Chapter 9: Legal Documentation and Negotiations

Foundational Legal Architecture of Category III AIFs

Operating an active Category III AIF requires a robust tripartite legal architecture established under Indian law:

INDENTURE OF TRUST

1. Indenture of Trust (Trust Deed)

Executed between the Settlor and the Trustee under the Indian Trusts Act, 1882:

• Declares the trust and formally ring-fences fund assets for the collective benefit of unit-holders.
• Outlines the statutory powers and liabilities of the Trustee, including authority to launch multiple open-ended or close-ended schemes.

2. Investment Management Agreement (IMA)

Executed between the Trustee and the Investment Manager (AMC):

• Delegates broad operational authority to the Manager to execute trades, deploy leverage up to 2x NAV, utilize derivatives, and contract with brokers and clearing members.
• Outlines the exact calculation methodology for management fees, performance fees, hurdle rates, and high-water marks.
• Outlines manager indemnification, standard of care, and removal provisions:
  • "For Cause" Removal: Typically requires a simple majority (>50%) or special majority (>66.7%) LP vote upon fraud, gross negligence, regulatory debarment, or criminal conviction.
  • "Without Cause" Removal: Requires a super-majority vote (typically $\ge 75%$ in value of LPs).

3. Contribution (Subscription) Agreement

Executed between each individual investor, the Trustee, and the Manager:

• Confirms the investor’s financial commitment, subscription amount, and acceptance of redemption schedules and lock-in terms.
• Contains extensive representations regarding accredited investor status, source of funds, AML/KYC compliance, and FATCA/CRS declarations.

Intermediary Agreements Peculiar to Category III AIFs

Unlike Category I and II private equity funds that interact primarily with corporate investee companies, Category III AIFs enter into high-velocity agreements with exchange intermediaries:

1. Professional Clearing Member (PCM) Agreement

• Critical for derivative-heavy Category III funds.
• Outlines margin collateral pledge mechanisms, collateral haircuts, intra-day margin call response times, and default liquidation rights of the clearing member if mark-to-market losses exceed thresholds.

2. Broker-Dealer & Direct Market Access (DMA) Agreements

• Establishes algorithmic order routing, colocation server cross-connects, latency benchmarks, and transaction commission schedules with institutional stockbrokers.

Side Letter Governance and the SEBI MFN Framework

Large institutional investors (anchor LPs, sovereign funds, family offices committing >₹25 Crores) frequently negotiate bilateral Side Letters with the Investment Manager:

Key Guidelines & Structure

• Side Letter and MFN Governance:
• [Anchor LP commits ₹50 Cr] > [Negotiates Side Letter (Tiered Fee Discount Extra MIS)]
• ▼
• [SEBI Mandated MFN Compendium Issued]
• ▼ ▼
• [Eligible Qualifying LPs] [Ineligible LPs]
• (Elect Matching Economic Terms (Commitment below the
• based on Commitment Size) Side Letter threshold)

Common Terms Negotiated in Category III Side Letters

1. Tiered Management Fee Discounts / Rebates: Reduced annual management fees (e.g., 1.25% instead of 2.0%) or discounted performance fee shares (15% instead of 20%) for large commitments.
2. Enhanced Reporting and Risk Transparencies: Daily or weekly risk exposures, Greeks monitoring ($\Delta, \Gamma, \Theta, \text{Vega}$), portfolio VaR reports, and customized ESG audits.
3. Key Person Co-Investment Rights: Preferential capacity allocations in future closed-capacity trading schemes.
4. Customized Redemption Windows: Shorter lock-in periods or discounted redemption fees (subject to fund liquidity).

SEBI Most Favored Nation (MFN) Mandates

To prevent unfair discrimination among unit-holders:

• The Manager cannot enter into side letters that adversely affect the economic or voting rights of other investors.
• Following the final close of a scheme, the Manager must circulate a comprehensive MFN Compendium summarizing all side letter rights granted to any unit-holder.
• Any qualifying investor with an equivalent capital commitment is legally entitled to elect identical rights.

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