Pro-rata and pari-passu rights of investors of AIFs
19.1. Pro-rata rights of investors of AIFs
19.1.1.
Regulation 20(21) of AIF Regulations states as under:
Except for the pro-rata rights covered under 20(21), all investors in a scheme of an Alternative Investment Fund (AIF) shall have pari-passu rights in all respects.
Pari-passu means that investors are treated equally and enjoy the same rights and obligations under the scheme.
SEBI may permit differential rights for selected investors, provided they are offered in the manner specified by SEBI and do not adversely affect the interests of the other investors in the scheme.
Differential Rights for Select Investors
An Alternative Investment Fund (AIF) may offer differential rights to select investors in a scheme.
Such differential rights can only be offered in the manner specified by SEBI from time to time.
The grant of differential rights must not adversely affect the rights or interests of the other investors in the same scheme.
Differential rights may relate to governance, reporting, information access, liquidity, or other investor-specific benefits, as permitted by SEBI.
Exemption for Accredited Investors Only Funds
The requirement of pari-passu rights under sub-regulation (22) does not apply to an Accredited Investors Only Fund.
An Accredited Investors Only Fund may provide different rights to different investors, without being bound by the pari-passu requirement.
This exemption recognizes that accredited investors are sophisticated investors who can negotiate and agree to customized investment terms.
Example:
An Accredited Investors Only Fund may grant one investor enhanced governance or information rights that are not available to other investors.
This is done without violating the pari-passu requirement under 20(22).
Existing Differential Rights Issued Before the 2024 Amendment
Any differential rights issued by an AIF before the notification of the SEBI (Alternative Investment Funds) (Fifth Amendment) Regulations, 2024 are subject to SEBI's transitional framework.
The requirement covers only those differential rights that do not fall within the first proviso to 20(22).
First provision of 20 (22) deals with Differential Rights for Select Investors.
Such differential rights cannot continue solely because they were granted before the amendment.
The AIF must deal with those rights in the manner specified by SEBI from time to time.
SEBI may prescribe the process for reviewing, modifying, regularising, or otherwise dealing with such differential rights.
Investors in a scheme of an Alternative Investment Fund (AIF) are entitled to rights in each investment of the scheme in proportion to their capital commitment.
The proceeds from each investment must also be distributed among investors on a pro-rata basis, according to their commitment to the scheme.
SEBI may specify exceptions to this pro-rata principle from time to time, which the AIF must follow.
Example:
If Investor A commits ₹60 crore and Investor B commits ₹40 crore to an AIF scheme.
Investor A is generally entitled to 60% and Investor B 40% of the rights in each investment and the proceeds from those investments, unless SEBI has prescribed a different treatment.
Treatment of Existing Non-Pro-Rata Investor Rights
This provision applies to schemes of an AIF that issued investor rights before the SEBI (Alternative Investment Funds) (Fifth Amendment) Regulations, 2024 came into effect.
If those investor rights are not proportionate to the investors' commitments and have not been exempted by SEBI, they cannot continue unchanged.
Such existing non-pro-rata rights must be dealt with in the manner specified by SEBI from time to time.
The provision enables SEBI to regulate the transition of older investment arrangements to ensure consistency with the revised pro-rata rights framework.
Example:
An AIF scheme launched before the 2024 amendment grants one investor a larger share of investment proceeds than its capital commitment would justify.
If this arrangement is not exempted by SEBI, the AIF must deal with those rights in the manner prescribed by SEBI.
19.1.2. Exception to the pro-rata requirement under Regulation 20(21)
Regulation 20(21) of the AIF Regulations generally requires investors to have rights pro-rata to their commitment in each investment of the scheme and in the proceeds from that investment.
However, this pro-rata requirement does not apply to the extent that an investor is unable or does not participate in the particular investment for either of the following reasons:
(a). Investor has been excused or excluded
If an investor has been excused or excluded from participating in a particular investment, that investor does not need to have pro-rata rights in that investment.
