Special situations funds: meaning, how they work in India

A special situations fund looks for value where an ordinary investor sees only risk. The target is usually a business that is stuck: it has borrowed more than it can repay, a lender wants out, a promoter needs cash fast, or a court-supervised process is under way. The fund steps in with money and patience, and tries to earn a return when the problem is fixed.

The fund is run by a manager and holds money from investors who commit large sums for years. Such funds are a type of alternative investment fund (AIF), the pooled vehicles that SEBI regulates under the SEBI (Alternative Investment Funds) Regulations 2012. A recent live case is Canonicus Capital, which closed ₹192 crore of a planned ₹500 crore special situations fund, according to StopDown's story.

The basic trade is to buy something cheap because it is troubled, then improve it or wait for it to recover. Returns come from a few places.

• Buying a stressed loan at a discount to its face value and recovering more than the price paid, through repayment, settlement or a sale of the collateral.
• Lending fresh money to a stretched company at a high interest rate, often with security over assets.
• Taking shares in a company that needs rescue capital, then selling them after it recovers.
• Backing a resolution plan for an insolvent company and running or reselling the business.

SEBI changed the AIF Regulations in January 2022 to add Special Situation Funds as a sub-category of Category I AIFs, as of November 2026. These funds may invest only in what the rules call special situation assets. That covers stressed loans that banks and other lenders are allowed to sell under RBI rules, and assets acquired through a resolution plan under the Insolvency and Bankruptcy Code, 2016 (IBC), along with other assets SEBI may specify.

The rules also let such a fund act as a resolution applicant under the IBC, if it meets that law's eligibility conditions. The minimum corpus for a Special Situation Fund is ₹100 crore, against ₹20 crore for most other AIF schemes, according to SEBI's table as summarised by law firms. The usual diversification cap that stops a Category I fund putting too much in one company does not apply to these funds, and they cannot take money from another AIF unless that AIF is also a Special Situation Fund. Check SEBI's current circular for any later change.

The label covers many cases, and a manager usually specialises in a few of them. Knowing the common types helps a reader judge what a fund's announcement actually means.

Each case needs a different skill. A loan purchase calls for legal and recovery teams, a rescue investment calls for operating experience, and an insolvency bid calls for people who know the tribunal process well.

• Stressed loans: a bank or NBFC sells a loan that the borrower has stopped repaying.
• Rescue financing: a business with a good product but too much debt needs fresh money to continue.
• Corporate actions: a demerger, a buyout of a minority, or a sale of a division creates a mispricing.
• Promoter funding gaps: an owner needs cash against shares or assets and cannot get it from a bank.
• Insolvency resolution: a fund bids to take over a company that has entered the IBC process, alone or with a partner.

Banks and NBFCs sell bad loans to clear their books. The sale follows the RBI Master Direction on Transfer of Loan Exposures, issued in 2021. A lender can sell a non-performing loan to an asset reconstruction company (ARC), to another eligible lender or to a fund that is allowed to buy it, usually through an auction.

The buyer pays a price below the loan's value. If the fund collects more than it paid, the gap is its profit. If the borrower stays broke and the collateral sells for little, the fund can lose money. This makes the work slow, legal and negotiation heavy.

The terms overlap, and people use them loosely. Distressed debt means buying the debt of a company in or near default. A special situations fund is wider: distressed debt is one of its tools, but it can also back a spin-off, a restructuring or a promoter in a cash crunch. Private credit means lending directly to companies outside banks and bond markets, often to healthy borrowers, and it targets steady interest rather than a rescue gain.

A venture fund backs growth and accepts that most bets fail. A special situations fund takes the opposite stance: it starts with a known problem and prices the risk into what it pays.

The main risk is that the recovery never comes. A borrower can go on stalling, a court case can run for years, or collateral can turn out to be worth less than expected. Time is also a cost: money tied up for five years earns less each year than the same profit made in two.

Other risks are about information. A stressed company often has patchy records, so the fund must dig into accounts, disputes and ownership before buying. A fund's results can also depend on a few large cases, which makes a single bad outcome costly. For these reasons the investors who back such funds are expected to be able to bear losses, and the manager is judged on recoveries realised, not on valuations alone.

Investors are mainly wealthy families, family offices, institutions and other large investors, because AIFs have a minimum commitment per investor of ₹1 crore under the AIF Regulations. They are drawn by the chance of higher returns than listed debt. They accept that money is locked up for years and that results are uneven, since each rescue is different.

Funds usually raise money in stages. A first close brings in the initial commitments and later closes add more. The StopDown story on Canonicus Capital describes exactly this: a first close of ₹192 crore against a ₹500 crore target.

Read the number carefully. A fund size can mean money committed by investors, which is paid in over time, not cash already in hand. Check whether the amount is a first close or a final close, and whether the target is a hope or a firm cap.

Also check what the fund will do with the money. A claim of backing special situations should be backed by a named strategy: stressed loans, rescue capital or insolvency bids. The category also carries tax questions around how gains are taxed in the fund and in the investor's hands, and these have drawn commentary from tax advisers. As with any rules-heavy topic, this page is general information, and a lawyer or tax adviser should be consulted before acting on it.