Provided further that the requirement under sub-regulation (22) of this regulation shall not apply to Large Value Fund for Accredited Investors: Provided further that any differential right already issued by an Alternative Investment Fund prior to the notification of the Securities and Exchange Board of India (Alternative Investment Funds) (Fifth Amendment) Regulations, 2024, not falling within the first proviso of sub-regulation (22) of this regulation, shall be dealt with in the manner as specified by the Board.”
Accordingly, in terms of first proviso to Regulation 20(22) of AIF Regulations, it is specified that differential rights may be offered by AIFs to select investors without affecting the rights of other investors, based on the following guiding principles: 12.1. Any such right shall not result in any investor bearing liability accrued or accruing to other investors of the AIF/scheme of AIF; 12.2. Any such right with respect to non-monetary / non-commercial terms shall not provide control to an investor on the decision making of the AIF/scheme of AIF, except in cases where investor/its nominee is part of any committee set up in terms of Regulation 20 (7) of AIF Regulations; 12.3. Any such right shall not alter the right(s) available to other investors under their respective agreements with the AIF/manager; and, 12.4. Any such right and eligibility to avail the same shall be transparently disclosed in the PPM of the AIF/scheme of the AIF.
In this regard, it has been decided that the Standard Setting Forum for AIFs (‘SFA’) shall, in consultation with SEBI, formulate the implementation standards for compliance with the aforesaid provision, prescribing the positive list of specific differential rights that may be offered by AIFs. Such list may be reviewed and updated by SFA, whenever necessary, in consultation with SEBI.
The implementation standards formulated by SFA shall be published on the websites of the industry associations which are part of SFA, i.e., Indian Venture and Alternate Capital Association (IVCA), PE VC CFO Association and Trustee Association of India, on or before January 15, 2025.
AIFs, Managers of AIFs and their Key Management Personnel shall ensure the following while issuing differential rights to select investors – 15.1. The differential rights shall be provided only in accordance with the implementation standards formulated by SFA. 15.2. The following shall be disclosed in the PPM - (a) Eligibility criteria for an investor to avail each differential right; and, (b) Any investor meeting the specified eligibility criteria for a differential right may opt to avail such right.
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Source: SecMarx — Pro-rata and pari-passu rights of investors of AIFs. Verbatim text is public record; SecMarx structuring (linkage to applying orders) is cited to us.