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UPDATE 1-Puerto Rico creditors open to mediation in bankruptcy court

(Recasts with court proceedings, judge's comments, adds dateline)

SAN JUAN, May 17 (Reuters) - Puerto Rico's main creditors, meeting before a U.S. bankruptcy judge in the largest public finance restructuring case in history, are interested in continuing mediation settlement talks to resolve the island's unpayable $70 billion debt bill.

A lawyer for Puerto Rico's federal financial oversight board told U.S. district court judge Laura Taylor Swain in opening arguments that the two main creditor groups both expressed interest in maintaining these talks while the case proceeds.

Swain, the soft-spoken Manhattan jurist tapped by the U.S. Supreme Court to handle the bankruptcy, said the "scope and scale" of the case "humbling" and that it "will certainly involve pain" but that "failure is not an option."

She added, before a packed courtroom with an estimated 100 people and two additional overflow rooms, that "devoting all our time to litigation cannot" be a way forward.

Wednesday's hearing is the start of a process that could take months or years. It is also a culmination of more than two years of bitter debate between Puerto Rico's government, its creditors and federal lawmakers over how the island should rework its debt load that has crippled its economy.

Earlier this month, the U.S. territory's central government entered a modified version of bankruptcy protection created under a federal rescue law known as PROMESA as a way to legally pave the way to cut its general obligation (GO) debt.

The island's sales tax authority, known as COFINA, followed suit days later with its own filing under Title III of the PROMESA law, which provides for the bankruptcy mechanism.

Attorney Martin Bienenstock said the board plans to press holders of GO and COFINA to mediate.

The dispute between these two groups is central to working out a restructuring that allows Puerto Rico, and its 3.5 million U.S. citizens, to rebuild an economy wracked by a 45 percent poverty rate, 11 percent unemployment rate and increasing emigration to the mainland United States.

The bankruptcy process will cover about half of Puerto Rico's debt, though other local public agencies are restructuring out of court, and some could enter bankruptcy later.

Bienenstock added that other agencies, including the highway authority PRHTA, will file for bankruptcy "soon."

Roughly $50 billion in underfunded pension liabilities will also be addressed in the court proceedings. The U.S. commonwealth also suffers from a near-insolvent public health system, having spent the last 10 years in recession with debt piling up to pay for basic services.

The bankruptcy promises to be lucrative for lawyers and financial advisers who represent the parties involved in the proceeding. Between the two cases, already more than 100 lawyers have requested permission to appear before Swain, court filings show.

(Reporting by Nick Brown; Writing by Daniel Bases; Editing by Bernard Orr)