Puerto Rico COFINA bondholders ask U.S. judge to rule in debt fight

(Reuters) - Puerto Rico’s so-called COFINA bondholders allege that around $3.5 billion of the island’s general obligation (G.O.) debt is invalid because it exceeded constitutional debt limits, ramping up bitter litigation between rival creditors of the struggling U.S. territory.

The COFINA group, whose bonds are backed by sales tax revenue, have asked a federal judge in San Juan to deny the G.O. group’s effort to stop Puerto Rico’s government from paying COFINA debt in favor of paying G.O. debt. The bondholders filed the legal brief in U.S. District Court in San Juan late Saturday night.

The G.O. group’s lawsuit, filed by hedge fund heavyweights like Aurelius Capital Management, Monarch Alternative Capital and Stone Lion Capital Partners, alleges that, because G.O. debt is guaranteed by Puerto Rico’s constitution, it must pay that debt ahead of all other obligations.

That has not been happening in Puerto Rico. The Caribbean haven buckling under $70 billion of debt has continued to pay COFINA bonds while skipping some G.O. payments under a 2016 emergency law.

In court papers, a group holding some $2.5 billion of senior COFINA debt, including hedge funds Cyrus Capital Partners LP, Tilden Park Capital Management and Scoggin Management LP, argued sales tax revenues are expressly excluded from the available resources Puerto Rico can use to pay G.O. debt.

Furthermore, $3.5 billion in G.O. debt issued in 2014 is invalid because it exceeded Puerto Rico’s constitutional debt limits, the COFINA group argued in asking Judge Francisco Besosa to deny parts of the lawsuit that seek to redirect COFINA claims to pay G.O. debt.

The G.O.-COFINA battle has become a flashpoint in Puerto Rico’s economic crisis, with both sides claiming ironclad legal rights to payment. The G.O. group has funded radio ads in Puerto Rico calling COFINA a “scam” and accusing its creditors of standing in the way of the island’s recovery.

On Friday, Puerto Rico’s government said it would begin debt restructuring talks with the G.O. group, and would seek “prompt and expeditious resolution” of the G.O.-COFINA squabble, though it did not take a position in the case.

The G.O. group’s lawsuit “is as flawed as its deceptive on-island ad campaign,” COFINA group spokesman Greg Marose said in a statement on Sunday, adding that the 2014 G.O. bonds “were clearly issued in violation” of Puerto Rico’s constitution.

A G.O. spokesman had no immediate comment on Sunday.

The crisis in Puerto Rico merges financial, political and human threads, marked by massive debt, high poverty, near-insolvent public healthcare and pension systems, and a rapidly shrinking population as locals flock to the mainland United States.

U.S. legislators last year pushed the island’s finances under the oversight of a federally-appointed board, which has pushed for austerity, drawing protests from locals and criticism from Governor Ricardo Rossello.

The board last week signed off on a recovery plan from Rossello’s administration, but conditioned its support on additional spending cuts.

Reporting by Nicholas Brown in New York; Editing by Jeffrey Benkoe and Alistair Bell