U.S. Investment Firms Challenge Puerto Rico Restructuring Law

Puerto Rico has approved legislation allowing some public agencies to restructure their debt. Above, a vacant building in San Juan. Getty Images

A pair of Wall Street investment firms is challenging Puerto Rico's new law allowing some public agencies to restructure their debt, saying it violates the U.S. Constitution.

Funds managed by Franklin Templeton Investments and OppenheimerFunds Inc. asked the U.S. District Court for the District of Puerto Rico to block the law, arguing that only Congress is allowed to create bankruptcy rules. The funds hold about $1.7 billion combined in debt from the Puerto Rico Electric Power Authority, which they say they believe will seek to restructure its debt under the act "imminently."

"We believe it is our responsibility to stand up for the rights of bondholders and our shareholders when the unlawful acts of issuers or others threaten those rights," Oppenheimer said in a statement. Franklin Templeton declined further comment.

Puerto Rico lawmakers last week approved legislation allowing some agencies such as the island's power, water and transportation authorities to restructure their debt. Those agencies have a combined $19.4 billion in bonds outstanding, according to estimates from Barclays PLC. The law doesn't apply to Puerto Rico's general-obligation or sales-tax bonds, which are backed by the island's taxing authority.

The move alarmed investors, who took the law's passage to mean Puerto Rico plans to change the terms of its utilities' debt, leading to losses for bondholders. Bonds from the power authority tumbled after Gov. Alejandro Garcia Padilla announced the measure and some investors said they worried a restructuring could come as soon as this week.

Government officials have said no restructuring is imminent. The island's Government Development Bank said it stands behind the Public Corporations Debt Enforcement and Recovery Act and will defend it. Puerto Rico has a "sovereign's right to pass its own debt enforcement statutes in areas not covered by federal law," the bank said in a statement Sunday in response to the filing.

"The Recovery Act was designed to fill a gap in the existing federal insolvency regime and ensure the continuity of critical public services," the bank's statement said.

The act is a bankruptcy law and "treads on the Congress's exclusive province in enacting such legislation," the firms said in the court filing. Because it allows the power authority to seize the collateral securing its bonds, it also provides for an unconstitutional taking of property, the complaint said.

Puerto Rico has about $73 billion in total obligations, including that owed by its so-called public corporations, and has been struggling with high unemployment and a sluggish economy. Its debt is widely held by mutual funds and individuals, and some investors worry that troubles on the island could escalate into a wider Puerto Rican default and spook buyers in the broader $3.7 trillion municipal bond market.

The power authority has about $8.8 billion in debt outstanding, while the Highways & Transportation Authority has about $7 billion and the Aqueduct and Sewer Authority about $3.5 billion, according to a March report by Barclays. Those bonds are separate from the island's general obligation debt, and in more immediate trouble because the agencies behind them are heavily indebted and face mounting deficits and liquidity problems.

Bonds from some Puerto Rican agencies fell last week after the legislation was proposed and credit-rating firms downgraded the utilities. Fitch Ratings said "bondholders now face a probable financial restructuring or default" by the power authority. Bonds from that agency maturing in 20 years or longer fell 15% last week, while those coming due sooner fell as much as 40%, the filing said.

The Franklin funds collectively hold about $907 million in bonds issued by the power authority, while Oppenheimer Rochester Funds hold about $821 million, the complaint said.

By Aaron Kuriloff    

U.S. Investment Firms Challenge Puerto Rico Restructuring Law