CHAPTER 9: LEGAL DOCUMENTATION AND NEGOTIATION – INVESTOR PERSPECTIVE (PART 4 OF 4)

9.6 SUPPORT SERVICES AGREEMENTS

Apart from the primary constitutional and contractual documents, an Alternative Investment Fund (AIF) relies on a web of support services to manage its day-to-day administration, reporting, and operational compliance. These services are outsourced to specialised intermediaries and are contractually bound by Support Services Agreements.

The main intermediaries include Merchant Bankers, Custodians, and Investment Advisors, alongside legal counsels, auditors, fund accountants, tax consultants, and valuation experts.

9.6.1 Agreement with the Merchant Banker

The appointment of a registered Merchant Banker is a critical regulatory and operational requirement for launching any standard AIF scheme. This relationship is governed by a formal Merchant Banker Agreement.

1. Fiduciary and Contractual Covenants

The agreement contains mutual covenants designed to ensure regulatory compliance and divide operational responsibilities:

• AIF Covenants: The fund's sponsor or manager covenants to provide the Merchant Banker with all necessary information, records, and documents regarding the AIF and the underlying investee companies. This ensures that the Merchant Banker can perform its due diligence effectively.
• Merchant Banker Covenants: The Merchant Banker covenants to perform its duties, conduct a comprehensive review of the PPM disclosures, and file the required due diligence certificate with SEBI in a time-bound manner.

2. Structural and Commercial Safeguards

• Arm’s Length Distance: The contract must stipulate clear operational provisions to guarantee that the Merchant Banker operates at absolute arm’s length from the AIF sponsor, manager, and associate entities to prevent conflicts of interest.
• Manager's Safeguards: The AIF manager must protect the fund's reputation by appointing a Merchant Banker with strong credentials, a clean track record, and extensive experience in AIF regulations and Private Placement Memorandums (PPMs).
• Commercial and Scope Boundaries: The agreement specifies the exact commercial terms (fees and expenses), scope of work, due diligence processes, and timelines for submitting regulatory filings. It also includes representations and warranties from the Merchant Banker regarding its regulatory registration and capabilities.

9.6.2 Agreement with the Custodian

Due to the strict safekeeping and compliance monitoring requirements under SEBI regulations, the Custodian Agreement is one of the most critical operational contracts in an AIF’s ecosystem.

1. Mandatory Appointment and Timing

The Sponsor or Investment Manager is mandated to appoint a registered Custodian to secure and track the assets of the fund.

• Critical Timing Rule: The Custodian Agreement must be fully executed, and the Custodian formally appointed, prior to the date of the scheme's first portfolio investment.

2. Scope of Custodial Services

The agreement is a legally binding contract that defines the custodian's role, which typically includes:

• Safekeeping of the AIF's physical and dematerialized securities.
• Compliance tracking, cash flow monitoring, back-office administration, and reporting as specified by SEBI.
• Execution of settlement transactions, corporate actions tracking (such as dividends and bonus issues), and Net Asset Value (NAV) computation assistance.

3. Independence and Commercial Terms

• Independence Rule: SEBI regulations mandate that the Custodian cannot be a related party of the Sponsor or the Investment Manager, unless highly specific exemption conditions are satisfied.
• Contractual Specifics: The agreement explicitly outlines the mutual obligations, liability limits, service level agreements (SLAs), and commercial terms (custody fees, transaction charges) of the engagement.

9.6.3 Agreement with the Investment Advisor

In complex cross-border or offshore fund structures, the offshore fund’s board of directors or investment manager often requires localized expertise to navigate the Indian market. They execute an Investment Advisory Agreement to onboard a local Investment Advisor.

