Cross-Scheme Cash and Allocation of a Bridge Round
A manager operates two Category II schemes: Scheme A, a 2020-vintage fund with Rs 250 crore committed, and Scheme B, a 2022-vintage fund with Rs 400 crore committed. Both have the same investment team but separate LPs and bank accounts. A portfolio company in Scheme A needs Rs 30 crore of bridge funding; Scheme A has only Rs 5 crore of cash. Scheme B has Rs 100 crore of undeployed cash. The manager transfers Rs 25 crore from Scheme B to Scheme A as a 'secured inter-scheme loan' at 9%, taking a charge over the portfolio company's shares. In the same week, the manager allocates a new, oversubscribed deal entirely to Scheme B because Scheme A is 'over-committed'. Scheme A's LPs discover the transfer and complain that they are being treated as a rescue vehicle for the manager's older fund.
1. Is the inter-scheme loan permissible? What are the regulatory and fiduciary problems?
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No. Each AIF scheme is a separate pool of assets with its own investors, PPM, accounts, and investment restrictions. Using Scheme B's cash to rescue Scheme A is a cross-scheme transaction that exposes B's LPs to A's risk without consent and may breach the PPM and the AIF Regulations. The 'secured loan' does not cure it: the collateral is an illiquid private company share, the 9% rate may not reflect the risk, and B's LPs did not approve an investment in A or in the portfolio company. It also creates a conflict because the manager controls both sides and may favour A. The transfer should be reversed. If B's LPs want exposure, they must approve a proper co-investment or acquisition at arm's length. The manager may face action for breach of fiduciary duty and for failing to segregate scheme assets. The manager should also check whether the transfer breached custody and bank-account controls.
2. How should the new deal have been allocated between the two schemes?
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The deal should be allocated under a pre-disclosed allocation policy, not by ad hoc choice. If both schemes have overlapping mandates, the default should be pro rata to available capital or remaining investment period, or a rotation policy, with a documented rationale. Scheme B may take the deal if Scheme A's PPM is exhausted or if Scheme A's LPs consent, but the manager cannot starve Scheme A of a good asset while using Scheme B to bail Scheme A out. The allocation should consider each scheme's investment period, concentration limits, reserves, and LP base. The LPACs of both schemes should review the conflict. If the deal was sourced by the manager's team for Scheme A, Scheme A should have the first right, subject to its ability to fund. Disclosure to both LP sets is essential, and the manager should not use the allocation as a reward or punishment for investor behaviour.
3. What should the manager and the LPAC do to remediate?
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The manager should reverse the inter-scheme loan, restore cash to Scheme B, and unwind the charge. It should convene the LPACs of both schemes with full disclosure and obtain independent legal and valuation advice. It should review all cross-scheme transactions and fee allocations for the past 12 months. It should adopt a written allocation and cross-scheme policy, with LPAC approval. If there is a breach, it should report to SEBI and remediate investor losses. The manager should not charge Scheme A for the cost of the rescue or Scheme B for the failed allocation. It should document conflicts and recusals. It should consider a third-party review of the manager's controls and segregation of bank accounts and custody. The LPAC should also assess whether the manager's conduct warrants a fee adjustment or other remedy for affected LPs.