Winding up and Liquidation of AIF

Ankita Tiwari

19 Apr, 2023

Alternative Investment Fund (AIF) is a fund established or incorporated under the SEBI (Alternative Investment Fund) Regulations, 2012 (SEBI AIF Regulations), 2012) in the form of a company, LLP, trust or a body corporate. As per the AIF Regulations, AIF means an investment vehicle which privately pools the funds collected from Indian as well as foreign investors to invest it in accordance with the specified investment policy for the benefit of its investors. AIF is covered only under the AIF Regulations and is outside the ambit of SEBI (Mutual Funds) Regulations of 1996, SEBI (Collective Investment Schemes) Regulations of 1999^[1] or any other regulation issued by the SEBI.
The AIF Regulations provide detail procedure for setting up an AIF however when it comes to the procedure for winding up of an AIF it is very basic.

Grounds for winding up of an AIF under the AIF Regulations

Regulation 29 of the AIF Regulations provide for winding up of AIFs. Regulation 29(1) prescribes how an AIF set up as a trust is to be wound up. Similarly, Regulation 29 (2), (3) and (4) prescribe the process of winding up of an AIF set up as LLP, Company and a Body Corporate respectively. Regulation 29 (2), (3) and (4)  states that the AIFs set up as LLP, Company and a Body Corporate shall be wound up under the provisions of respective Acts under which they are formed.

Regulation 29(1) provides that a trust may be wound up on following grounds:

1. Completion of the tenure of the AIF or all schemes launched by the AIF as provided in the AIF’s Private Placement Memorandum (PPM);
2. The trustees of the AIF come to a mutual conclusion that the AIF should be wound up in the interest of the investors;
3. A resolution is passed by 75% of the investors of the AIF as per the value of their investment in the AIF at a meeting of unit holders regarding winding up of the AIF;
4. If SEBI directs that the AIF should be wound up in the interest of investors.

Similar grounds are provided under regulation 29(2) for winding up of an AIF as LLP. Except that in regulation 29(2) three grounds are provided instead of four. The ground missing under regulation 29(2) but available under regulation 29(1) is the one which allows the trustees to wind up the AIF if they mutually decide that it would be in the interest of the AIF. As AIFs set up as LLPs do not have trustees or any equivalent body, it makes sense as to why this ground has been omitted under regulation 29(2).

Regulation 29(3) and 29(4) which provides for the winding up of a company and body corporate respectively, as prescribed by the provisions of the Act under which they are set up.

The AIF Regulations fail to provide that the board of directors (BOD) of an AIF set up as a Company may wind up an AIF if they are of an opinion that  would be in the interest of the investors, even though the BOD have a fiduciary duty towards the company and its shareholders and are comparable to trustees of a trust.

Process involved in winding up of an AIF and surrendering the certificate of registration