• Delegation of Power: The offshore investment manager delegates deal-scouting, assessment, and execution advice to the local advisor while remaining directly responsible to the offshore investors.
• Scope of Advisory Services: The local Investment Advisor provides critical on-site support in sourcing deals, conducting local commercial due diligence, executing transactions, and managing portfolio companies post-investment.
• Structure Variations: Depending on the complexity of the fund’s investment strategy, the setup may involve an offshore advisor coupled with an on-shore sub-advisor to ensure complete regulatory and operational coverage.
• Agreement Boundaries: The contract defines the investment advisory fees, the advisory team's bandwidth commitments, and the precise process for delivering non-binding investment recommendations to the offshore manager.

9.7 THE SEBI INVESTOR CHARTER FOR AIFs

To institutionalise transparency, protect investor interests, and establish uniform standards of conduct, SEBI introduced the Investor Charter for Alternative Investment Funds. AIF managers are required to disclose this Charter to facilitate informed decision-making among prospective and existing unit holders.

9.7.1 Vision and Mission of the AIF Industry

• Vision Statement: To develop the Alternative Investment Fund (AIF) industry on professional and ethical lines and maintain high standards of governance and transparency.
• Mission Statement:
  • Maintain high professional and ethical standards within the AIF industry.
  • Comply with all applicable regulations and co-operate with the regulators in all aspects of the AIF activity.
  • Act in a fiduciary capacity towards the investors.

9.7.2 Core Business Transacted with Investors

The Investor Charter defines the three primary activities an AIF organization transacts with its investors:

1. Capital Mobilization: Raising investment capital from domestic and global investors.
2. Investment Operations: Deploying the pooled capital into portfolio companies in accordance with the stated investment strategy to generate positive returns.
3. Distribution of Proceeds: Orderly distribution of realized returns back to the investors as per the fund’s waterfall terms.

9.7.3 Categories of Services Provided to Investors

1. On-boarding Services: Sharing the PPM and constitutional deeds, facilitating KYC registration with KRAs, and executing the contribution agreement.
2. Obtaining Consent for Structural Changes: Actively seeking investor consent for major changes, including changes in the Sponsor/Manager, changes in control, PPM amendments (strategy, tenure, fees), and premature winding-up.
3. Dissemination of Financial Information: Sharing regular NAV details, financial performance metrics of underlying investee companies, and scheme-wide performance track records.
4. Disclosures of Material Risks and Events: Providing immediate notices regarding regulatory inquiries, legal actions, material liabilities, and breaches of the PPM or contribution agreements.
5. Intimation of Non-Material Changes: Informing investors of routine operational updates, such as changes in the AIF's bank accounts, corporate addresses, or contact information.
6. Grievance Redressal Support: Providing a structured, time-bound mechanism to address and resolve investor complaints.

9.8 STATUTORY TIMELINES FOR AIF SERVICES

The Investor Charter mandates strict statutory timelines for delivering key services and disclosures to investors:

9.8.1 Valuation and Financial Disclosures

• Portfolio Valuation (Category I & II AIFs): Must be conducted at least once every 6 months. This can be extended to once a year only if approved by 75% of the investors by value of their investment in the scheme.
• NAV Disclosure (Category III AIFs):
  • Close-ended schemes: Quarterly basis.
  • Open-ended schemes: Monthly basis.
• Investee Company Financials (Category I & II AIFs): Disclosed to unit holders within 180 days from the close of the financial year (or earlier as per the fund documents).

9.8.2 Transparency and Operational Updates

• PPM and Fund Document Amendments: Consolidating and disclosing all changes within 1 month from the end of each financial year.
• Ad-hoc Disclosures (Material risks, liabilities, litigation, PPM breaches): Must be disclosed as and when they arise or are likely to arise.
• Conflict of Interest Disclosures: Disclosed to investors as and when they arise.

9.8.3 Complaint and Grievance Redressal

• Direct Investor Complaints: AIF managers must respond and resolve direct grievances within 30 days of receiving the complaint.
• SEBI / SCORES Grievance Redressal: Complaints forwarded via SEBI’s SCORES platform must be fully resolved within 21 calendar days from the date of receipt.

