NISM-Series-XIX-E Alternative Investment Fund Managers: Chapter 13 – Fund Monitoring, Reporting and Exit (Part 4 of 4)

The final phase of an Alternative Investment Fund (AIF) or scheme’s lifecycle involves its winding up, liquidating its assets, and distributing the proceeds to investors. Given the illiquid nature of Category III AIF holdings (such as Pre-IPO shares or structured debt), SEBI has established a highly structured winding-up, liquidation, and dissolution framework. This framework protects investor interests, ensures orderly asset disposition, and prevents the "evergreening" of bad assets.

This study guide (Part 4 of 4) covers the statutory grounds for winding up, the 1-year liquidation period, the regulatory details of Liquidation Schemes, mandatory in-specie distributions, and the SEBI Dissolution Period regulations.

1. Winding Up of an Alternative Investment Fund (Section 13.5)

Winding up is the formal legal process of closing down an AIF scheme, selling its investments, satisfying liabilities, and returning capital to the unit holders.

1.1 Statutory Grounds for Winding Up (Regulation 29)

Under Regulation 29 of the SEBI (Alternative Investment Funds) Regulations, 2012, a close-ended AIF or scheme must be wound up and dissolved under any of the following four conditions:

1. Tenure Expiry: When the registered tenure of the AIF or scheme (including any approved extensions) as disclosed in the Private Placement Memorandum (PPM) is complete.
2. Trustee Opinion: If the Trustees or the Trustee Company determine that the scheme must be wound up in the absolute interest of the unit holders.
3. Investor Resolution: If not less than 75% of the investors by value of their total investment in the AIF pass a formal resolution in a meeting of unit holders to wind up the fund.
4. SEBI Directive: If SEBI issues a direct order to wind up the fund or scheme in the interest of investors or the wider securities market.

1.2 Structural Differences in Winding Up Procedures

The specific legal framework for executing a winding-up depends on the legal constitution of the AIF:

• Trust Structure: Governed by the provisions of the Indian Trusts Act, 1882.
• Company Structure: Must be wound up in accordance with the Companies Act, 2013.
• Limited Liability Partnership (LLP) Structure: Must be wound up in accordance with the Limited Liability Partnership Act, 2008.
• Body Corporate Structure: Must be wound up under the specific statute under which the entity was originally constituted.

1.3 Operational Restrictions Post-Intimation

When winding up is triggered:

• Immediate Intimation: The Trustees, Board of Directors, or Designated Partners of the AIF must immediately intimate SEBI and all investors of the circumstances leading to the winding up.
• Investment Freeze: On and from the date of such intimation, the AIF is prohibited from making any fresh investments on behalf of the fund or scheme.
• No Fee Accrual for New Sourcing: Since active investment ceases, the manager's role shifts strictly to liquidation and distribution.

2. The Liquidation Period and Asset Realisation

Once the winding-up process is initiated, the fund enters a strict, time-bound phase to realise cash from its holdings.

2.1 Timeline and Definition

The Liquidation Period is a mandatory 1-year window following the expiry of the tenure (or extended tenure) of the AIF scheme.

• Primary Objective: During this 1-year period, the Investment Manager must fully sell all the assets of the scheme, settle all outstanding liabilities, and distribute the remaining cash proceeds to the unit holders.
• Extension Bar: No extension is permitted on this 1-year liquidation timeline.

2.2 In-Specie Distribution Options

If the AIF scheme is unable to sell certain assets due to lack of market liquidity during the 1-year winding-up process, the manager can make an in-specie distribution. This means the physical unliquidated securities are distributed directly to the investors' demat accounts instead of cash.

• Investor Approval: In-specie distribution generally requires the approval of at least 75% of the investors by value of their investment in the AIF scheme.
• PPM Alignment: The process must align with the terms explicitly disclosed in the fund's PPM, Contribution Agreement, or Subscription Agreement.

3. The Liquidation Scheme Framework (Section 13.6)

To manage highly illiquid assets without forcing distressed fire-sales, SEBI historically permitted AIFs to use a structured Liquidation Scheme.

