A Category Built for a Specific Job
Most Category I sub-categories exist to channel capital toward growth — start-ups, SMEs, infrastructure. Special Situation Funds (SSF) exist for the opposite end of the credit cycle: acquiring and working out debt that has already gone bad. SEBI carved this out as a distinct Category I sub-category (under Chapter III-B of the AIF Regulations) specifically because stressed-debt investing needs a different regulatory posture than growth-stage venture investing — larger tickets, RBI-aligned acquisition mechanics, and a direct interface with the Insolvency and Bankruptcy Code.
What Counts as a 'Special Situation Asset'
An SSF's mandate centres on 'special situation assets' — principally stressed loans acquired from banks, NBFCs, and other financial institutions, along with related security interests and other distressed exposures the fund's PPM defines. This is narrower than "distressed investing" as a broad strategy label (see our companion article on distressed asset investing beyond IBC) — an SSF's regulatory identity is specifically tied to the stressed-loan acquisition mechanism.
Minimum Corpus and Ticket Size — Deliberately Set High
SEBI calibrated SSF thresholds well above standard Category I norms, reflecting the scale and risk profile of distressed-debt investing:
- Minimum scheme corpus: ₹100 crore
- Minimum investment per investor: ₹10 crore for standard investors
- ₹5 crore for Accredited Investors
- ₹25 lakh for employees/directors of the SSF or its manager This is a materially higher bar than a typical Category I venture fund, and deliberately so — SEBI's intent is to keep this category accessible to genuinely sophisticated, well-capitalised investors capable of absorbing the binary outcomes distressed-debt investing produces.
How SSFs Acquire Stressed Loans
SSFs can acquire stressed loans under RBI's Transfer and Distribution of Credit Risk Directions, once SSF is included within the class of entities RBI permits such transfers to. In practice, this means an SSF steps into a lender's shoes on a defaulted or near-defaulted loan, acquiring the underlying credit exposure (and associated security) at a negotiated discount to face value, with the thesis that active workout, restructuring, or recovery will realise more value than the loan's current market price reflects.
The Six-Month Lock-In — and Its One Exception
Loans acquired under the RBI framework carry a mandatory 6-month lock-in before the SSF can dispose of them further — a provision designed to prevent stressed-loan flipping and keep SSFs genuinely engaged in workout activity rather than pure arbitrage. The one exception: this lock-in is waived where disposal happens through recovery from the borrower itself — i.e., the SSF can be repaid by the borrower at any time; the lock-in only restricts onward sale of the loan to a third party.
SSFs as Resolution Applicants Under IBC
An SSF can act as a resolution applicant in a Corporate Insolvency Resolution Process (CIRP), subject to meeting IBC's own eligibility requirements (including Section 29A disqualification checks). This gives SSFs a genuine seat at the table in formal insolvency resolution, distinct from — but complementary to — acquiring stressed loans bilaterally outside a formal CIRP. Our companion article, "When a Portfolio Company Defaults," covers financial-creditor mechanics and Committee of Creditors participation in detail; an SSF is simply one specific vehicle type that can exercise those rights.
Due Diligence Standards — Matched to ARC-Level Rigour
SEBI requires SSFs to apply due diligence standards to their stressed-loan investors that are no weaker than what RBI mandates for Asset Reconstruction Company (ARC) investors — both at initial onboarding and on a continuous basis. This is a deliberate regulatory alignment: since SSFs and ARCs both ultimately compete for the same stressed-loan pool, SEBI has ensured SSFs can't undercut ARC-level investor scrutiny as a competitive shortcut.
SSF vs ARC — Two Routes to the Same Market
A natural question for anyone evaluating this space: why would a stressed-loan seller (or an investor wanting exposure) choose an SSF over an Asset Reconstruction Company? The structural differences matter:
- Regulator: ARCs are RBI-regulated under the SARFAESI Act; SSFs are SEBI-regulated AIFs.
- Investor instrument: ARCs typically issue Security Receipts (SRs) linked to specific asset pools; SSF investors hold AIF units in a pooled, diversified structure.
- Flexibility: An SSF's AIF wrapper allows a broader palette of strategies (equity conversion, resolution-applicant participation) alongside pure loan acquisition, compared to an ARC's more constrained SARFAESI toolkit.
Why This Category Matters for India's Credit Cycle
India's banking system periodically generates meaningful stressed-asset volumes, and the SSF framework gives sophisticated capital a regulated, SEBI-recognised route to participate in resolving it — complementing ARCs and the IBC process rather than competing to replace either. For fund managers with genuine credit workout expertise, it's a distinct, high-conviction category worth understanding on its own terms rather than treating as "just another Category I sub-category."
Structuring an SSF Correctly From Day One
Given the elevated minimum corpus, the RBI-alignment requirements, and the ARC-equivalent due diligence bar, SSF structuring needs both SEBI and RBI-framework fluency at the PPM drafting stage. We advise sponsors evaluating this category on eligibility, PPM structuring, and the operational due diligence framework SEBI expects.
This article is for general informational purposes and does not constitute regulatory advice specific to any fund's structuring decisions.