As the initial vintages of funds registered under the AIF Regulations, 2012 regime approach their terminal phases, the procedural intricacies of liquidation, winding up, and the management of unliquidated investments have come to the forefront. The highly articulated ‘Dissolution Period’ and ‘Liquidation Scheme’ frameworks introduced between 2023 and 2025 reflects a maturing ecosystem that prioritizes investor protection, market transparency, and the orderly disposal of illiquid assets.
Foundational Classification
The legal prerequisite for the liquidation of an AIF is the expiration of its tenure. Regulation 13(1) mandates that Cat. I and Cat. II funds must be close-ended, and their tenure must be determined at the time of application. The calculation of this tenure typically begins from the date of the first close.
The Legal Mechanism of Winding Up
The winding up of an AIF is a legal process distinct from the operational liquidation of its assets. Regulation 29 provides the statutory grounds and procedures for this termination, which vary depending on the legal form of the fund. For the majority of Indian AIFs established as trusts, the winding up is triggered by the expiry of the tenure, the opinion of the trustees that winding up is in the interest of investors, or a resolution passed by seventy-five percent of the investors by value.
Upon the trigger of winding up, the fund must intimate SEBI and its investors of the circumstances leading to the termination. From the date of this intimation, the fund is prohibited from making any further investments. The period following this intimation is the Liquidation Period, which the regulations define as a one-year window during which the manager must liquidate all assets, satisfy liabilities, and distribute the remaining proceeds to the unit holders. The failure to complete this process within the specified time frame has historically led to a regulatory impasse, particularly when dealing with unliquidated investments.
Liquidation Schemes to the Dissolution Period
The Dissolution Period is defined as the time frame following the expiry of the liquidation period for the purpose of liquidating unliquidated investments. Its tenure cannot exceed the original tenure of the scheme and cannot be extended. During this period, the fund is strictly prohibited from accepting new commitments, making new investments, or charging management fees.
Dissolution Procedure
Entering a Dissolution Period is not an automatic right of the manager. It is a conditional privilege subject to investor protection norms. The primary requirement is obtaining the positive consent of at least seventy-five percent of the investors by value. To ensure that this consent is informed and that dissenting investors have a fair exit, the manager must arrange a bid for a minimum of twenty-five percent of the value of the unliquidated investments. The bid must be arranged for the consolidated value of all unliquidated investments in the scheme’s portfolio. If the manager successfully secures such a bid, they must offer the dissenting investors the option to fully exit the scheme using the proceeds of this bid. If any portion of the bid remains after satisfying the dissenting investors, it may be used to provide a pro-rata exit to the consenting investors.
In-Specie Distribution and Mandatory Triggers
When a fund is unable to sell its assets for cash, it may resort to in-specie distribution – the distribution of the underlying securities to the investors. Regulation 29(8) and 29(9) govern this process. The 2024 amendments introduced mandatory in-specie distribution in two specific scenarios:
- First scenario occurs during the liquidation period if the fund fails to obtain the seventy-five percent consent required to either enter a Dissolution Period or for a voluntary in-specie distribution. In such cases, the manager must distribute the unsold assets in-specie to all investors without further consent.
- The second scenario occurs at the end of the Dissolution Period. If any investments remain unsold upon the expiry of this terminal phase, they must be mandatorily distributed in-specie.
Constraints of In-Specie Distribution
The process of in-specie distribution is fraught with legal and logistical complexities, particularly for Category II AIFs that may hold diverse assets like unlisted debentures or private equity in sectors with FDI restrictions. The manager is required to value these investments through two independent valuers and determine the fair value. A dissociation option must be provided to non-consenting investors where the manager attempts to buy out their share. If a buyout is not feasible, the investments are written off.
Fiduciary Obligations and the Role of the Trustee
The terminal phase of an AIF’s lifecycle places an heightened burden on the fiduciary actors – the Manager and the Trustee. A landmark development in AIF jurisprudence is the SEBI enforcement action in the matter of India Asset Growth Fund (IAGF) and its trustee, Vistra ITCL. In this case, the fund’s tenure had expired, but the assets remained unliquidated for years without a formal regulatory extension. SEBI penalized the trustee, rejecting the defense that its role was merely passive and that it had informed the regulator of extensions backed by eighty percent investor consent. The regulator clarified that Regulation 29(1)(a) is mandatory; upon expiry of the tenure, the winding-up process must commence, and the trustee has a proactive duty to forewarn the manager and ensure regulatory compliance. This confirms that AIF trustees in India are considered active guarantors of compliance rather than mere administrative bodies.
The 2026 Regulatory Consultation
The most recent phase of regulatory evolution is captured in the consultation paper of February 5, 2026. SEBI observed that many funds are unable to formally surrender their registration because they cannot achieve a “NIL” bank balance, often due to pending litigation, tax demands, or the need to retain funds for operational expenses like audit and compliance.
SEBI has proposed allowing funds to retain money beyond the permissible fund life in specific, defined circumstances. This includes demonstrable tax notices or pending litigation, provided seventy-five percent investor consent is obtained for the retention. Funds meeting these criteria can be tagged as ‘Inoperative Funds,’ which allows them to benefit from a lighter compliance framework.
This proposal marks a significant shift in the SEBI’s philosophy, recognizing that exit should be as operationally efficient as entry. By reducing the regulatory burden on terminal-stage funds, SEBI aims to ensure that the remaining capital is preserved for satisfying legitimate liabilities rather than being consumed by compliance costs.
Reporting Obligations and Transparency during Liquidation
Transparency remains a non-negotiable requirement throughout the winding-up process. Regulation 22 and subsequent circulars mandate that AIFs disclose all transactional, operational, and risk-related information to their investors periodically. When entering a Dissolution Period, a fund must file a detailed Information Memorandum (IM) with SEBI.
The IM for the Dissolution Period must include the dates of the initial and final close, the end date of the tenure, cumulative investments made, and specific details of the unliquidated assets, including their latest valuation and the percentage of investor consent obtained. A Merchant Banker must provide a due diligence certificate ensuring that the disclosures are true, fair, and in compliance with the regulations.
Conclusion
The evolution of AIF Regulations in relation to the terminal stages of a fund’s life, represents a sophisticated synthesis of market flexibility and regulatory oversight. The introduction of the Dissolution Period and the subsequent refinements to in-specie distribution norms have provided much-needed operational certainty in an inherently illiquid asset class. As the industry looks toward 2026, the proposed Inoperative Fund status promises to address the final bottleneck in the AIF lifecycle – the administrative struggle to surrender registration amidst pending legal or tax contingencies. These collective measures ensure that India’s private capital ecosystem remains transparent, accountable, and sustainable, providing global and domestic investors with a clear and predictable pathway from deployment to final exit.