The Institutional Mismatch: Why SEBI’s Transplantation of Section 2(76) Relational Frameworks Suffocates Private Contractual Autonomy in Alternative Investment Funds : Author: Aditi Pandey
India's regulatory regime for private investment is undergoing a radical shift in structure, as the Securities and Exchange Board of India (SEBI) last week unveiled a detailed consultation paper on the rationalisation of the concept of "associate" under the SEBI (Alternative Investment Funds) Regulations 2012 (AIF Regulations) according to a "related party" framework borrowed directly from Section 2(76) of the Companies Act 2013 . Previously anchored to the simple threshold of 15% shareholding, the conflicted transaction regime under existing AIF Regulations now introduces a complex set of relationships that runs counter to the basic contractual autonomy underpinning private funds structures
ARTICLE
Introduction and the Conflict of Frameworks
India's regulatory regime for private investment is undergoing a radical shift in structure, as the Securities and Exchange Board of India (SEBI) last week unveiled a detailed consultation paper on the rationalisation of the concept of "associate" under the SEBI (Alternative Investment Funds) Regulations 2012 (AIF Regulations) according to a "related party" framework borrowed directly from Section 2(76) of the Companies Act 2013[1]. Previously anchored to the simple threshold of 15% shareholding, the conflicted transaction regime under existing AIF Regulations now introduces a complex set of relationships that runs counter to the basic contractual autonomy underpinning private funds structures. By creating an institutional misalignment between private pooled vehicles and public operating entities, this regulatory transplant will have serious consequences on transaction efficiency; as at late 2025 funds managing more than INR 15.74 lakh crore in capital commitments are likely to have significant macroeconomic capital formation implications for the Indian economy.[2]
From Associate to Related Party: Rationale and Conscious Exclusions
SEBI observes that the legacy 15% standard fails to capture self-evident conflicts, such as an AIF investing in a company sharing a director with the manager, or where immediate relatives hold controlling stakes[3]. The proposed definition drastically expands this scope by adopting the relationship-based filters of the Companies Act 2013. Consequently, if an AIF manager's director is merely a member of a private company, that company becomes a related party, triggering a 75% investor consent requirement by value under Regulation 15(1)(e) or Regulation 15(1)(ea), even if the director holds no share capital[4]. This broad net sweeps in benign transactions, delaying capital deployment and escalating transaction costs.
Significantly, SEBI proposed notable exclusions, confining the definition strictly to the manager and sponsor of the AIF, while excluding the related parties of trustees and AIF-level directors due to their limited role in day-to-day decisions[5]. Furthermore, SEBI retains the narrow "associate" term in administrative contexts where a broader scope is unwarranted. These include Regulation 11(2) for the disclosure of disciplinary history in the Private Placement Memorandum (PPM) and Regulation 20(11A) for custodian selection[6]. Yet, distinct doctrinal ambiguities persist. The consultation paper remains entirely silent on the statutory friction it creates within its own regulatory architecture. Specifically, it fails to reconcile this new Section 2(76) baseline with the pre-existing, distinct "related party" definition housed in Regulation 19A(3) for Angel Funds within the AIF Regulations themselves[7]. By layer-pasting public market philosophies onto private structures without cleaning up internal text, the proposal threatens to create a dual, fragmented compliance landscape that leaves market participants exposed to conflicting transactional thresholds.
Standardizing the Consent Conundrum
SEBI also proposed a uniform 75% investor consent threshold by value, replacing legacy two-thirds (66.6%) requirements for material alterations of strategy under Regulation 9(2) or tenure extensions under Regulation 13(5)[8]. All conflicted related-party transactions will similarly require 75% approval. To calculate consent, fund managers must choose one of three voting methodologies, disclosed in the PPM and applied consistently across the scheme[9]:
Methodology Option
Voting Calculation Mechanism
Operational and Economic Implications
Deemed Consent
Non-responses within specified timelines are treated as approvals.
Implements operations in an efficient manner; favoured by advanced institutional investors.
Present and Voting
Only active votes cast are counted; abstentions are not included in denominator.
Aligns with public market standards; rewards active participation but increases complexity.
Express Voting
Only affirmative votes are counted against the total value of the fund.
Offers absolute investor protection but creates high execution risk when participation is low.
The Core Institutional Mismatch and Judicial Context
This uniform voting matrix, while mathematically structured, exposes the deeper institutional mismatch driving SEBI’s current policy direction. Fund governance and corporate governance operate on fundamentally distinct legal planes. While public retail markets naturally require extensive regulatory paternalism to protect fragmented, non-professional shareholders, alternative investment vehicles rely on a foundational architecture of private contracts negotiated between sophisticated fiduciaries and institutional Limited Partners (LPs). Imposing corporate relational frameworks restricts the freedom of the LP and General Partner (GP) to manage portfolio risks through contract.
