Table of Contents
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 │
│ Settlor & Trustee establish Trust │
│ Defines powers, duties, unit classes │
└───────┬────────────────────────┬───────┘
│ │
Executes Contribution │ │ Appoints Manager
Agreement ▼ ▼
┌──────────────────────────────────────┐ ┌──────────────────────────────────────┐
│ CONTRIBUTION AGREEMENT │ │ INVESTMENT MANAGEMENT AGREEMENT │
│ Investor (LP) & Trustee/Manager │ │ Trustee & Investment Manager │
│ Governs subscription, redemption terms│ │ Sets fees, leverage delegation, │
│ lock-in, AML/KYC representations │ │ standard of care, removal "For Cause"│
└──────────────────────────────────────┘ └──────────────────────────────────────┘
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:
Category III Intermediary Contracts:
┌───────────────────────────────────────┐
│ Custody Agreement │ • Independent safekeeping of securities and cash
│ (Mandatory SEBI-Registered Custodian) │ • Verifies asset ownership and trade settlements
└───────────────────┬───────────────────┘
│
┌───────────┴───────────┐
▼ ▼
┌───────────────────────┐ ┌───────────────────────┐
│ Professional Clearing │ │ Institutional Broker │
│ Member (PCM) Contract │ │ (DMA & Algorithm Gate)│
│ Margin management, │ │ Low-latency execution,│
│ derivatives settlement│ │ algorithmic routing │
└───────────────────────┘ └───────────────────────┘
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:
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
- 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.
- Enhanced Reporting and Risk Transparencies: Daily or weekly risk exposures, Greeks monitoring ($\Delta, \Gamma, \Theta, \text{Vega}$), portfolio VaR reports, and customized ESG audits.
- Key Person Co-Investment Rights: Preferential capacity allocations in future closed-capacity trading schemes.
- 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.