Distribution Agreement
Also written Agreement with distributor · AIF distribution agreement · Placement agreement
The contract between an AIF's investment manager and a distributor, defining the distributor's role, binding it to a code of conduct and fixing how commission may be paid.
In plain language
An AIF sells only by private placement. Even so, somebody has to reach the investors. That somebody is a distributor.
The Distribution Agreement is drawn up between the investment manager of the AIF and the agency being appointed as distributor. Note who signs: the manager, not the trustee and not the fund.
The agreement does two jobs.
It defines the role of the distributor and prescribes a code of conduct. The code is mostly a list of things the distributor may not do. It may not alter the manager's marketing material. It may not take on debts in the manager's name. And it may not offer a rebate to win a sale.
It also fixes the money. SEBI has set rules on how a distributor may be paid, and they differ by category of AIF.
The short version of those rules: Category III AIFs may pay nothing upfront. Category I and II may pay up to a third upfront. The rest is paid as a trail over the life of the fund.
And an investor who is already paying a fee to an adviser must be onboarded on a Direct Plan, with no commission at all.
How it works
Section 13.7.3 covers the agreement and the commission framework together.
Who signs and what it does. The Distribution Agreement is drawn up between the Investment Manager of the AIF and the agency being appointed as a distributor for the AIF products. It defines the role of the distributor and prescribes a Code of Conduct.
The workbook's four named covenants.
| Covenant | Substance |
|---|---|
| No alteration of documents | The distributor agrees not to make any statement or do any act, including any alteration, addition, modification or erasure, on any marketing literature or document of, issued by, provided by the investment manager, or filled up by an investor |
| No liability in the manager's name | The distributor agrees not to incur or purport to incur any debt or liability on behalf of the investment manager unless specifically authorised in writing |
| Training | The manager may, on reasonable notice, arrange seminars, meetings and training sessions, and the distributor agrees to make all reasonable endeavours to attend |
| No rebates | The distributor shall not allow or offer to allow, directly or indirectly, as an inducement, any rebate of any amount to a prospect or a unit holder to purchase, redeem or transact units |
The agreement also provides for the commercial arrangement between the parties, the marketing support the manager will give, and representations and warranties binding both. Usually it specifies the products and the geography to which it extends.
The commission framework. SEBI's circular of 10 April 2023 sets four rules:
- Investors who approach the AIF through a SEBI registered intermediary that is separately charging the investor a fee — such as an advisory fee or a portfolio management fee — must be onboarded via a Direct Plan only, which involves no payment of commissions.
- In other cases, AIFs shall disclose the distribution or placement fee, if any, to investors at the time of on-boarding.
- Category III AIFs shall charge distribution or placement fee only on an equal trail basis. No upfront fee may be charged, directly or indirectly. And any such fee paid shall be only from the management fee received by the manager.
- Category I and Category II AIFs may pay up to one-third of the total distribution or placement fee upfront, and the remaining two-thirds on an equal trail basis over the tenure of the fund.
| Category I and II | Category III | |
|---|---|---|
| Upfront share | Up to one-third | Nil |
| Balance | Equal trail over the fund tenure | Equal trail, all of it |
| Source of the fee | Not restricted by this rule | Only from the management fee received by the manager |
Why the distributor matters at all. Chapter 7, section 7.1.4.6, says distributors and placement agents are important not only in the selling function but in creating wider awareness and familiarity among the investor community about AIF products, services, investment strategies and their return potential — just as happened in the mutual fund industry after 1994.
A worked example
Konkan Capital, the investment manager of two AIFs, appoints Sahyadri Wealth Distributors Pvt Ltd. The total distribution fee negotiated is 1.5% of the commitment raised.
Scheme 1 — Konkan Growth Fund, a Category II AIF. Sahyadri raises Rs 200 crore, so the total fee is Rs 3 crore. Fund tenure is 6 years.
| Line | Working | Rs crore |
|---|---|---|
| Total distribution fee | 1.5% of Rs 200 crore | 3.00 |
| Maximum payable upfront, at one-third | 3.00 ÷ 3 | 1.00 |
| Balance payable on equal trail | 2.00 | |
| Trail per year, over 6 years | 2.00 ÷ 6 | 0.333 |
Scheme 2 — Konkan Long Short Fund, a Category III AIF. Sahyadri raises Rs 150 crore, so the total fee is Rs 2.25 crore. Fund tenure is 5 years.
| Line | Working | Rs crore |
|---|---|---|
| Total distribution fee | 1.5% of Rs 150 crore | 2.25 |
| Payable upfront | Nil | 0.00 |
| Payable on equal trail, per year | 2.25 ÷ 5 | 0.45 |
And the source is restricted. Konkan Capital charges a management fee of 2% on Rs 150 crore, or Rs 3 crore a year. The Rs 0.45 crore of trail must come out of that Rs 3 crore, leaving Konkan Rs 2.55 crore. The scheme cannot be charged separately for it.
