Associate Exit and Co-Investment in a Category II Fund

The transaction is not prohibited outright, but it is an associate transaction and a material conflict. Under the AIF Regulations, a Category I/II fund's investment in an associate of the sponsor or manager requires enhanced investor consent-at least 75% of investors by value-and must be on arm's-length terms. Because the PPM is silent, the manager cannot rely on a general co-investment clause. It must convene an LP vote with full disclosure: an independent valuation report, the affiliate's cost base, the split between secondary and primary legs, and the benefit to the affiliate. The 25% single-investee cap for Category I/II also matters: Rs 150 crore is exactly 25% of the Rs 600 crore corpus, leaving no headroom for follow-on capital or guarantees. The manager should size below the cap or obtain a clear limit. The primary leg alone may be less conflicted, but the package should be voted as one. If consent is not obtained, the fund can only do the primary leg if that leg is not itself an associate investment, or it should walk away. The manager should also check whether the secondary purchase triggers PPM transfer restrictions and whether an independent fairness opinion is required.

Co-investment is permitted only where the PPM and fund documents allow it, and it must be offered on the same terms and price as the fund's investment. Giving the anchor investor exclusive access because it is supportive of the conflicted deal is preferential treatment. The manager should first adopt and disclose an allocation policy-typically pro rata to commitments or a pre-agreed co-investment pool. If the anchor investor was pre-designated in the PPM, the manager must still tell other LPs and give them a fair opportunity to participate. The co-investment terms should mirror the fund's economics: no undisclosed fee, no carried interest on the co-investment unless the PPM says so, and no different valuation. The manager should document why the anchor was selected and obtain LPAC or independent-director approval. Co-investment should not be used as a reward for approving the associate transaction; the two decisions should be separated and voted separately.

The CEO should recuse himself from the investment committee's deliberation and vote, and the minutes should record the recusal and the reasons. His Target board seat gives him access to confidential information and creates a duty to Target that may conflict with his duty to the fund. The manager should establish an information barrier so that Target board information is not used for the fund's investment decision. If the remaining investment committee members are not independent, the manager should constitute a conflicts committee of independent members or seek LPAC approval. The CEO's dual role must be disclosed in the investor consent materials. If the committee proceeds without managing the conflict, the transaction can be challenged, and the manager may face regulatory action for breach of fiduciary duty and its code of conduct. The manager's duty is to act in the best interest of the scheme and its investors, not the affiliate.