1. Intimation to SEBI and distribution of proceeds
   Regulation 29(5) prescribes that the trustees or Trustee Company or the BOD or designated partners of an AIF as the case may be shall intimate SEBI and the investors of AIF about the winding up of the AIF. After the intimation has been made to SEBI and its investors, no further investments shall be made on behalf of the AIF. Regulation 29(7) provides a time limit of one year from the date of intimation for liquidating the assets of the AIFs and distributing the proceeds of the liquidation to the AIF’s investors after satisfying all the liabilities of the AIF. The AIF may also choose to make an ‘unspecific definition’ of AIF’s assets after obtaining approval from at least 75% of the investors by value of their investment in AIF which should also be in compliance with the requirements laid down in PPM and contribution agreement/subscription agreement for any specie distribution of assets, if any.
2. Surrender of certificate of registration
   As per regulation 29(9), the certificate of registration issued to an AIF shall be surrendered to SEBI upon winding up of an AIF. The trustees of the AIF shall after the distribution of assets, write to SEBI declaring that the registration certificate of the AIF has been surrendered.. After this the SEBI will cancel the registration of the AIF and the name of AIF shall be removed from the list of AIFs registered with SEBI as well as from SEBI’s website.
3. Documents required to be submitted to SEBI for surrendering certificate of registration
   SEBI issued a “FAQs for applications filed by AIFs with SEBI for their pose registration activities (FAQs) on 23^rd March 2022 which provide ease of doing business to AIFs and also address the issue of surrender of certificate of registration. Section 3.3 of the FAQs provide a list of documents required to be submitted by an AIF for surrender of certificate of registration as an AIF. It is a comprehensive list which requires the manager or trustee to give various declarations/undertakings. The declarations relate to the liquidation and distribution of assets to the unit holders and that no further investments shall be undertaken by the AIF post winding up. The following documents are prescribed by SEBI to be submitted for granting approval regarding surrender of the AIF’s certificate of registration:
   1. Duly signed application or cover letter stating the details of surrender of registration of the AIF and rationale for the same;
   2. Attested copy of  resolution taken for surrender of registration depending upon the legal structure of the AIF;
   3. Duly signed and stamped copy of declaration from AIF’s investment manager and a practicing CA stating that all assets have been liquidated and proceeds have been distributed among unit holders proportionately;
   4. Duly signed and stamped copy of declaration from the investment manager that the AIF is being wound up and has stopped all activities as an AIF including accepting any further investments for the AIF;
   5. Duly signed and stamped copy of declaration from the AIF’s investment manager and trustee that no enquiry, proceeding or any other action has been initiated or is pending against the AIF;
   6. Duly signed and stamped copy of declaration from the AIF’s investment manager and trustee that the AIF regarding compliance of all AIF regulation relating to winding up;
   7. Duly signed and stamped copy of declaration from AIF’s investment manager and trustee that every schemes of AIF have been wound up;
   8. Attested copy of bank statement of the AIF or lasted audited financial accounts of the fund or scheme;
   9. Original certificate of registration of the fund.
4. Maintenance of records after completion of winding up of an AIF
   As per regulation 27(1), the manager or sponsor of an AIF has to maintain records pertaining to the AIF such as the description of the assets under the scheme, valuation policies and investment strategy. In addition, regulation 27(2) requires maintenance of the aforementioned records for a tenure of 5 (five) years from the date of winding up of the AIF. Where the AIF is set up in form of a trust, the trustee is responsible for ensuring compliance with this requirement. However, when it comes to company or an LLP, it is unclear how this requirement will be complied with other than by entrusting records of the AIF to a third party escrow agent for a period of five years and instructing the third party escrow agent to comply with any regulatory requests for information and to destroy such records after the expiry of five years.
5. Compliance to be carried out until the certificate of registration is cancelled by SEBI
   Even after exiting from its investments and distributing all the investment proceedings to its investors, the AIF is required to carry out the following till the acceptance of surrender of certificate of registration by SEBI and removal from the register of AIFs:
   1. File quarterly return with SEBI
   2. Conduct annual audit of the PPMs as required by SEBI circular no. SEBI/HO/IMD/DF6/CIR/P/2020/24 dated 5^th February, 2020, and
   3. Prepare annual compliance test report.
      These compliances are required as time taken by SEBI to cancel an AIF registration and remove AIF’s name from the register of AIFs varies from AIF to AIF. Before cancelling the AIF registration, the SEBI may make inquiries or seek information from the AIF’s trustee and investment manager. In the meanwhile, the AIF has to continue filing quarterly returns with SEBI, conduct annual audit of its PPM and prepare an annual compliance test report.
6. Surrendering the PAN and TAN
   The PAN and TAX of an AIF are surrendered after all tax related matters including any disputes with the tax department and unsettled liabilities and refunds if any, are received.
7. Executing a deed of dissolution
   After the cancellation of PAN and TAN of AIF, it is common for a trustee to execute a deed of dissolution of AIF.

Liabilities arising Post-winding up of an AIF

One challenge arises at the time of winding up an AIF is that a provisions is to be made for liabilities which arise after liquidation of AIF and returning proceeds to its investors. Few liabilities which arise post the winding up are tax liabilities and indemnity claims from entities that acquired assets from the AIF before it was wound-up. In addition to this, it common for AIFs to have a share purchase agreement or other similar contracts to dispose of or exit from portfolio investments. These agreements require the seller to give representations and warranties to the buyer relating to the portfolio company along with its assets and may also offer indemnities to protect such breach of representation and warranties. The indemnity may arise under SPAs after winding up of the AIF. Further, a notice for escaping assessment may be issued by the Income Tax Department under section 148 of the Income Tax Act, 1961 within 10 years from the end of the relevant assessment year. So an AIF’s trustee may receive a tax notice under this section within 10 years after the exit or distribution of exit proceeds to its investors.

Conclusion

Winding up of an AIF is an integral part of the life cycle of an AIF just like the formation of AIF. Once the decision to terminate an AIF is taken, the liquidator proceeds for the liquidation of the assets of AIF within the prescribed time frame. Upon liquidation, the distribution of assets is made as per the distribution mechanism set out in the PPM.