July 20, 2016 / 9:45 PM / 2 years ago

Creditors sue Puerto Rico leaders, allege violation of new U.S. law

SAN JUAN, July 20 (Reuters) - Holders of Puerto Rico’s most senior public debt sued the cash-strapped U.S. territory on Wednesday, saying it siphoned money away from bondholders in breach of a new U.S. law that brings the island’s finances under federal oversight.

The lawsuit, filed in San Juan federal court by hedge funds including Aurelius and Stone Lion, may have little short-term impact due to a wide-reaching halt on litigation imposed by the very law they say Puerto Rico violated. It is unclear how the courts will interpret this lawsuit vis-à-vis the newly enacted law.

The Puerto Rico Oversight, Management and Economic Stability Act, or PROMESA, was signed into law by U.S. President Barack Obama just days before the island was due to make a roughly $2 billion debt payment, which its government said it could not honor.

The complaint accuses Puerto Rico and its Governor Alejandro Garcia Padilla of violating PROMESA by issuing a moratorium on its July 1 payment of nearly $800 million in constitutionally backed, general obligation debt.

It is the opening salvo in what is likely to be a contentious, months-long restructuring process in Puerto Rico. The territory faces $70 billion in debt, a stagnant economy, rampant poverty and emigration, and a failing healthcare system.

In the complaint, the bondholders say they are not looking to compel payment on their debt, but are asking the court to prevent Puerto Rico “from unlawfully dissipating these assets before the Oversight Board is fully operational.”

Puerto Rico also ran afoul of PROMESA by passing a Fiscal Year 2017 budget that did not set aside money for full payment of GO debt, the bondholders allege.

The bondholders say the 2017 budget “makes huge transfers” to entities “that apparently enjoy political favor but are indisputably junior to” the bondholders, like the island’s woefully underfunded pension system, and its insolvent Government Development Bank, which is its primary fiscal agent.

PROMESA imposes a halt on litigation stemming from missed debt payments as federal officials get to work appointing members of a federal oversight board that will be responsible for finding economic fixes for Puerto Rico and facilitating debt restructuring talks with the island’s creditors. (Reporting by Nick Brown; editing by Daniel Bases and David Gregorio)

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