3.1 Structural Features of a Liquidation Scheme

• Definition: A Liquidation Scheme is a separate, close-ended AIF scheme launched solely for the purpose of housing and liquidating the unliquidated investments of an expired "Original Scheme".
• Naming Convention: The scheme must explicitly contain the words "Liquidation Scheme" in its name.
• Operational Restrictions:
  • The Liquidation Scheme is prohibited from accepting any fresh commitments or capital from any investors.
  • It is prohibited from making any new investments in any portfolio companies.
  • Its tenure is strictly determined at the time of filing its PPM with SEBI and is not available for any extension.
  • It does not receive a separate "Liquidation Period" of its own.
• PPM Filing Concession: Liquidation Schemes are exempt from the requirement of obtaining SEBI's formal comments on their PPM, allowing for speedier launches.

3.2 The 25% Mandatory Bid Arrangement

To prevent managers from dumping valueless assets into a Liquidation Scheme to hide poor performance metrics, SEBI instituted a mandatory bidding check:

• The Rule: The AIF or its Investment Manager is legally required to arrange an independent, binding bid for a minimum of 25% of the total value of the unliquidated investments from the Original Scheme.
• Consolidated Valuation: Bids must be arranged for units representing the consolidated value of each unliquidated investment in the portfolio.
• Valuation Disclosure: The valuations of the unliquidated investments, conducted by two independent Registered Valuers, along with the arranged Bid Values, must be fully disclosed to all investors.

3.3 Pricing and Valuation Rules on Transfer

When unliquidated investments are transferred from the Original Scheme to the newly launched Liquidation Scheme, the allotment value is determined as follows:

\[\text{Allotment Value} = \text{Bid Value (if 25% Bid is Successfully Arranged)}\]

\[\text{Allotment Value} = \text{One Rupee (if 25% Bid Arrangement Fails)}\]

The "One Rupee" valuation rule serves as a severe penalty for the Investment Manager, as it writes down their performance track record reported to Performance Benchmarking Agencies.

3.4 Exits for Dissenting Investors

Unit holders in the Original Scheme who do not wish to transition into the Liquidation Scheme are classified as dissenting investors:

• The Exit Option: Dissenting investors must be offered an option to fully exit the Original Scheme.
• Funding the Exit: Their exit is funded directly out of the 25% bid arranged by the AIF Manager.
• Unsubscribed Portion: After dissenting investors are paid out, any remaining, unsubscribed portion of the 25% bid is distributed on a pro-rata basis to non-dissenting investors.
• Related Party Bar: If the bidder or their related parties are existing investors in the Original Scheme, they are prohibited from using the bid to exit the scheme.

3.5 Post-April 2024 SEBI Restriction on Liquidation Schemes

While the Liquidation Scheme framework remains a key theoretical and historical element of the AIF regulations, SEBI introduced a major update:

• The Mandate: No AIF shall launch any new Liquidation Schemes post April 25, 2024.
• Alternative Route: For funds winding up after this date, the primary routes for managing unliquidated assets are direct In-Specie Distribution or entering the Dissolution Period.

4. Mandatory In-Specie Distribution on Consent Failure (Section 13.6.3)

If a fund manager cannot obtain the required approvals for a structured exit, SEBI enforces an automatic, non-consensual wrap-up mechanism.

4.1 Automatic Grounding without Consent

If an AIF scheme fails to obtain the requisite 75% investor consent by value for either launching a Liquidation Scheme or executing a standard in-specie distribution of unliquidated assets, the manager cannot let the assets hang in limbo.

• The Rule: The unliquidated investments must be mandatorily distributed to the investors in-specie, without obtaining the consent of 75% of the investors.
• The Penalty Valuation: This mandatory, non-consensual in-specie distribution is executed at a value of One Rupee.
• Benchmarking Impact: This write-down is recorded in the manager's performance track record reported to Performance Benchmarking Agencies, severely impacting their market reputation.
• Investor Write-Off: If any individual investor is unwilling to accept their portion of the in-specie securities at this nominal One Rupee valuation, the investment is written off entirely by that investor.

5. The Dissolution Period Regulation (Section 13.7)

The Dissolution Period is a regulated alternative that allows an AIF scheme to remain in existence for the sole purpose of liquidating its remaining assets, without requiring the launch of a new, separate Liquidation Scheme.

