Hedge Funds Sue Puerto Rico in N.Y. Over Fiscal Crisis Law

  • Lawsuit claims legislation can’t be applied to 2014 bonds
  • Suit is over $3.5 billion in general-obligation bonds

Puerto Rico was sued in New York by a group of hedge funds claiming it’s illegally using an emergency fiscal-crisis law to dodge payments on $3.5 billion in bonds that are supposed to be guaranteed by the island’s constitution.

The Emergency Moratorium and Financial Rehabilitation Act, signed into law in April just 48 hours after being presented to Puerto Rico’s legislature, can’t be applied to the general-obligation bonds at the center of the case, the group said in a complaint filed Tuesday in Manhattan federal court.

Governor Alejandro Garcia Padilla “has flouted centuries-old federal constitutional protections for contract and property rights,” Mark Stancil, an attorney for the bondholders, said in a statement.

The U.S. territory can’t pay all its debt, and the hedge funds’ decision to sue instead of keep negotiating “demonstrates their continued refusal to acknowledge the reality of the commonwealth’s fiscal crisis,” Grace Santana, Padilla’s chief of staff, said in a statement. She called the suit an attempt "to disrupt the commonwealth’s ability to keep the lights on and provide essential services.”

Talks Fail

Talks between Puerto Rico and some bondholder groups over revised debt payments have failed in the weeks since the U.S. Supreme Court struck down its law that would have allowed some agencies to turn to court to restructure their debt. Puerto Rico, with the population of Oklahoma and an economy smaller than Kansas, has more debt -- $70 billion -- than any U.S. state government except California and New York.

“The lawsuit highlights the growing likelihood of potentially chaotic litigation if the federal government plays no role in resolving Puerto Rico’s fiscal crisis,” Ted Hampton, an analyst in New York at Moody’s Investors Service, said in a statement. 

The debt load includes $12.5 billion in outstanding general-obligation bonds that are entitled “to the highest priority among all of Puerto Rico’s expenditures,” even if the commonwealth must raise taxes to pay up, the group said in the complaint.

Puerto Rico’s constitution was written to prevent politicians from using “fiscal stress” to dodge payments on public debt, and it bars the commonwealth from claiming sovereign immunity in suits over missed payment of interest and principal, the group said.

Bondholders’ Claims

The bondholders’ suit includes a laundry list of alleged fiscal shenanigans by the commonwealth, including claims that Puerto Rico improperly diverted tax revenue to a state-run financing corporation to issue more debt rather than repaying bondholders. The Puerto Rico Sales Tax Financing Corp. has been issuing billions of dollars in unsustainable debt since 2006 “using a structure that transparently attempts to evade the Constitutional Debt Priority Guarantee,” according to the bondholders.

“The Puerto Rico Constitution’s carefully calibrated provisions do not permit such subterfuge,” the plaintiffs say.

The case is Jacana Holdings I LLC v. Commonwealth of Puerto Rico, 1:16-cv-04702, U.S. District Court, Southern District of New York (Manhattan).

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