This is relevant to the excuse/exclusion situations covered under Chapter 15.
Example:
Total scheme commitment = ₹100 crore.
Investor A has committed ₹20 crore, giving A a 20% commitment.
The AIF makes an investment of ₹50 crore in Company X.
Investor A is validly excused from participating in Company X's investment.
The AIF can therefore make the investment without giving Investor A a 20% share in that particular investment.
(b). Investor has defaulted on its contribution
If an investor fails to provide its pro-rata contribution required for a particular investment, the pro-rata requirement does not apply to that investor to the extent of the default.
Example:
Investor A is entitled to contribute ₹2 crore towards a particular investment.
Investor A fails to provide the ₹2 crore drawdown.
The AIF can proceed with the investment using contributions from the other investors.
Investor A's pro-rata rights in that particular investment can be reduced to reflect the amount it actually contributed.
19.1.3. Exception for carried interest / additional return
Regulation 20(21) generally requires the proceeds from an AIF's investments to be distributed to investors pro-rata to their commitment.
However, this pro-rata requirement does not apply to the extent that an investor has agreed to share part of its return or profit with the Manager or Sponsor.
Such sharing must be based on the Contribution Agreement entered into between the investor and the AIF/Manager/Sponsor.
This can be structured as:
Carried interest.
Additional return.
Any similar arrangement.
Example:
Investor A is entitled to receive ₹10 crore from an investment.
Under the Contribution Agreement, Investor A has agreed that ₹1 crore of its profit/return will be shared with the Manager as carried interest.
Investor A therefore receives ₹9 crore, while ₹1 crore goes to the Manager as carried interest.
This difference from a strictly pro-rata distribution is permitted under this exception.
19.1.4. Subordinate / Junior Classes of Units
Regulation 20(21) generally requires investors to have rights pro-rata to their commitment in the investments of an AIF.
However, SEBI allows certain specified entities to voluntarily accept lower returns or bear a greater share of losses than their normal pro-rata entitlement.
These entities may therefore invest in junior/subordinate classes of units, which have lower priority compared with other classes of units.
The following entities can subscribe to such junior/subordinate units:
(a). Manager or Sponsor - The Manager or Sponsor of the AIF can accept lower returns or bear a greater share of losses.
(b). Multilateral or Bilateral Development Financial Institutions - Development financial institutions operating on a multilateral or bilateral basis can also take subordinate units.
(c). State Industrial Development Corporations - State Industrial Development Corporations are permitted to subscribe to such units.
(d). Government-related entities
This includes entities:
Established, owned or controlled by the Central Government;
Established, owned or controlled by a State Government; or
Established, owned or controlled by a foreign government.
It specifically includes Central Banks and Sovereign Wealth Funds.
Example:
Suppose an AIF has two classes of units:
Class A: Senior units
Class B: Junior/subordinate units
The AIF makes an investment and earns ₹100 crore.
A normal investor holding Class A may receive returns first, while the holder of Class B may receive a lower return or bear a larger portion of losses.
If the Manager has subscribed to Class B units, the Manager can agree to take this subordinate position.
This gives the AIF greater flexibility to attract investors with different risk and return preferences.
19.1.5. Minimum loss-sharing by Sponsor/Manager
There is an important limit on the flexibility given under Para 19.1.4.
Although the Sponsor or Manager may subscribe to a junior/subordinate class of units, they cannot structure their investment in a way that makes them bear less loss than their proportionate share.
The Sponsor/Manager must bear losses at least in proportion to their holding in the AIF, compared with the other unit holders.
So , the Sponsor/Manager cannot take the benefit of a preferential loss arrangement where other investors bear a larger share of losses while the Sponsor/Manager bears less than its pro-rata share.
Example:
Suppose an AIF has:
Total investment = ₹100 crore
Sponsor/Manager investment = ₹10 crore
Other investors = ₹90 crore
The Sponsor/Manager therefore holds 10% of the AIF.
If the AIF suffers a loss of ₹20 crore:
Sponsor/Manager must bear at least 10% of the loss = ₹2 crore.
