Hedge fund sues Puerto Rico over new bond law

Capitol building in San Juan, Puerto Rico
Ricardo Arduengo | AP
Capitol building in San Juan, Puerto Rico

A big New York investment firm isn't happy that Puerto Rico has made it easier for some local public companies to restructure their debts.

BlueMountain Capital Management, a more than $20 billion hedge fund firm that focuses on investing in credit instruments, announced Tuesday it had filed a lawsuit against the government of Puerto Rico challenging the legality of the recently enacted Puerto Rico Public Corporation Debt Enforcement and Recovery Act.

BlueMountain owns power revenue bonds from the Puerto Rico Electric Power Authority, which it said is likely to seek to avoid its debts under the new law. PREPA has recently been downgraded by various ratings agencies to near-junk status. The struggling island-wide utility company reached a deal with some lenders in early July to delay its required payments by several weeks.

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"Puerto Rico's new debt avoidance law breaks faith with PREPA's investors by erecting an unconstitutional bankruptcy regime to subvert their contractual rights—which is exactly what the Commonwealth promised it would never do," Theodore Olson, a lawyer representing BlueMountain with Gibson, Dunn & Crutcher, said in a statement.

"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. The Constitution of the United States plainly forbids that approach," Olson, the former U.S. Solicitor General, added.

Read MorePuerto Rico on shaky ground with creditors

BlueMountain, founded in 2003 by Andrew Feldstein and Stephen Siderow, added this statement:

"We regret that we have no other way to ensure our legal, contractual rights than to file a complaint in the court system," the hedge fund firm said. "Rather than walking away from contracts, the Commonwealth and PREPA should collaborate with its investors to develop real solutions that put PREPA, the Commonwealth and its institutions on a path to financial stability. These solutions exist. We look forward to working constructively to arrive at a resolution."

Puerto Rico, an unincorporated territory of the U.S., was also sued by mutual fund managers Franklin Templeton Investments and OppenheimerFunds over the new law in federal court. They claim the new law is unconstitutional.

Read MorePuerto Rico seeks dismissal of US funds' lawsuit

"United States law provides a framework for the nation's companies and municipal entities to address their financial challenges while continuing their services. However, Puerto Rico's public corporations fall through the cracks of these laws," David Chafey, president of the Board of Directors of the Government Development Bank for Puerto Rico, said earlier this year about the new law.

"Therefore, the Recovery Act is created to provide a clear legislative framework that allows public corporations to address their financial difficulties without compromising any essential services provided by these corporations. It is worth noting that this law excludes the Commonwealth's debt and other entities explicitly excluded."

—By CNBC.com's Lawrence Delevingne.