The Securities and Exchange Board of India (SEBI) has enacted a significant framework for Alternative Investment Funds (AIFs), allowing them to hold onto liquidation proceeds beyond their usual fund life under specified conditions. This move comes as part of a broader strategy to address pending liabilities and operational expenses for AIFs that have already wound up their investments.
New Framework for Retaining Liquidation Proceeds
On June 16, 2026, SEBI announced that AIFs can retain liquidation proceeds if they face litigation notices or regulatory demands. Specifically, funds can keep these proceeds if at least 75% of their investors approve this decision or if the funds are needed to cover residual operational expenses associated with the winding-up process. Importantly, SEBI clarified that litigation-related communications encompass notices from a range of authorities including tax agencies, courts, and law enforcement entities, meaning funds must be vigilant about any potential liabilities.
This framework also mandates that managers must disclose not only the amount they intend to retain but also the expected timeline for which they plan to keep these funds. Furthermore, should the retention be for operational expenses, the fund can only do so for a period not exceeding three years following the end of the permissible fund life.
Introduction of ‘Inoperative Fund’ Status
The regulator formalized the ‘Inoperative Fund’ status for AIFs, which have liquidated all investments but still hold proceeds due to pending litigation or other obligations. Under this designation, such AIFs are prohibited from making new investments, launching new funds, or collecting management fees, fostering a clearer operational framework for these entities. The retained money can only be put into instruments authorized under existing AIF Regulations, ensuring that funds are used transparently and responsibly.
To ease compliance burdens, SEBI has exempted Inoperative Funds from several standard regulatory obligations, including quarterly and annual activity reporting, compliance test reports, performance benchmarking disclosures, and certain certifications for key investment personnel. This step could provide much-needed relief for funds attempting to navigate complex finalization processes while minimizing operational strain.
Implementation and Reporting Requirements
The implementation standards for eligible operational expense heads will be crafted by the Standard Setting Forum for AIFs (SFA) in consultation with SEBI. AIFs retaining funds and Inoperative Funds will be required to present an annual report detailing retained funds and outstanding liabilities to both SEBI and investors. This report must be submitted within 30 days following the end of each financial year, ensuring transparency and accountability.
Importantly, these new conditions extend to Venture Capital Funds registered under the older SEBI (Venture Capital Funds) Regulations, 1996, helping to harmonize the regulatory landscape for AIFs across different categories.
What This Means
This tailored approach allows AIFs more flexibility in managing their financial obligations, particularly in a landscape where litigation and regulatory scrutiny can often complicate closure processes. By empowering funds to retain necessary liquidation proceeds, SEBI is effectively promoting a more organized winding-up process, thereby enhancing investor confidence. Furthermore, the introduction of the Inoperative Fund status provides a structured framework that mitigates ambiguity and offers clearer guidelines for funds unable to fully complete their investment lifecycle due to unforeseen circumstances.
For investors, the regulations serve as a protective measure, ensuring funds are properly managed even in winding scenarios. However, they must remain vigilant about how these retained proceeds are utilized and maintained, particularly in cases of pending litigation or financial obligations.
Frequently Asked Questions
What constitutes a litigation notice under the new framework?
A litigation notice can originate from tax authorities, regulatory bodies, law enforcement agencies, or courts and involves any potential liabilities, including tax-related issues, even if they have not yet materialized.
How long can AIFs retain liquidation proceeds?
AIFs can retain liquidation proceeds indefinitely under specific conditions, provided they have received appropriate approvals from investors or must cover operational costs, subject to a three-year limit post-fund lifespan.
What will happen to Inoperative Funds?
Inoperative Funds will cease to accept new investments, launch new schemes, or charge management fees while being permitted to invest retained funds only in specific compliant instruments.
Are there any exemptions for Inoperative Funds?
Yes, Inoperative Funds are exempt from numerous regulatory requirements, including routine reporting and performance disclosures, easing their compliance burden as they wind down operations.
