Puerto Rico Faces Hedge Fund Lawsuits as U.S. Reprieve Ends

(Bloomberg) -- Puerto Rico is facing a fresh round of creditor lawsuits after a temporary reprieve on litigation was lifted, exposing the distressed Caribbean island to the consequences of the defaults on much of its $70 billion of debt.

Hedge funds holding $1.4 billion of general-obligation bonds sold in 2014, including Aurelius Capital Management and Monarch Alternative Capital, sued the commonwealth in New York state court in Manhattan, seeking payment on overdue principal and interest. Insurer Ambac Financial Group Inc. and funds that own sales-tax backed bonds sued in the U.S. District Court of San Juan in an effort to block the government from spending that money before bondholders are paid.

“They're breaking every agreement and security feature they set up to borrow the money,” said Daniel Solender, head of municipals at Lord Abbett & Co., which manages $19 billion of state and local debt, including commonwealth securities. “The creditors have to challenge that because the rules have been broken.”

The cases filed Tuesday are the first of what's expected to be a wave of new legal challenges from investors seeking to force the U.S. territory to pay what it owes. With the government so far unable to reach an agreement with bondholders, such lawsuits threaten to expose Puerto Rico to adverse legal rulings and could lead the island and its federal overseers to use bankruptcy-like procedures to cut its debts in court.

That process was created under U.S. legislation enacted last year to help Puerto Rico arrest its fiscal crisis, given the difficulty of restructuring debt sold by more than a dozen agencies and backed by varying legal pledges. Analysts have speculated that Puerto Rico would need to utilize such a court-supervised proceeding to force creditors to accept losses.

The lawsuits, similar to others that were filed months ago, came after a stay imposed by the federal rescue law lapsed on Monday night.

In one of the new cases, funds holding about $1.9 billion of senior sales-tax bonds know as Cofinas -- including those run by Whitebox Advisors, Merced Partners and Tilden Park Capital Management -- sued Governor Ricardo Rossello and his administration to stop a fiscal plan that diverts the revenue to the commonwealth's general fund, which they said violates the U.S. and Puerto Rico constitutions. Such shifts raise the risk that the island will default on the bonds, and the fiscal plan doesn't specify which creditors have the highest legal claim to the small share of money allocated to bondholders.

Puerto Rico has already defaulted on its general-obligation bonds, the securities behind the lawsuit filed in New York state court.

Senior Cofinas with a 6.05 percent coupon and maturing in 2036, the most-actively traded sales-tax bonds in the past three months, changed hands Tuesday at an average 61.3 cents on the dollar, up from an average 60.4 cents the day before, data compiled by Bloomberg show. General obligations due in 2041, the most active Tuesday, traded for an average of 59.5 cents on the dollar, up from 59.1 cents Monday.

Yennifer Alvarez, a spokeswoman for the governor, didn't immediately respond to a phone message and email.

Ambac, which insures about $1.3 billion of senior Cofinas, filed a similar suit against Rossello and the members of Puerto Rico's federal oversight board, asking the court to declare the fiscal plan unconstitutional and illegal because it requires using sales-tax revenue for general-fund expenses.

Jose Luis Cedeno, a spokesman for the federal oversight board, didn't have an immediate comment.

While negotiations between Puerto Rico and its creditors have so far failed to produce a restructuring deal, the commonwealth is still engaged in “meaningful conversations” with certain bondholders and creditor groups, Gerardo Portela Franco, executive director of the island's Fiscal Agency and Financial Advisory Authority, said in a statement Monday.

The cases are Aristeia Horizons LP v. Rossello, 17-01566; and Ambac Assurance Corp. v. Commonwealth, 17-01567, both in U.S. District Court, District of Puerto Rico (San Juan). Aurelius Investment LLC v. Commonwealth of Puerto Rico, 652357/2017, New York State Supreme Court, New York County (Manhattan.)

--With assistance from Chris Dolmetsch and David Glovin

To contact the reporter on this story: Michelle Kaske in New York at mkaske@bloomberg.net.

To contact the editors responsible for this story: Christopher Maloney at cmaloney16@bloomberg.net, William Selway