9.9 INVESTOR RESPONSIBILITIES

The Investor Charter balances investor rights with clear responsibilities to maintain industry integrity and fund security:

1. Responsibility to Comply with KYC Rules: Unit holders must provide complete, accurate, and timely financial, identity, and tax residency information to the fund.
2. Responsibility to Abide by the Contribution Agreement: Investors must carefully read, understand, and abide by the capital drawdown terms, voting guidelines, and default clauses of their signed contracts.
3. Responsibility to Evaluate Intermediaries: Unit holders must verify the reliability of investment information and the credentials of the distributors or wealth advisors they engage.
4. Responsibility to Maintain Confidentiality: Investors are strictly prohibited from disclosing any material, non-public information received by virtue of their participation in the AIF, unless permitted by the fund documents.

9.10 KEY TERMS AND EXAM-RELEVANT CONCEPTS

1. Custodian Agreement

A legally binding contract between the AIF and an independent custodian for safekeeping securities. It must be executed prior to the fund’s first portfolio investment.

2. Investment Advisory Agreement

A contract delegating localized deal sourcing and advisory support from an offshore fund manager to an on-shore investment advisor.

3. Investor Charter

A SEBI-mandated transparency document detailing the rights, services, timelines, and responsibilities of investors in an AIF.

4. Valuation Frequency Rule

The regulatory timeline requiring Category I and II AIFs to value portfolio investments at least once every 6 months, unless extended to 12 months with 75% investor consent.

5. Investee Disclosures Timeline

The requirement for Category I and II AIFs to share the financial statements of investee companies with investors within 180 days of the financial year-end.

6. SCORES 21-Day Redressal Rule

The strict regulatory timeline requiring AIF managers to resolve SEBI/SCORES-forwarded investor complaints within 21 calendar days.

9.11 KEY TAKEAWAYS

• Support services agreements provide the operational backbone of an AIF, ensuring that critical functions like custodial safekeeping and due diligence are managed professionally.
• The Custodian must be appointed early—specifically, before any scheme portfolio investments are made—and must operate independently of the manager.
• The Investor Charter is a transparency tool designed to align investor expectations regarding AIF service delivery, governance, and dispute resolution.
• Category I and II AIFs operate under a 180-day financial disclosure rule for portfolio companies and must conduct asset valuations at least once every 6 months.
• Grievance timelines are strict: AIF managers have 30 days to resolve direct investor complaints, which drops to 21 days for complaints routed through SEBI's SCORES platform.
• Investors must maintain strict confidentiality of all non-public fund operations and data as a key term of their participation.

9.12 CHAPTER 9 (PART 4) — MCQ REVIEW QUESTIONS

1. A Custodian Agreement for an Alternative Investment Fund scheme must be executed and the custodian appointed prior to which operational milestone?

(a) The declaration of the final close of the scheme
(b) The date of the first investment of the scheme
(c) The submission of the PPM to SEBI
(d) The initial board meeting of the Sponsor entity

Answer: (b) The date of the first investment of the scheme

2. Under the SEBI Investor Charter, what is the mandatory frequency for valuing portfolio investments in Category I and Category II Alternative Investment Funds?

(a) At least once every month
(b) At least once every quarter
(c) At least once every 6 months
(d) At least once every 24 months

Answer: (c) At least once every 6 months

3. If an investor in a Category II AIF registers a formal complaint against the fund manager through SEBI's SCORES platform, the manager must redress the grievance within how many days?

(a) 7 calendar days
(b) 21 calendar days
(c) 30 calendar days
(d) 45 calendar days

Answer: (c) 30 calendar days

4. Under the Investor Charter, how can a Category I or II AIF extend its portfolio valuation frequency from 6 months to once a year?

(a) By obtaining a simple majority (51% consent) of unitholders
(b) By getting approval from 75% of investors by value of their investment
(c) By submitting a unilateral request to the registered Merchant Banker
(d) By paying a compensatory surcharge to the Custodian

Answer: (b) By getting approval from 75% of investors by value of their investment