The comparison of trends in international and domestic courts underlines this mismatch. In the United States, the U.S. Court of Appeals for the Fifth Circuit in the landmark case National Association of Private Fund Managers v. SEC (NAPFM) invalidated the Securities and Exchange Commission's Private Fund Adviser Rules[10]. The court found that the regulator had overstepped its statutory powers in seeking to regulate private contractual arrangements, finding that sophisticated investors do not require retail-style paternalism[11].
This mandate for structural predictability is further reinforced by recent domestic judicial trends. In Securities and Exchange Board of India v. Ram Kishori Gupta (Ram Kishori Gupta), the Supreme Court of India strictly curbed regulatory arbitrariness by affirming that the principle of res judicata is fully applicable to SEBI’s quasi-judicial proceedings[12]. The apex court held that once an enforcement action achieves finality, the regulator cannot dynamically reopen the same cause of action to shift compliance goalposts[13]. By extension, if the judiciary binds SEBI to the finality of its own administrative boundaries to preserve public policy, SEBI’s current proposal to retroactively disrupt private fund architectures by importing sweeping public corporate law definitions represents a clear overreach.
While in Mr. Nilesh Shah & Ors. v. SEBI (Nilesh Shah) the Supreme Court emphasized that compliance with mutual fund regulations cannot be overlooked even if investors eventually make profits, holding that “market integrity being the paramount consideration, profit or loss to investors is immaterial to determine whether a regulatory infraction has occurred” (emphasis supplied)[14]. Pursuant to the Securities and Exchange Board of India Act 1992 (SEBI Act 1992), the regulator operates with a wide mandate to protect market integrity, but forcing the private market to wear the restrictive clothing of a public listed company destroys transactional velocity[15].
Suggested Reforms
To balance regulatory oversight with market efficiency, SEBI should adopt a tiered, materiality-based framework. First, transactions below a specific materiality threshold—such as 5% of the fund’s net asset value—should be exempted from the rigid 75% approval requirement, provided they are cleared by an independent Limited Partner Advisory Committee (LPAC). Second, Large Value Funds for Accredited Investors and accredited investor-only schemes should be granted conditional autonomy to contractually define related parties and negotiate custom voting thresholds in their PPMs, reflecting their sophisticated investor base. Finally, SEBI must unify the related-party definition with Regulation 19A(3) to avoid a dual, fragmented compliance landscape[16].
Conclusion
The proposed transplantation of Section 2(76) of the Companies Act 2013 into AIF Regulations represents an overreach that suffocates private contractual autonomy. To build a resilient corporate debt and private equity ecosystem, India must balance regulatory oversight with the operational flexibility required by private capital.
[1] Securities and Exchange Board of India, Consultation Paper on Review of Related Party Transaction Framework for Alternative Investment Funds (30 June 2026).
[2] Securities and Exchange Board of India, Alternative Investment Funds Industry Report (December 2025).
[3] Securities and Exchange Board of India, Consultation Paper on Review of Related Party Transaction Framework for Alternative Investment Funds (30 June 2026).
[4] Securities and Exchange Board of India (Alternative Investment Funds) Regulations 2012, regs 15(1)(e), 15(1)(ea).
[5] Securities and Exchange Board of India, Consultation Paper on Review of Related Party Transaction Framework for Alternative Investment Funds (30 June 2026).
[6] Securities and Exchange Board of India (Alternative Investment Funds) Regulations 2012, regs 11(2), 20(11A).
[7] Securities and Exchange Board of India (Alternative Investment Funds) Regulations 2012, reg 19A(3).
[8] Securities and Exchange Board of India, Consultation Paper on Review of Related Party Transaction Framework for Alternative Investment Funds (30 June 2026).
[9] ibid.
[10] National Association of Private Fund Managers v Securities and Exchange Commission, US Court of Appeals for the Fifth Circuit (2025).
[11] ibid.
[12] Securities and Exchange Board of India v Ram Kishori Gupta (Supreme Court of India).
[13] ibid.
[14] Mr Nilesh Shah and Others v Securities and Exchange Board of India (Supreme Court of India).
[15] Securities and Exchange Board of India Act 1992.
[16] Securities and Exchange Board of India (Alternative Investment Funds) Regulations 2012, reg 19A(3).