Puerto Rico Hit With Lawsuit After Litigation Freeze Expires

Associated Press

SAN JUAN, Puerto Rico -- Bondholders filed to sue Puerto Rico Tuesday in the first legal challenge that hit the U.S. territory after a freeze on litigation that protected it from lawsuits expired amid a deep economic crisis.

A group representing those who bought $16 billion worth of bonds backed by Puerto Rico's sales tax said in the lawsuit that a government plan to cut its $70 billion debt is unconstitutional. The group accused government officials of strong-arming it into what it called "unfair, unjust, and illegally punitive terms."

The lawsuit is expected to be one of several as bondholders seek to recuperate the millions of dollars they invested in Puerto Rico government bonds. Puerto Rico already faced about a dozen lawsuits before the litigation freeze was implemented as part of a rescue package that U.S. Congress approved last year.

The newest suit comes after the administration of Gov. Ricardo Rossello failed to negotiate any deal with bondholders after the May 1 deadline of the litigation freeze. Puerto Rico has defaulted on $1.3 billion of principal owed since the previous governor declared the $70 billion public debt load unpayable in June 2015.

Puerto Rico Chief of Staff William Villafane told the Associated Press just hours before the freeze expired that the government preferred to reach a deal with bondholders. But he said embracing a bankruptcy-like process could be an option if negotiations fail.

"At least essential services would be guaranteed," he said.

Puerto Rico could soon announce a historic, bankruptcy-like procedure to restructure a portion of its $70 billion debt. By comparison, the U.S. city of Detroit had $9.3 billion of obligations when it filed for bankruptcy in 2013 in the biggest U.S. municipal bankruptcy ever.

A fiscal plan for Puerto Rico sets aside $800 million a year for debt payments, a fraction of the $35 billion due in interest and payments over the next decade.

Puerto Rico was besieged by creditor lawsuits Tuesday following the expiration of a key legal deadline in the renegotiation of its $73 billion mountain of debt.

Bond insurer Ambac Assurance Corp., which has $10 billion in guarantees on the line in Puerto Rico's debt crisis, filed lawsuits in federal court challenging the territory's debt-cutting plan. Hedge funds holding sales-tax bonds called Cofinas also sued to prevent Puerto Rico from spending their collateral for other purposes.

The lawsuits "aren't surprising given recent proposals to creditors and legislation passed allowing for the invasion of Cofina revenues," said Nader Tavakoli, the former Ambac chief executive who runs EagleRock Capital Management LLC.

Meanwhile hedge funds led by Aurelius Capital Management LP sued Puerto Rico in New York state court, seeking to recoup past-due payments on $1.4 billion in defaulted general obligation bonds. Creditors holding Cofina bonds and general obligation bonds were already battling in another case for top priority.

The mounting legal claims signaled a collapse in restructuring negotiations, heightening the likelihood that the federal board overseeing Puerto Rico's finances will place the territory under bankruptcy protection, though no such filing appeared to have been made by Tuesday evening.

Ambac asked for a court order barring the board from invoking the quasi-bankruptcy proceeding, known as Title III, that Congress designed specifically for Puerto Rico. A spokesman for the oversight board didn't immediately respond to a request for comment.

A legal shield protecting Puerto Rico from lawsuits expired Monday. Without having invoked Title III or signed standstill agreements with creditors, Puerto Rico for the moment is exposed to debt-related claims stemming from its fiscal plan, which allocates roughly $800 million a year over the next decade for debt payments. Creditors are owed more than four times that amount annually.

Private restructuring talks came apart over the weekend, when creditors publicly rejected a debt-restructuring offer that pays sales-tax bondholders and general obligation bondholders a maximum of 58 cents and 77 cents on the dollar, respectively. Some of those recoveries were contingent on a broader revival of Puerto Rico's economy.

Not all groups in negotiations received the offer, which Puerto Rico circulated among certain creditors outside the scope of an agreed-upon set of mediation rules, according to a person familiar with the matter.

Ambac filed a lawsuit against the U.S. Treasury Department and Treasury Secretary Steven Mnuchin in a bid to bar Puerto Rico's access to a federal excise tax imposed on rum manufactured in the territory and sold in the mainland U.S.

The insurer filed two other lawsuits over Puerto Rico's alleged efforts to break the lein securing the $17 billion in sales-tax bonds. One, in federal court, sought a court order safeguarding the revenue stream that backs those bonds. A second, in New York state court, demands that Cofina bond trustee Bank of New York Mellon Corp. call a default and declare senior Cofina bonds that don't mature for years to be fully due and payable.

A spokeswoman for BNY Mellon said the bank "has performed its obligations as trustee under the governing documents and will defend vigorously against this meritless suit."

BNY Mellon is caught between two factions of Cofina holders. Accelerating the Cofina bonds would mean stopping payments to junior holders, including mutual funds that are some of Puerto Rico's largest creditors.

Write to Andrew Scurria at Andrew.Scurria@wsj.com

(END) Dow Jones Newswires

May 02, 2017 18:34 ET (22:34 GMT)