The private credit industry’s litigation wave continues to evolve. A newly filed lawsuit against Blue Owl Technology Credit Advisors LLC targets a core feature of modern private credit structures: whether an investment adviser can be held liable for collecting advisory fees on payment-in-kind (“PIK”) income that may never be realized in cash.
As D&O Diary readers will recall, the first wave of private credit litigation largely involved securities claims arising from valuation disputes, redemption pressures, and liquidity concerns. However, the allegations in this latest lawsuit are different. Rather than challenging disclosures or asset values alone, the plaintiffs seek to challenge the compensation structure itself, alleging that Blue Owl received excessive fees based on unrealized PIK income and manager-determined valuations. If this theory gains traction, it could represent a significant expansion of litigation risk for private credit managers and their boards.
A copy of the complaint can be found here.
Background: What Is PIK Interest?
Because payment-in-kind (“PIK”) income is central to the allegations in this case, it is useful to briefly review how PIK structures work and how the term is used in the private credit context.
Historically, a “payment-in-kind” referred to the satisfaction of an obligation through goods, services, inventory, property, or other non-cash consideration rather than cash. A debtor might, for example, transfer an asset or inventory to satisfy an obligation rather than making a cash payment.
In modern leveraged finance and private credit markets, however, the term generally refers to a financing feature that allows a borrower to defer cash interest payments. Instead of paying interest in cash, the unpaid interest is added to the outstanding principal balance of the loan, causing the amount owed to increase over time.
For example, a borrower with a $100 million loan carrying a 10% PIK interest rate may add the $10 million annual interest obligation to the principal balance rather than paying it currently in cash. At the end of the year, the loan balance would increase to $110 million, and future interest would accrue on the higher amount.
PIK structures are frequently used by highly leveraged borrowers or companies experiencing liquidity constraints because they reduce near-term cash obligations. For lenders, PIK interest can increase overall returns if the borrower ultimately repays the accumulated balance. However, because lenders recognize income before receiving cash, the economic value of that income depends on the borrower’s future ability to repay or refinance the obligation. For that reason, investors often view increasing levels of PIK income as a potential indicator of borrower stress or deteriorating credit quality.
The Lawsuit
Shareholders of Blue Owl Technology Finance Corp. (“OTF”), a publicly traded business development company sponsored and managed by Blue Owl Capital, filed suit in the Southern District of New York against Blue Owl Technology Credit Advisors LLC, OTF’s investment adviser and administrator.
The complaint asserts claims under Section 36(b) of the Investment Company Act of 1940, which imposes a fiduciary duty on investment advisers with respect to the compensation they receive from registered investment companies. The plaintiffs allege that Blue Owl breached that duty by receiving advisory compensation that allegedly was so disproportionate to the services provided that it could not have resulted from arm’s-length bargaining.
Like the earlier Section 36(b) lawsuit involving another Blue Owl-sponsored BDC, the complaint alleges that Blue Owl’s dual role as valuation designee and fee recipient created an inherent conflict. According to the complaint, Blue Owl determines the fair value of OTF’s illiquid Level 3 assets while simultaneously receiving management fees and incentive fees tied to those valuations. The plaintiffs allege that this structure incentivized higher valuations and increased advisory compensation.
The complaint also raises familiar allegations regarding discounts between reported NAV and market trading prices, valuation questions involving software-sector loans, and concerns regarding the valuation of assets held across affiliated Blue Owl vehicles.
What distinguishes this lawsuit from earlier private credit litigation, however, is its focus on PIK income.
According to the complaint, approximately $43 million of OTF’s first-quarter 2026 net investment income consisted of PIK interest and dividends, representing roughly 25% of reported net investment income. Plaintiffs allege that Blue Owl earned management fees and incentive fees on that accrued income despite the fact that OTF had not actually received cash payments from borrowers. The complaint further alleges that the advisory agreement does not contain a meaningful clawback mechanism requiring the adviser to return fees if the PIK income ultimately proves uncollectible.