5.1 Structural Entry Requirements

• Definition: The Dissolution Period is the period following the expiry of the 1-year liquidation period of the scheme, specifically designed to wind down the unliquidated investments of the AIF.
• Consent Threshold: Entering a Dissolution Period requires the formal written consent of at least 75% of the investors by value of their investment in the AIF scheme.
• Filing Document: The scheme must file an Information Memorandum along with a formal Due Diligence Certificate issued by a SEBI-registered Merchant Banker with SEBI.
• Timing of Filing: This filing must be completed before the expiry of the 1-year liquidation period or any approved extension of the liquidation period.

5.2 Disclosures and Valuation Transparency

Prior to seeking investor consent to enter a Dissolution Period, the Investment Manager must provide comprehensive disclosures to all unit holders:

• The proposed tenure of the Dissolution Period.
• Granular details of the remaining unliquidated investments.
• The value recognition of the unliquidated investments for reporting to Performance Benchmarking Agencies.
• An indicative range of bid values along with independent valuations of the unliquidated investments carried out by two independent Registered Valuers.

5.3 Operational Conditions and Timeline Caps

• Tenure Cap: The dissolution period of an AIF scheme cannot exceed the original tenure of the scheme and cannot be extended in any manner upon expiry.
• Investment Bar: The scheme is prohibited from accepting any fresh capital or commitments from any investors.
• Trading Bar: The scheme is prohibited from making any new investments during the Dissolution Period.
• Compliance Reporting: Upon completing the asset sales and distributing the final cash, the Investment Manager must submit a formal compliance report to SEBI on the SEBI Intermediaries Portal.

6. Key Takeaways

• 75% Winding Up Threshold: An AIF can be wound up early by investors if at least 75% of unit holders by value pass a resolution.
• Immediate Investment Freeze: The moment winding-up intimation is sent to SEBI and investors, the AIF is prohibited from making any fresh investments.
• The 1-Year Liquidation Rule: After tenure expiry, AIFs have a strict 1-year liquidation period to sell assets and pay off liabilities.
• The Penalty "One Rupee" Rule: If an AIF fails to get 75% consent for an orderly wind-down, unliquidated assets are mandatorily distributed in-specie at a nominal value of One Rupee, severely writing down the manager's performance metrics.
• Liquidation Scheme Ban: SEBI has prohibited the launch of any new Liquidation Schemes post April 25, 2024, leaving direct In-Specie Distribution and the Dissolution Period as the primary wind-down routes.
• No Extensions on Dissolution: The Dissolution Period cannot exceed the scheme's original tenure and cannot be extended under any circumstances.

7. Important Terms & Definitions

• Regulation 29 (SEBI AIF Regulations): The specific statutory clause defining the conditions under which an AIF or its schemes must be wound up and dissolved.
• Liquidation Period: A strict 1-year window post-tenure expiry during which the Investment Manager must liquidate all scheme assets and pay off liabilities.
• Liquidation Scheme: A dedicated close-ended scheme launched solely to hold and gradually liquidate unliquidated assets transferred from an expired original scheme.
• Dissenting Investor: An investor in the original scheme who votes against a proposed liquidation transfer and is entitled to exit via cash proceeds from a mandatory 25% bid.
• In-Specie Distribution: The physical distribution of unliquidated portfolio securities (instead of cash) directly to the demat accounts of the fund's investors.
• Dissolution Period: A regulated period post-liquidation window during which an AIF scheme remains in existence to liquidate its remaining assets without launching a separate Liquidation Scheme.

8. Key Statutory Thresholds and Valuation Formulas (Simple Line Format)

• Investor Consent for Winding Up: Investor Consent for Winding Up = (Value of Consenting Units / Total Outstanding Scheme Units) >= 75%

• Transfer Value of Unliquidated Portfolio with Bids: Transfer Value to Liquidation Scheme = Bid Value (if Minimum 25% Bid is Arranged)

• Penalty Transfer Value without Bids: Transfer Value to Liquidation Scheme = INR 1 (if Minimum 25% Bid is NOT Arranged)

• Investor Consent for Dissolution Period: Investor Approval for Dissolution Period = (Value of Approving Units / Total Outstanding Scheme Units) >= 75%

• Dissolution Period Maximum Duration: Maximum Dissolution Period = Original Tenure of the Scheme