The boom and the backlash

Driven by the appeal of its flexibility and access to liquidity, private credit has ballooned into a global market exceeding $1.7 trillion, with conservative forecasts projecting $2.6 trillion by 2028. That growth has drawn active scrutiny. In 2025 and into 2026, the Securities and Exchange Commission (SEC) has intensified examinations of private fund advisers, focusing on fee disclosures, valuation practices, and conflicts of interest. The Financial Stability Board and the Bank of England have warned that market opacity could mask systemic risk. Meanwhile, disputes between lenders and borrowers – around covenant enforcement, forced amendments, and payment-in-kind (PIK) or PIK toggle abuse – have begun landing in courtrooms. The question is no longer just whether private credit poses systemic risk. The question now is who bears legal exposure when things go wrong?

The private credit market is facing a wide range of developments. In 401(k) portfolios, private credit assets are beginning to appear as part of their asset mixes, while investors who once drove private credit are growing increasingly concerned about their portfolios’ exposure to disruptive entrants into the technology sector, where their assets are heavily leveraged, according to AnnaMaria Andriotis and Peter Rudegeair in the Wall Street Journal and Bill Alpert in Barrons.

Where the risk lives

Risk lives in the margins. For private credit, like subprime mortgages, myriad unknowns paired with the built-in risk-sharing nature of arrangements and instruments create substantial margins for risk to grow (for more on this, read Greg Ip’s article in the Wall Street Journal.)

The following three features of the private credit market create substantial risk:

Valuation opacity: Private credit instruments do not trade on secondary markets, so valuations are marked by fund managers themselves, often quarterly. This opacity means that there is no singular, agreed-upon way to define or measure the assets, Alpert explained. It is compounded by the fact that much of the credit is issued both to and by private companies, meaning the myriad public disclosures often available to assess the health of parties are unavailable, according to Jared Elias and Elisabeth de Fontenay writing in the Yale Law Journal. In a downturn, reported Net Asset Values (NAVs) may not reflect credit deterioration for months, and a sudden repricing could trigger forced selling across institutional portfolios.

Bank interconnections: Banks provide subscription lines, warehouse financing, and NAV-based lending facilities to private credit funds, meaning defaults would not stay confined to asset managers and their limited partners. Previously understood by analysts as a “plus” for the private credit market, the allocation of risk across the financial spectrum creates a whole swath of players, beyond just banks and insurance companies, who not only share in the risk but also carry rights affected by litigation.

Concentration risk: Portfolios are heavily weighted toward leveraged, sponsor-backed companies underwritten during the low-rate era, and deteriorating debt service coverage ratios suggest losses could arrive in clusters. What’s more (as Andriotis and Rudegeair explain in their article), funds are particularly vulnerable to the AI-driven shocks in the software industry – a technology sector where much of the capital in private credit has been steered.

Where litigation enters the picture

As portfolios come under strain, disputes accelerate across three categories:

• Valuation disputes are the most fertile ground: when fund managers mark their own books, and those marks determine fees and carried interest, limited partners who suspect inflated or stale valuations are increasingly willing to bring claims.
• Covenant enforcement battles are also intensifying. Many deals were documented with borrower-friendly terms – loose covenants, expansive EBITDA add-backs, generous cure rights – and lenders are discovering their protections are weaker than expected.
• Fund governance disputes are multiplying as semi-liquid fund structures raise questions about redemption rights and fiduciary duties, with SEC enforcement signals also opening the door to both regulatory proceedings and follow-on private litigation.

Though private credit arrangements carry caps on redemption, a number of funds saw redemption withdrawals hit those caps in the first quarter, Alpert of Barrons found. While, as private companies, many of the entities distributing credit are not subject to the various derivative actions that their public counterparts face, fund managers still owe substantial duties and can face complex, expensive legal action for failing to mitigate risk appropriately.

Why expert legal determinations are essential

For teams advising institutional investors, the immediate priority is reviewing fund documents – LPAs, side letters, and valuation policies – to identify contractual levers before losses materialize. For lenders, the focus should be on enforcement readiness: forbearance negotiations, intercreditor disputes, and restructuring proceedings in complex structures involving unitranche facilities and layered co-lender arrangements. Finally, for banks with indirect exposure through fund financing lines, litigation risk is less obvious but no less real.