SEBI Issues Guidelines Regarding Pro-Rata and Pari-Passu Rights of Investors of AIFs

Securities and Exchange Board of India (“SEBI”), vide its notification dated November 18, 2024, had notified the SEBI (Alternative Investment Funds) (Fifth Amendment) Regulations, 2024 (“AIF Amendment Regulations”), thereby amending the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”). The amendments were introduced with respect to maintaining pro-rata and pari-passu rights of investors in a scheme of an Alternative Investment Fund (“AIF”).

SEBI, vide its circular dated December 13, 2024 (“AIF Circular”), has now laid down the guidelines in respect of granting pro-rata and pari-passu rights of investors of AIFs.

• Pro-rata rights of investors of AIFs: SEBI, vide AIF Amendment Regulations, had notified that the investors of a scheme of an AIF 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 specified by SEBI. However, this shall not apply to angel funds.

The AIF Circular has 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 (i) an investor has been excused or excluded from participating in the said investment; or (ii) 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 investment 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, 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/scheme of the AIF – (i) investment manager or sponsor of the AIF; (ii) Multilateral or Bilateral Development Financial Institutions; (iii) State Industrial Development Corporations; and (iv) 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 (“Exempted Entities”). In the event an investment manager or sponsor of an AIF subscribes to junior/subordinate class(es) of units/scheme of the AIF, the amount invested by the AIF or its scheme cannot be utilized by an investee company, directly or indirectly, to repay any of its obligations or liabilities towards the investment manager or sponsor of the AIF or their associates.

With respect to the existing AIFs/schemes of AIFs that have adopted priority distribution model (i.e., schemes that issued senior and junior/subordinate classes of units) in terms of the AIF circular dated November 23, 2022, and do not fall under the category of Exempted Entities, shall neither accept any fresh commitment nor make investment in a new investee company, directly or indirectly. In the event the investment limits specified under the AIF Regulations are breached pursuant to compliance hereunder, such breach may not be considered as non-compliance with applicable provisions of the 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 investment manager.

• Pari-passu rights of investors of AIFs: Pursuant to the AIF Amendment Regulations, the rights of investors of a scheme of an AIF shall be pari-passu in all aspects other than the rights of the investors which are pro rata to their commitment to the scheme of AIF. Further, Large Value Fund for Accredited Investors (“LVFs”) were exempted in this regard. The AIF Circular has 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:
  • Any such right shall not result in any investor bearing liability accrued or accruing to other investors of the AIF/scheme of AIF;
  • 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 the investment committee constituted by the investment manager;
  • Any such right shall not alter the right(s) available to other investors under their respective agreements with the AIF/investment manager; and
  • Any such right and eligibility to avail the same shall be transparently disclosed in the Private Placement Memorandum (“PPM”) of the AIF/scheme of the AIF.

Further, Standard Setting Forum for AIFs (“SFA”), in consultation with SEBI, shall formulate the implementation standards in this regard, prescribing the positive list of specific differential rights that may be offered by AIFs. AIFs, investment managers and their key management personnel shall ensure that the differential rights are provided only in accordance with the implementation standards formulated by SFA.

Further, in terms of the standard template for PPMs prescribed by SEBI vide its circular, AIFs are required to disclose in their PPM about any differential right offered to an investor(s). In this regard, AIFs/schemes of AIFs whose PPMs were filed post applicability of the aforesaid circular, i.e., on or after March 1, 2020, shall report the details of differential right(s) which do not fall under the implementation standards formulated by SFA in the format as specified in the AIF Circular, on or before February 28, 2025. Further, the investment manager shall immediately terminate/discontinue those differential rights which are ascertained to be affecting the rights of other investors.

Furthermore LVFs, whose PPMs are filed with SEBI for launch of scheme post the date of issuance of the AIF Circular, may avail exemption from the requirement of maintaining pari-passu rights after making appropriate disclosure in the PPM and obtaining an undertaking from accredited investor at the time of on-boarding to the LVF. Existing LVFs may also avail exemption in this regard provided that each investor of the scheme provides a waiver to this effect in the manner as specified in the AIF Circular.

To read the AIF Amendment Regulations click here and to read the AIF Circular click here

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