Other investors can bear the remaining ₹18 crore.
The Sponsor/Manager cannot agree to bear only ₹1 crore, because that would be only 5% of the loss despite holding 10% of the AIF.
19.1.6. Protection against routing AIF funds back to the Sponsor/Manager
19.1.6 prevents the Sponsor or Manager from using the AIF's investment money to indirectly recover money owed to them by an investee company
If the Sponsor or Manager invests in a junior/subordinate class of units of the AIF, the money invested by the AIF must genuinely be used for the investment purpose.
The investee company cannot use the AIF's investment money, either directly or indirectly, to repay:
Any obligation owed to the Sponsor.
Any obligation owed to the Manager.
Any obligation owed to their associates.
The idea is to prevent a conflict of interest or circular flow of funds where:
The Sponsor/Manager appears to take investment risk through a junior class but ultimately gets its money back through the investee company.
Example
Sponsor invests ₹10 crore in a junior class of an AIF.
The AIF then invests ₹50 crore in Company X.
Company X already owes ₹5 crore to the Sponsor.
Company X cannot use the ₹50 crore received from the AIF to repay that ₹5 crore liability to the Sponsor.
The AIF's money must be used for the legitimate investment/business purpose and not to settle the Sponsor's or Manager's existing claims.
Applicability on existing AIFs/schemes of AIFs
19.1.7. Treatment of existing AIFs with non-pro-rata rights
19.1.7 deals with AIFs/schemes that were already in existence before the pro-rata requirement was introduced.
Regulation 20(21) of the AIF Regulations introduced the general requirement that investors should have rights pro-rata to their commitment.
However, some AIFs/schemes that were issued before November 18, 2024 may already have arrangements where investors have rights that are not pro-rata to their commitment.
These existing arrangements are not automatically invalid.
If such non-pro-rata rights:
Existed before November 18, 2024; and
Are not specifically exempted by SEBI,.
they must be dealt with in the manner specified by SEBI.
Example
AIF X was launched before November 18, 2024.
Its fund documents provide Investor A with rights that are different from what would be available based purely on A's commitment.
After the introduction of Regulation 20(21), this arrangement is identified as non-pro-rata.
If SEBI has not exempted this arrangement, AIF X cannot simply decide how to handle it.
It must follow the treatment prescribed by SEBI for such existing non-pro-rata rights.
19.1.8. Existing Priority Distribution Structures
AIFs/schemes that were already in existence on November 18, 2024 and had a Priority Distribution Model are subject to restrictions.
A Priority Distribution Model means the scheme has different classes of units, such as:
Senior units.
Junior/Subordinate units.
These structures give different classes different priorities in receiving investment proceeds.
If the scheme does not fall within the exemption mentioned in Para 19.1.4, it cannot expand its existing structure in the following ways:
Fresh commitments
The scheme cannot accept any fresh commitment from investors.
New investments
The scheme cannot make investments in a new investee company.
This restriction applies whether the investment is made Directly or Indirectly.
Example:
AIF X existed on November 18, 2024 and had Senior and Junior units.
If it is not covered by the Para 19.1.4 exception:
It cannot accept a fresh ₹10 crore commitment from a new investor.
It cannot accept additional fresh commitments from existing investors.
It cannot invest in a new Company Y.
It also cannot indirectly invest in Company Y through another investment vehicle.
19.1.9. Protection from a Technical Breach of Investment Limits
Following the restrictions discussed in Para 19.1.8, an AIF may sometimes be unable to make fresh investments or accept fresh commitments.
Because of this, an existing AIF/scheme may end up breaching an investment limit prescribed under the AIF Regulations.
A similar situation may also arise because of the SEBI circular dated November 23, 2022 on the same subject.
In such a situation, the breach will not be treated as non-compliance with the applicable AIF Regulations or SEBI circulars, to the extent the breach has occurred because of these requirements.
