Impact investing: Do use of proceeds clauses actually work?

Impact investing has gained significant traction in India, driven by a growing pool of domestic and international capital seeking measurable outcomes alongside financial returns. Unlike conventional investment, where the investor’s mandate ends at return optimisation, impact investing imposes an additional layer of accountability with the expectation of generating quantifiable social, environmental or developmental impact.

Within this framework, the “use of proceeds” clause often becomes the most critical provision in investment documentation.

Limits of use of proceeds

Yet the efficacy of use of proceeds clauses, particularly in the Indian context, is more qualified than their contractual prominence might suggest.

The first limitation is evidentiary, rooted in the basic economic principle that money is fungible. The Companies Act, 2013 mandates that funds raised through preferential allotments be credited to a separate bank account pending allotment, with protection lapsing on completion of allotment – after which tracing precise deployment of invested capital becomes more difficult.

This difficulty is compounded where the investee company operates across multiple business verticals, runs centralised treasury operations, or faces overlapping demands from capital expenditure programmes and working capital requirements.

The second limitation is remedies. Under the Indian Contract Act, 1872 a party claiming damages for breach must ordinarily establish loss flowing from the breach, subject to the usual principles of causation, remoteness and proof.

Misallocation harms beyond monetary remedies

This difficulty is compounded; a significant breach will not necessarily result in diminished enterprise value or quantifiable financial loss. Impact is not priced into conventional valuation methodologies; the most meaningful consequences of misallocation may therefore be reputational, relational or mission-critical, and beyond the reach of standard remedial frameworks.

Specific performance is not always an effective answer either. Once funds have been deployed, literal compliance with the originally agreed use may be impossible to compel. While injunctions may restrain anticipated misuse if detected in time, identifying misuse early enough may be difficult in practice.

The Companies Act, 2013 prescribes consequences for misstatements in offer-related disclosures (including end use), but those do not translate into an automatic investor claim for damages as the framework is primarily compliance-oriented.

The exception is fraud where courts may grant rescission and restitution. But the threshold for establishing fraud is high. It would be insufficient to merely establish breach but rather that representation on intended use of funds was knowingly false to induce investment. Typically, such remedies are awarded only when promoters siphoned funds for personal gain.

Drafting for enforceable fund deployment

This is precisely why drafting must move beyond a bare covenant and focus on enforceability.

The most effective supplement is a robust information, audit and reporting regime that records deployment and identifies any breach. At minimum, the investee company should be required to furnish periodic fund utilisation statements linked not only to broad categories but also board-approved budgets, project heads, implementation milestones and impact metrics.

Investors should also negotiate accessible inspection and audit rights broad enough to encompass bank statements, vouchers, invoices, management accounts, utilisation certificates and project-level financial records.

Investors should additionally consider appointment rights for senior finance executives or independent forensic auditors to confirm application of proceeds. If such rights are not commercially feasible, consider designating senior finance personnel to certify the application of proceeds to ensure management accountability.

Equally important is identifying contractual consequences for breach. Even claims for liquidated damages must be supported by evidence of loss. In such cases, investors can consider enhanced investor rights (such as consent rights or board representation rights), suspension of future tranches, accelerated exit options or pricing adjustments – each triggered on any breach of the “use of proceeds” clause. Foreign investment must also comply with foreign exchange regulations.

A use of proceeds covenant is not self-executing; its practical utility depends on the monitoring, reporting and enforcement architecture that surrounds it.

Mita Sood is a partner at Bharucha & Partners