The plaintiffs assert that Blue Owl effectively received current cash compensation based on income that may never ultimately be realized, while shareholders remained exposed to the risk that borrowers would be unable to repay or refinance the underlying obligations. According to the complaint, each dollar of accrued PIK income allegedly increased asset values, management fees, incentive fees, and potentially capital gains calculations before any corresponding cash was received.
The lawsuit seeks recovery of allegedly excessive advisory compensation under Section 36(b).
Discussion
The significance of this lawsuit lies not in the PIK allegations themselves, but in what the plaintiffs are attempting to do with them.
Historically, excessive fee litigation has been concentrated in the mutual fund industry. Section 36(b) claims typically involve allegations that an investment adviser charged fees so disproportionately large that they could not have been the product of arm’s-length bargaining. Courts evaluating these claims generally focus on factors such as the nature and quality of services provided, adviser profitability, economies of scale, comparative fee structures, and the independence and effectiveness of board oversight.
This lawsuit seeks to apply those traditional excessive-fee principles to the private credit industry.
The plaintiffs are not merely alleging that Blue Owl’s valuations were incorrect. Nor are they simply alleging that shareholders suffered losses. Rather, they allege that the adviser’s compensation structure itself created incentives that allegedly diverged from shareholder interests. Specifically, the complaint alleges that Blue Owl benefited financially from higher valuations and the recognition of PIK income, while shareholders bore the risk that those valuations could later decline and that accrued income might never be realized in cash.
That distinction matters. This most recent complaint against a Blue Owl entity attempts to convert what might otherwise be viewed as ordinary investment and valuation judgments into allegations that the adviser was improperly compensated because of structural conflicts embedded within the fee arrangement.
For private credit managers, the concern is that this theory is highly portable. Many private credit funds invest in illiquid assets. Many rely on internal valuation processes. Many recognize PIK income. And many utilize management fee and incentive fee structures tied to asset values and investment income. If plaintiffs are successful in framing these common industry practices as evidence of conflicted decision-making, similar claims could emerge across the private credit sector, particularly during periods of credit stress.
Like other recent litigation aimed at private credit firms, this case highlights the potential impact on E&O and D&O underwriters.
From an E&O perspective, the complaint challenges the adviser’s professional services, including valuation determinations, portfolio management activities, income recognition practices, and fee calculations. To the extent the lawsuit seeks recovery based on alleged misconduct in the rendering of investment advisory services, there may be E&O underwriter exposure.
The D&O implications are more indirect but could be significant. The complaint allegations repeatedly focus on governance, oversight, and the approval of the advisory arrangement. Excessive fee cases frequently examine the conduct of directors responsible for reviewing advisory agreements and monitoring conflicts of interest. If valuation issues, credit losses, or liquidity concerns were to worsen, plaintiffs could seek to pursue follow-on claims alleging that directors failed adequately to oversee the adviser or failed to address known conflicts associated with the compensation structure.
The case also raises potential coverage questions regarding the insurability of any recovery. Because the lawsuit seeks the return of allegedly excessive advisory compensation, insurers may contend that any amounts representing improperly obtained fees constitute restitution, disgorgement, or the return of ill-gotten gains rather than covered loss.
Finally, the timing of the lawsuit is particularly noteworthy. On the same day the complaint was filed, The Wall Street Journal reported that investors sought approximately $12 billion of withdrawals from private credit vehicles during the second quarter, highlighting growing concerns regarding valuations, liquidity, and portfolio quality across portions of the market. In that environment, plaintiffs’ lawyers are likely to scrutinize not only portfolio performance but also the compensation structures that benefit from reported valuations and income.
Whether OTF shareholders ultimately prevail on the excessive fee theory remains to be seen. However, the case is noteworthy because it seeks to recast core private credit practices, including manager-driven valuations, PIK income recognition, and related fee arrangements, as evidence of fiduciary conflicts and excessive compensation. As investor scrutiny intensifies and market conditions become more challenging, managers’ ability to defend these practices could emerge as a defining issue for the sector.