Compliance Test Report
Even though the breach is not treated as regulatory non-compliance, it cannot simply be ignored.
The Manager must:
Identify the breach.
Record it in writing.
Include it in the Compliance Test Report (CTR).
The CTR is prepared by the Manager in accordance with Para 21.2 of the SEBI Master Circular for AIFs.
Example:
An existing AIF has a priority distribution structure.
Because of Para 19.1.8, it cannot accept fresh commitments or make investments in new investee companies.
As a result, the composition of its investment portfolio causes it to exceed a particular investment limit prescribed under the AIF framework.
Normally, exceeding that limit could be treated as a compliance issue.
Here, however, the breach is protected to the extent it has resulted from compliance with Para 19.1.8 or the November 23, 2022 SEBI circular.
The Manager must still record the breach in the Compliance Test Report.
19.2. Pari-passu rights of investors of AIFs
19.2.1.
Regulation 20(22) of AIF Regulations states as under:
The AIF can negotiate or provide differential rights to particular investors.
Such rights can be offered only if they do not adversely affect or alter the rights of the other investors in the AIF/scheme.
Therefore, the AIF has flexibility to structure certain investor-specific rights, but this flexibility cannot be used to take away or reduce the existing rights of other investors.
The differential rights must be provided in accordance with the guiding principles specified by SEBI.
Example:
An AIF has 10 investors.
Investor A negotiates an additional reporting right, such as receiving more frequent portfolio reports.
The AIF may provide this additional right to Investor A, provided it does not reduce or otherwise affect the rights of the remaining 9 investors.
(a). Liability cannot be shifted to other investors
An AIF may provide differential rights to selected investors.
However, those rights cannot be structured in a way that makes one investor responsible for the liabilities of another investor.
An investor should only bear liabilities that arise from its own participation or obligations.
Therefore, the AIF cannot give a selected investor a special right that effectively transfers another investor's liability onto that investor.
Example:
Investor A has a liability of ₹2 crore arising from its participation in the AIF.
Investor B has negotiated certain differential rights.
The arrangement cannot require Investor B to bear Investor A's ₹2 crore liability.
(b). Differential rights cannot give control over AIF decisions
An AIF may give differential rights to selected investors, including rights that are non-monetary or non-commercial in nature.
However, these rights cannot give the investor control over the decision-making of the AIF or its scheme.
In other words, an investor cannot use special contractual rights to effectively control how the AIF makes its investment or other decisions.
There is an exception where the investor, or its nominee, is formally part of an Investment Committee or other committee constituted under Regulation 20(7).
Example:
Investor A is given a special right to receive additional information about the AIF.
This is generally permissible because it does not give Investor A control over the AIF's decisions.
However, the AIF cannot give Investor A a contractual right to approve or veto every investment decision merely because Investor A is a selected investor.
If Investor A's nominee is formally appointed to the Investment Committee under Regulation 20(7), the nominee may participate in decision-making in that capacity.
(c). Existing rights of other investors must remain unchanged
An AIF may give differential rights to selected investors.
However, giving such rights to one investor cannot change, reduce, restrict or otherwise affect the rights already available to other investors.
The rights of each investor continue to be governed by the agreement entered into between that investor and the AIF/Manager.
Therefore, a special arrangement with one investor cannot be used to modify the contractual rights of another investor without affecting the terms applicable to that other investor.
Example:
Investor A negotiates a special reporting right with the AIF.
Investor B already has a contractual right to receive quarterly reports under its agreement with the AIF.
Giving Investor A additional reporting rights cannot take away or reduce Investor B's quarterly reporting rights.
(d). Differential rights must be disclosed in the PPM
If an AIF offers differential rights to selected investors, those rights must be clearly disclosed in the PPM.
The PPM must also explain the eligibility criteria for investors who can avail those rights.
This ensures that investors are aware:
What special or differential rights may be available;
Which investors are eligible to receive them; and
The conditions for exercising those rights.
The arrangement should therefore not come as an undisclosed preferential benefit to a particular investor.