The Direct Plan case. Sahyadri also introduces Mrs Latha Iyer, who already pays Sahyadri a portfolio management fee on a separate mandate. She commits Rs 5 crore.
Because the intermediary introducing her is separately charging her a fee, she must be onboarded on a Direct Plan only, with no commission. Sahyadri earns nothing on the Rs 5 crore — which would otherwise have been 1.5%, or Rs 7.5 lakh. The rule exists to stop the same firm being paid twice on the same investor.
A code of conduct breach. To close another commitment, a Sahyadri relationship manager offers to refund Rs 2 lakh of his own commission to the investor. That is a rebate offered as an inducement to transact units, and the agreement prohibits it directly or indirectly. The fact that it comes from his own pocket makes no difference to the covenant.
A second breach. The same manager adds a slide to the manager's investor presentation showing a 22% target return the PPM does not contain. That is an addition to marketing literature issued by the investment manager, which the first covenant forbids outright.
Why NISM asks about it
Chapter 13 (Legal Documents and Negotiations), section 13.7.3 (Agreement with Distributor), carries the covenants and the commission framework from SEBI's circular of 10 April 2023. Chapter 7, section 7.1.4.6, introduces distributors and placement agents among the service providers.
The reliably examined figures are the commission rules: one-third upfront for Category I and II with the balance on equal trail over the tenure, and no upfront at all for Category III, whose fee must come only from the management fee received by the manager. Expect the Direct Plan rule — an investor introduced by a SEBI-registered intermediary that is separately charging the investor a fee must be onboarded on a Direct Plan with no commission. The covenant most likely to be tested is the prohibition on rebates offered as an inducement.
Common exam traps
- One-third upfront is for Category I and II only. Category III may pay nothing upfront, directly or indirectly.
- For Category III the fee comes out of the management fee, not out of the scheme. That restriction applies to no other category under this rule.
- Equal trail means over the tenure of the fund, not over a fixed number of years chosen by the manager.
- The Direct Plan trigger is that the intermediary is separately charging the investor, not that the investor asked for a direct plan.
- The agreement is between the investment manager and the distributor. Not the trustee, and not the AIF itself.
- A rebate is prohibited even out of the distributor's own commission. The covenant catches it directly or indirectly, as an inducement.
- The no-alteration covenant covers documents filled up by the investor too, not only the manager's marketing literature.
- Disclosure of the fee is at on-boarding. Disclosing it later, in an annual report, does not satisfy the rule.
Where this is taught
Free preparation for NISM Series XIX-CRelated terms
- Code of conductThe conduct obligations a broker accepts as a condition of registration — integrity, due skill and care, no manipulation, and a specific list of duties owed to the client and to other brokers.
- Direct and regular plansThe two routes into the same mutual fund scheme: a direct plan with no distributor and a lower expense ratio, and a regular plan that pays distributor commission — same portfolio, separate NAVs.
- Private placement memorandumThe offer document of a Category III AIF, filed with SEBI through a merchant banker at least 30 days before a scheme launches — and the document SEBI comments on but never approves.
- Investor PresentationThe core marketing document an AIF distributor prepares from the PPM's disclosures, analysing the fund and scheme for investors and showing how it fits their needs.
- Contribution AgreementThe agreement between one investor, the trustee and the investment manager that sets the terms on which that investor participates in the AIF — the contract that turns a commitment into units.
- Management FeeThe fixed annual fee an AIF pays its investment manager for managing the fund — charged on committed capital in Category I and II funds and on gross NAV in Category III, regardless of performance.
- Set-up CostThe one-time cost of forming the fund and issuing its units, charged to investors as a percentage of capital commitments — up to 1.5% or 2.5% — and usually amortised over the first 36 months.
- Custodial agreementThe legally binding contract between an AIF and its custodian, fixing the scope of custody services, the parties' mutual obligations and the commercial terms.
- Merchant banker agreementThe contract by which an AIF appoints a SEBI-registered merchant banker to file its placement memorandum with SEBI and certify the adequacy of its disclosures.
- Equal trail basisSEBI's rule that a Category III AIF may charge distribution or placement fee only as an equal trail — no upfront fee at all, and paid only out of the manager's own management fee.
- DP agreementThe contract between a depository participant and a Category III AIF as beneficial owner, setting out each side's rights and duties for depository services such as dematerialisation.