Puerto Rico Sued for Diverting Cash After Federal Law Passed

Updated on
  • Puerto Rico’s fund diversion violates federal law, funds claim
  • Aurelius, Autonomy and Monarch sue island’s Governor

A group of hedge funds sued Puerto Rico Governor Alejandro Garcia Padilla, claiming the island government is using a default on its debt to shirk its responsibility to pay bondholders.

Puerto Rico defaulted on almost $1 billion of principal and interest on July 1 as Garcia Padilla said the commonwealth was unable to pay creditors and continue essential services. It happened one day after President Barack Obama enacted a law, called Promesa, creating a federal control board to oversee the restructuring of the commonwealth’s $70 billion of debt. The law also shields Puerto Rico from creditor lawsuits seeking repayment.

A section within Promesa prohibits Puerto Rico from enacting new laws that transfer funds or assets in violation of the island’s constitution until the federal control board is in place. Obama has until Sept. 15 to form the panel. The hedge funds say the July 1 default goes against that provision.

“Just hours after Promesa took effect, Puerto Rico brazenly violated this provision by enacting extraordinary measures diverting many hundreds of millions of dollars,” Andrew Rosenberg, a lawyer at Paul Weiss Rifkind Wharton & Garrison, which is representing the hedge funds, said in a statement. The provision “is designed to preserve the status quo until the oversight board is formed. Puerto Rico’s officials have upended the status quo.”

The hedge funds sought to invalidate the commonwealth’s actions and obtain a limited injunction to reverse the fund transfers.

‘Oversight Board’

“This lawsuit does not seek to compel payment on plaintiffs’ bonds; rather, it seeks to prevent the commonwealth from unlawfully dissipating these assets before the oversight board is fully operational,” the funds said in the complaint.

Garcia Padilla’s chief of staff said the commonwealth, coping with the “gravest fiscal crisis” in its history, now faces multiple suits by bondholders and other creditors demanding payment and expects more to come.

“The commonwealth and its agencies and instrumentalities have been forced to choose between providing essential services — like hospitals, electricity, security, and education — and making debt service payments to bondholders,” Grace Santana said in a statement.

The hedge funds hold ”substantial amounts” of Puerto Rico general-obligation bonds and debt guaranteed by the commonwealth, according to the complaint. The island’s constitution stipulates that such debt must be repaid before other bills. Puerto Rico has about $18 billion of general obligations and debt guaranteed by the commonwealth, according to the Government Development Bank.

Garcia Padilla is reviewing a fiscal 2017 budget that the legislature passed last month. It would direct about $800 million to Puerto Rico’s public employee pension systems -- about $150 million more than was budgeted last year -- and $250 million from the general fund to prop up the insolvent Government Development Bank, the hedge funds said in the complaint.

Entities managed by Aurelius Capital Management, Autonomy Capital, Covalent Partners, FCO Advisors, Monarch Alternative Capital and Stone Lion Capital Partners filed the suit Wednesday in the U.S. District Court in San Juan.

Some of those funds, Aurelius, Autonomy, FCO Advisors and Monarch, filed suit against Puerto Rico last month in Manhattan federal court over the island’s local debt moratorium law, which allows the governor to skip debt-service payments through January.

The case is Lex Claims v. Padilla, 16-cv-02374, U.S. District Court, District of Puerto Rico (San Juan).