Example:
An AIF provides a special reporting right to investors who meet certain eligibility conditions.
The PPM should clearly state:
The nature of the special reporting right; and
The conditions an investor must satisfy to receive it.
19.2.3. Permitted Differential Rights
The SFA, in consultation with SEBI, will formulate implementation standards for the differential rights that AIFs can offer to selected investors.
These standards will contain a positive list of specific differential rights that may be offered.
A positive list means that the AIF can offer only those differential rights that are specifically included in the list.
Therefore, the AIF does not have unlimited freedom to create any type of preferential or differential right for an investor.
The SFA may review and update the list whenever necessary.
Any such review or update will be carried out in consultation with SEBI.
Example:
Suppose the implementation standards permit certain additional reporting rights for eligible investors.
An AIF may offer those rights if the investor satisfies the prescribed conditions.
However, the AIF cannot independently create a completely new type of differential right that is not included in the positive list.
19.2.4. Publication of Implementation Standards
The implementation standards prepared by the SFA will be made publicly available.
They will be published on the websites of the industry associations that form part of the SFA:
Indian Venture and Alternate Capital Association (IVCA)
PE VC CFO Association
Trustee Association of India
AIFs and their Managers can refer to these websites to access the latest implementation standards relating to differential rights.
Example:
SFA formulates standards specifying the differential rights that an AIF may offer to eligible investors.
These standards are published on the websites of IVCA, PE VC CFO Association and Trustee Association of India.
The Manager can refer to the applicable standards before offering any differential rights to an investor.
19.2.5. Conditions for offering differential rights
AIFs, their Managers and Key Management Personnel must ensure the following when offering differential rights to selected investors:
(a). Rights must follow the SFA standards
Differential rights can be offered only in accordance with the implementation standards formulated by the SFA.
The AIF cannot independently create or offer a differential right outside the framework permitted by those standards.
Therefore, the Manager must first check whether the proposed differential right is covered by the applicable SFA implementation standards.
Example:
An AIF wants to give a particular investor a special reporting right.
The Manager must ensure that this right is permitted under the SFA implementation standards before offering it.
(b). Eligibility must be disclosed in the PPM
The PPM must clearly disclose:
(i). Eligibility criteria
The specific conditions that an investor must satisfy to avail each differential right must be stated in the PPM.
Different differential rights may have different eligibility criteria.
Example:
Right A may be available to investors committing at least ₹50 crore.
Right B may be available only to certain categories of institutional investors.
These eligibility conditions must be clearly stated in the PPM.
(ii). Eligible investors must have the option to avail the right
If an investor satisfies the eligibility criteria for a particular differential right, the investor may choose whether or not to avail it.
The AIF cannot make the differential right compulsory merely because the investor satisfies the eligibility criteria.
Example:
The PPM states that investors meeting a particular eligibility criterion can receive additional reporting rights.
Investor A satisfies the criterion.
Investor A must be given the option to take the additional reporting right.
Investor A can also choose not to avail it.
Applicability on existing AIFs/schemes of AIFs
19.2.6. Disclosure regarding impact on other investors
The SEBI standard PPM template requires AIFs to clearly inform investors about the treatment of differential rights.
If an AIF offers differential rights to certain investors through:
Separate classes of units; or
Side letters or other agreements
the PPM must state that these rights must not adversely affect the rights of other investors.
This protection covers:
Economic rights, such as entitlement to returns or distributions.
Other rights, such as contractual or governance-related rights available to other investors.
Therefore, giving a selected investor a special benefit cannot come at the expense of the rights already available to other investors.
Example:
An AIF gives Investor A a special right through a side letter.
The special right cannot reduce Investor B's entitlement to investment proceeds or take away a contractual right that Investor B already has.
19.2.7. One-time reporting for existing differential rights
SEBI introduced a one-time reporting requirement through its Circular dated December 13, 2024.
