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Insurers Ambac, Assured throw latest punch in PR fight

Puerto Rico's debt crisis has entered a new phase as two of the island's top bond insurers filed a lawsuit challenging an emergency step taken to pay its bondholders.

The decision to "claw back" $163 million in December, a move made by Puerto Rican Gov. Alejandro Garcia Padilla to help fund the pending debt-service payments, was unconstitutional, according to Ambac Financial Group and Assured Guaranty, which insure or reinsure approximately $8 billion of the Commonwealth's debt.

The move was taken in order to raise nearly $1 billion to pay the bondholders Jan. 4.

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The two companies filed the complaint late Thursday seeking to stop the clawbacks and names numerous senior officials including the U.S. territory's governor, secretary of Treasury, and the president of the Government Development Bank as defendants. The complaint was filed in the U.S. District Court of Puerto Rico in San Juan.

The Puerto Rican Capitol in San Juan
Getty Images
The Puerto Rican Capitol in San Juan

The suit alleges that in December, the commonwealth, through an executive order issued by the governor, unlawfully recaptured revenues pledged for payment of certain tax-supported bonds. That was done in order make the full $329 million interest payment due to holders of its general obligation bonds, which carry strong legal protections.

The insurers argue that the diversion of pledged funds resulted in a default of approximately $36 million due on bonds issued by PR's infrastructure authority, also known as "PRIFA." As a result of the default, the insurers were forced to pay out $10.75 million under insurance policies that backed a portion of the defaulted bonds. Ambac, the largest insurer of Puerto Rico-issued debt, had the most exposure to the default, paying out about $10 million on claims related to the PRIFA bonds it insures.

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The lawsuit also seeks an injunction to prevent Puerto Rico from using the clawback mechanism in the future.

"We remain hopeful that the commonwealth will abandon these illegal tactics, and turn instead toward good-faith negotiations aimed at solutions instead of confrontation," Nader Tavakoli, Ambac's president and chief executive officer, said in a statement. "While we are optimistic that the government of Puerto Rico will begin to act responsibly, at this time we have no choice but to protect our stakeholders through judicial recourse."

On Monday, after the default, Garcia Padilla told CNBC that the island was actively preparing for impending creditor lawsuits. He cautioned that litigation would be very pricey and that "every dollar used to pay lawyers will be a dollar … not available to pay creditors."

Meanwhile, some of the bondholder attempts to negotiate with Puerto Rican issuers have been stalled by unwillingness on the government side, according to creditors involved with the talks.

"Everyone on the creditor side is very frustrated," said a senior official involved in the attempts. In an interview with CNBC on Tuesday, municipal bond investor Hector Negroni, whose firm, FCO Advisors, has exposure to Puerto Rico, made similar comments.

In a written statement issued Friday, Garcia Padilla said that the lawsuit filed by the insurers "will force a race to the courthouse" and cautioned that both parties face great uncertainty absent the legal framework necessary to orderly restructure the island's $70 billion debt load.

"With no legal framework to handle this impending litigation crisis, both the commonwealth and its creditors will soon face the opposite of due process and rule of law," Garcia Padilla said in a written statement. He put blame on U.S. lawmakers for "answering to Wall Street lobbyists" and ignoring Puerto Rico's crisis and its 3.5 million American citizens.

Garcia Padilla also urged Congress to take swift action by "immediately enacting the Puerto Rico Emergency Financial Stability Act," in order to "prevent this humanitarian crisis from spinning out of control."