July 2, 2026

By David Brunk, civil litigation attorney

The Loan That Never Pays Cash, and the Fees That Always Do

By David Brunk  ·  July 2, 2026  ·  Fiduciary

Imagine a simple arrangement. You give a manager $10 million to lend out on your behalf. The manager finds a borrower and makes a loan at 12 percent interest, with one unusual feature: the borrower never has to send a check. Instead, every year, the unpaid interest is added to the loan balance. After the first year the borrower owes $11.2 million. After the second, roughly $12.5 million. On paper, your investment is growing beautifully. The manager reports the loan's rising balance as income, marks the asset up on your account statement, and charges you two fees: a management fee calculated on the growing size of the portfolio, and an incentive fee calculated on the income the loan is "earning." Both fees are paid in actual cash, every quarter, out of your money.

Then, in year five, the borrower who could never afford to write a check does exactly what borrowers who can never afford to write a check tend to do. It defaults. The swollen loan balance is written down to a fraction of its value. Your account statement finally tells the truth. And here is the detail that matters: the manager keeps every dollar of the fees it collected along the way. There is no obligation to give any of it back. The income never existed as cash, the gains never existed at all, but the fees were real, and they are gone.

Nothing in that story is illegal on its face. Versions of it are disclosed, in careful language, in the public filings of some of the largest credit funds in the United States. Whether the arrangement is nonetheless unlawful, as a breach of the fiduciary duty that federal law imposes on fund advisers, is now the subject of a rapidly growing body of federal litigation.

Payment in Kind

The loan in the story is a payment-in-kind, or PIK, instrument. PIK interest accrues to the loan balance instead of being paid in cash. It is a legitimate financing tool with a built-in tension: it is most attractive to borrowers who cannot service their debt in cash, which is to say, the borrowers most likely to eventually default. When a business development company, a BDC, holds PIK instruments, accounting rules let it recognize the accrued interest as net investment income each quarter even though no cash arrives. At an externally managed BDC, that paper income flows directly into the adviser's compensation.

The complaint in Siegel v. Blue Owl Technology Credit Advisors LLC, pending in the Southern District of New York, describes three channels through which a single PIK dollar pays the adviser. The accrued interest capitalizes into loan principal, which raises gross assets, the base for the management fee. It flows into net investment income, the base for the income incentive fee. And by propping up carrying values, it delays the recognition of losses. The same complaint quotes the fund's own annual report: the adviser "is not obligated to return the Incentive Fee it receives on PIK interest that is later determined to be uncollectible in cash." According to a survey cited in that complaint, roughly half of comparable publicly traded BDCs include a look-back or clawback provision for exactly this situation. The funds now being sued do not.

The scale is not hypothetical. The Siegel complaint alleges that over three fiscal years, roughly $454 million of Blue Owl Technology Finance Corp.'s $1.25 billion in net investment income was non-cash PIK, and that the fund declared distributions exceeding its actual cash earnings by approximately 52 percent. A companion suit against the adviser of Ares Capital Corporation, the largest BDC in the country, alleges approximately $490 million in gross PIK accrued in 2025, about 34 percent of net investment income, in a year the adviser collected $773 million in total fees calculated, in the complaint's words, "on asset investment marks that it controls."

The Non-Accrual Dial

PIK has a quieter companion. When collection of a loan becomes doubtful, a fund is supposed to place it on non-accrual status and stop recognizing its income. Non-accrual is the industry's public gauge of credit trouble, and it is a gauge the manager itself reads and reports. The pending cases allege two ways the dial gets managed. A fund can simply delay the designation, keeping doubtful income in the fee base. Or it can restructure: when a borrower cannot make its cash payments, amend the loan to convert cash interest to PIK. The borrower now technically owes no cash it is failing to pay, the loan stays "performing," the non-accrual ratio stays low, and the income keeps accruing.

