The Commonwealth of Puerto Rico responded yesterday to the lawsuit by the Franklin and Oppenheimer Funds that sought dismissal of the recently legislated Public Corporation Debt Enforcement and Recovery Act (“Act”) as unconstitutional.

Puerto Rico Muni

One of the main claims by the funds was that the operation of the federal Bankruptcy Code could not be usurped by the Commonwealth by creating law for composition of indebtedness that may operate as binding on a creditor without that creditor’s consent.

Puerto Rico and PREPA file motions to dismiss

Motions to dismiss the funds’ complaint were filed separately by both the Commonwealth of Puerto Rico as well as the Puerto Rico Electric Power Authority (PREPA).

PREPA claimed that complaint by the funds was premature as it lacked standing and that it had not taken any steps for obtaining relief under the Act. It said that the lawsuit “should be dismissed on ripeness grounds unless and until PREPA files for relief under the act.”

The Commonwealth countered the funds’ argument regarding impairment of contracts saying that this would be justifiable if it achieved “an important government purpose.”

The Commonwealth also argued that its public corporations were unable to avail themselves of protection under Chapter 9 and therefore section 903 was not applicable to the Commonwealth. Section 903 provides that “a State law prescribing a method of composition of indebtedness of [a] municipality may not bind any creditor that does not consent to such composition.”

The Commonwealth claimed that Supreme Court allowed state and local governments to pass restructuring laws provided they did not conflict with federal statutes.

One more fund opposes Puerto Rico’s new law

A hedge fund, BlueMountain Capital Management LLC, also joined the fray yesterday. It filed suit in federal court in Puerto Rico claiming that Puerto Rico’s Public Corporation Debt Enforcement and Recovery Act was unconstitutional because federal laws do not allow the Commonwealth, like the states, from enacting independent bankruptcy legislation.

“The problems raised by Puerto Rico’s massive debt burden are undoubtedly very serious, but tearing up contracts, disregarding federal law and abusing power to arbitrarily pick winners and losers is not the answer,” said Theodore Olson, a lawyer at Gibson, Dunn & Crutcher LLP who is representing BlueMountain. “The Constitution of the United States plainly forbids that approach.”

Funds having exposure to over $400 million worth of bonds issued by PREPA are currently under management of BlueMountain Capital Management LLC.