ANALYSIS OF SEBI’S DENIAL OF WAIVER OF RIGHTS BY INVESTORS OF AIF
Updated: Nov 9, 2020
This post is authored by Anurag Shah, a B.A.LL.B candidate at School of Law, Christ University.
In its interpretative letter dated September 17th, 2020, the Securities and Exchange Board of India (SEBI) provided informal guidance to Lets Venture Advisors LLP (LV Angel Funds). The guidance was related to the SEBI (Alternative Investments Funds) Regulations, 2012 (AIF Regulations). LV Angel Funds is a trust which is registered with SEBI as a category I AIF. As per Regulation 3(4) (a) of the AIF Regulations, a category I AIF can invest in start-ups or early-stage ventures or social ventures or small and medium-sized enterprises (SMEs). Through a request for interpretation under SEBI (Informal Guidance) Scheme, 2003, LV Angel funds had sought certain clarifications related to the AIF Regulations.
The main objective of the AIF Regulations was to bring all the funds established in India or to be established in India under one omnibus regime. AIFs are divided into three broad categories on the basis of the kind of investments they undertake. An AIF which invests in start-ups and new businesses with high growth potentials is known as Category I AIF. Funds that invest in equity and debt securities are known as Category II AIF, while the funds that employ various complex and diverse trading strategies to achieve short term capital gains are known as Category III AIFs. Each of these categories has a minimum requirement that the fund must meet before it is recognized as an AIF. As per Regulation 19A(2) of the AIF Regulations, to be registered as an Angel fund under Category I AIF, two requirements must be met: firstly the body corporate must have a minimum net worth of Rs. Ten Crores, and secondly, the individual investors constituting such body corporate must have net tangible assets of at least Rs. Two Crores excluding the principal residence.
LV Angel Funds wanted to constitute a Limited Liability Partnership (LLP) consisting of different angel investors. The same was being done for succession and estate planning. The individual partners of the LLP had a minimum net worth of Rs. Two Crores each, however, the LLP would not be able to reach the threshold of the body corporate under the regulation. Therefore, LV Angel Funds sought guidance on whether an LLP, the partners of which qualified as angel investors in personal capacity, would be considered angel investors even if the LLP does not meet the Ten Crores threshold for body corporates.
Moreover, Regulation 19G(3) of the AIF Regulations provide for the manager of an angel fund to obtain an undertaking from every individual angel investor providing their approval for the concerned investment, before such an investment is made. LV Angel Funds had received representations from their investors that they wanted to waive off this statutory right. The investors found it very cumbersome to provide approval for every investment. The investors stated that as long as certain investors agree to participate in an investment (Lead Investors), they wanted the fund manager to assume that all the investors consent to the said investment.
SEBI considered all the interpretations of the queries and answered them in negative. The stance taken by SEBI for the first query was that the LLP is a distinct entity. An LLP is separate from its partners and therefore, the body corporate requirements must also be met. This interpretation is in line with Section 3 of the Limited Partnership Act of 2008, which provides that an LLP would be considered a separate legal entity from its partners. Therefore, irrespective of the net worth of the partners, the LLP must also have a minimum net worth as prescribed in the AIF Regulations for it to be considered an angel investor.
Concerning the second issue, SEBI was of the view that the statutory right provided under Regulation 19G (3) equips the investor with the right to object to any such investment by the fund which they think is not fit for them. The right cannot be waived as the AIF Regulations do not provide for such waiving of rights. Therefore, the second interpretation has the effect of providing a precedent in the form that the rights under the AIF Regulations cannot be waived off. However, this particular interpretation has to be seen in the light of the Doctrine of Waiver in India.
Doctrine of Waiver of Rights
A legal right is considered as an interest which the law protects by imposing corresponding duties on others. However, the Doctrine of Waiver of rights provides for instances when these legal rights can be waived off by a person whose interest the law seeks to protect. Waiving of different kind of rights has been considered by the Indian Courts. While the waiving of fundamental rights in India is not permitted, the same is permissible for contractual rights under Section 63 of the Indian Contract Act, 1872. The issue arises in the case of statutory rights, like the right under AIF Regulations.
Statutory rights can be waived off as well, however, there have been multiple restrictions imposed by the Courts on it. For waiving a statutory right, a person must first be fully cognizant of the right he/she is waiving off. Moreover, a person can waive off his rights in multiple ways which include estoppels and election. The most important requisite is that a waiver of a statutory right is only permissible as long as such waiver does not infringe the rights of the others and is not against the public policy or morals. The crux of this restriction is that no person can waive off any statutory right which has been enacted in the public interest. These aspects are generally ascertained by looking into the legislative intent of the statute and the right.
Analysis and Conclusion
The AIF Regulations incorporate a duty on the fund manager to take approvals from the investors before every investment. In relation to this duty, the investors have the right to object to any investment. SEBI denied the waiving off the right as the same would go against the interest of the public and because the AIF Regulations do not provide for waiving off any rights. It is pertinent to note that for waiver of right none of the precedents state that a provision for such waiving must be expressly given in the statute itself. Therefore, it can be safe to assume that even in the absence of a specific provision that allows the waiving; the same can be done if it satisfies the conditions. In the situation of LV Angel Funds, it is the investors who are requesting this waiver and are fully cognizant. Therefore, the only question is the fulfilment of the third condition related to the public interest.
The test to determine whether the nature of interest that is involved in a statutory right is private or public is whether the rights pertain to the party alone or whether the general welfare of the society is also involved. The angel investors, unlike the investors of a listed entity, are specific individuals which meet the threshold of the AIF Regulations. In case these specific individuals choose to waive off a statutory right, the same would not have any considerable impact upon the welfare of the general public. Moreover, the fact that Category I AIFs invest in start-ups and SMEs, the impact of an investment not going as planned would also not have an effect upon the general public. If the same situation was related to the investors of a listed entity, it would have a different and substantial effect on the general public, as in cases of listed companies, public money at large is involved.
In light of the points mentioned above, speaking from the backing of precedents, SEBI’s interpretation takes a very restrictive view on the Doctrine of Waiver and the same could have been allowed as it would benefit these angel funds and investors. As was represented by LV Angel Funds, getting an undertaking of approval before every transaction is cumbersome and a hassle. If the investors unilaterally decide to waive off this right, this would make it easy for the fund managers to seamlessly undertake investments. The same would remove an additional duty upon the manager, thereby decreasing the economic cost of compliance for the Angel Funds.
The stance taken by SEBI can also be analyzed by comparing it with the waiving off the right to a dividend. Neither the Companies Act, 2013 nor any of the SEBI Regulations specifically provide for waiving off a right to a dividend. However, it is an accepted practice for investors to waive off their right to a dividend so that the same can be utilized for the day-to-day activities of the company that would eventually benefit the shareholders in the long term. This goes against the stance taken by SEBI in the informal guidance given to LV Angel funds as one of the reasons given by SEBI was that the AIF Regulations do not provide for waiving off rights enshrined under it. Moreover, the Supreme Court has laid down that the source of the right - contractual, statutory, or constitutional - should not be the basis for allowing a waiver. Rather, the test should be whether the benefit of the right is conferred on the public or an individual. This is why even though a right to the dividend arises from the Articles of Association of the company, the same can be waived off owing to the fact that the benefit of this right is for the investors and not the public. Going by this same logical flow, the right of an investor to object to an investment is also for the benefit of the investor and not the general public. This clearly puts forth a proposition that SEBI could have considered allowing this waiver as it would make investments seamless for angel funds.
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