The shareholder suits against FS KKR Capital Corp. in the Eastern District of Pennsylvania allege the shape this takes in public. For five consecutive quarters, the class action complaint alleges, the company assured investors that legacy credit problems were being addressed through restructuring. Then, in two steps, the gauge caught up: non-accruals rose, hundreds of millions in portfolio value evaporated, management conceded the identified problem companies accounted for only half the losses, the quarterly distribution was cut from $0.70 to $0.48, and the company's chief investment officer acknowledged a non-accrual rate above the long-term industry average. Ratings agency data cited in press coverage put FS KKR's PIK share of investment income at more than double the peer median in the period before the disclosures.

Why Technology Lending

It is not a coincidence that the sharpest allegations involve technology debt. Blue Owl Technology Finance Corp. concentrates roughly three quarters of its portfolio in software and technology companies. The suit against the Ares adviser alleges the fund understated its software exposure, reporting 23.8 percent while an independent analysis put the real figure near 30 percent. Software borrowers are the natural habitat of PIK: recurring-revenue businesses bought at high leverage on the theory that growth would outrun the interest, now confronting both higher rates and investor anxiety about what artificial intelligence does to software business models. Analysts at major banks have projected software defaults in private credit well above market averages through 2027. A lender to that sector faces exactly the choice these lawsuits describe: put struggling borrowers on non-accrual and watch income, fees, and the distribution shrink, or restructure into PIK and let the balances, and the fee base, keep growing.

The Cases

The fee-focused cases proceed under Section 36(b) of the Investment Company Act, which imposes a fiduciary duty on fund advisers with respect to their own compensation and does not require proof of fraud. Delman v. Blue Owl Credit Advisors LLC and Siegel v. Blue Owl Technology Credit Advisors LLC, now consolidated before Judge Katherine Polk Failla in the Southern District of New York with an initial conference set for September 10, 2026, target the advisers of Blue Owl's two flagship BDCs. Siegel v. Ares Capital Management LLC, filed in May 2026 with prominent securities counsel, extends the theory to the industry's largest fund. Ataii v. Blue Owl Technology Credit Advisors LLC and Jones v. FS/KKR Advisor, LLC carry it into the District of Maryland, where most BDCs are incorporated. No court has yet ruled on whether the theory states a claim; the only prior decision applying Section 36(b) to a BDC dismissed a complaint that alleged merely above-average fee rates, and the current complaints are built to clear that bar with named positions and fee arithmetic.

A second group of cases attacks the same conduct as securities fraud. Stuart v. FS KKR Capital Corp. and a companion derivative suit allege the restructuring-and-reassurance pattern described above. Class and derivative actions against BlackRock TCP Capital in the Central District of California allege that even as non-accruals climbed, the fund's marks lagged reality until a further 19 percent single-quarter cut to net asset value. These fraud cases carry a heavier burden: they must plead intent, and courts treat valuations as opinions. A Maryland federal court dismissed a similar suit against a small BDC adviser in March 2026 on precisely that ground, a decision now on appeal to the Fourth Circuit. The lesson running through the early results is that outcomes are turning less on the underlying conduct than on which legal theory plaintiffs choose to pursue it with.

What Investors Should Watch

The dashboard gauge that matters is distribution coverage. In every version of this story, the fund's payout is the public promise that the reported income is real. A fund whose distributions persistently exceed its cash earnings, as opposed to its accounting earnings, is making that promise with borrowed conviction. The complaints described here allege coverage gaps that ran for years before any court filing: distributions 52 percent beyond cash income at one fund, a dividend held steady on "spillover" rhetoric at another until it was cut by nearly a third. Investors, and the advisers who recommend these products to them, can compute cash coverage from public filings today, for any BDC, without waiting for a lawsuit to do the arithmetic.

The federal cases will decide whether advisers must return fees earned on income that never arrived. They will not, whatever their outcome, pay individual investors for what they were never told at the point of sale. Those are separate questions, with separate answers, and they belong to the investors themselves.

The allegations described here are taken from the filing and remain unproven; no responsive pleading is reflected in the source document.

David Brunk is a civil litigation attorney. He can be reached at david@newmanbrunk.com.