This reporting requirement covers AIFs/schemes where:
The PPM was filed with SEBI on or after March 1, 2020; and
The AIF/scheme had already provided differential rights to certain investors; and
Those differential rights do not fall within the implementation standards formulated by the SFA.
This was intended to identify and report existing differential rights arrangements that were outside the permitted SFA framework.
Reporting
The reporting requirement applies to AIFs and Schemes of AIFs where the PPM was filed with SEBI on or after March 1, 2020.
The scheme had issued differential rights that were not covered by the SFA implementation standards.
Nature of the requirement
The reporting was a one-time requirement, rather than a recurring periodic filing.
The purpose was to give SEBI visibility over existing differential rights arrangements that did not fit within the subsequently prescribed framework.
Example
An AIF filed its PPM with SEBI in 2021.
It subsequently gave a particular investor a special contractual right through a side letter.
That differential right does not appear in the SFA's permitted implementation standards.
Since the PPM was filed after March 1, 2020, the AIF falls within the scope of the one-time reporting requirement.
19.2.8. Differential rights that affect other investors
The differential rights that were reported to SEBI under the one-time reporting requirement must be examined to determine whether they affect the rights of other investors.
If any differential right is found to adversely affect the rights of other investors, the Manager must immediately terminate or discontinue that differential right.
The Manager cannot continue such a right merely because it was already provided to an investor before the reporting requirement.
The focus is on protecting the rights of the other investors in the AIF/scheme.
Example
An AIF had given Investor A a special right under a side letter.
The right was reported to SEBI because it was outside the SFA implementation standards.
On examination, it is found that exercising this right reduces the economic entitlement of other investors.
The Manager must immediately discontinue/terminate Investor A's differential right.
The waiver to this effect as mentioned in para 19.2.8 above.
19.2.8. Pari-passu exemption for LVFs and AI-only funds
LVFs whose PPMs are filed with SEBI for launching a scheme after December 13, 2024 may avail an exemption from the requirement of maintaining pari-passu rights among investors.
The same exemption is also available to AI-only funds.
This exemption allows such LVFs and AI-only funds to offer differential rights to selected investors, even where those rights may affect the interests of other investors.
Conditions for availing the exemption
(i). Disclosure in the PPM
The scheme must make an appropriate disclosure in its PPM regarding the exemption from maintaining pari-passu rights.
Investors should therefore be made aware that:
The fund may avail the exemption.
Differential rights may consequently be offered to selected investors.
(ii). Undertaking from the Accredited Investor
At the time of onboarding an investor into An LVF or An AI-only fund.
The fund must obtain an undertaking from the Accredited Investor in accordance with Para 10.5.1 of the SEBI Master Circular for AIFs.
The undertaking must contain the following clause:
“The prospective investor is aware that LVF/AI only fund may avail exemption from the requirement of maintaining pari-passu rights among investors.
Therefore, may offer differential rights to select investors which might affect interest of others investors of the LVF/AI only fund.
Example
An LVF files its PPM with SEBI on January 10, 2025.
Since the PPM is filed after December 13, 2024, the LVF may avail the pari-passu exemption.
It must:
Make the required disclosure in its PPM; and
Obtain the specified undertaking from each Accredited Investor at onboarding, containing the prescribed clause.
19.2.9. Exemption for Existing LVFs from Pari-passu Rights
Existing LVF schemes as on December 13, 2024 may avail an exemption from the requirement of maintaining pari-passu rights among their investors.
“Pari-passu” means investors generally have equal rights and treatment within the same class, subject to the applicable terms.
The exemption is not automatic.
The exemption can be used only when each investor of the LVF scheme specifically provides a waiver agreeing to the departure from pari-passu rights.
Therefore, the LVF cannot rely on a general or blanket waiver. Each investor must specifically provide the required waiver.
Example:
An LVF existed on December 13, 2024.
The scheme wants to provide different rights to different investors.
The LVF may avail the exemption from pari-passu treatment only if every investor specifically agrees to waive the pari-passu requirement.
If even one investor does not provide the required waiver, the exemption cannot be assumed for that investor.
