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UPDATE 1-U.S. Supreme Court turns away Puerto Rico pension fund dispute

(Adds background on case, paragraphs 3-10)

WASHINGTON, Oct 7 (Reuters) - The U.S. Supreme Court on Monday declined to take up a dispute over the assets of Puerto Rico's largest public sector pension fund even as the U.S. Caribbean island territory's bankruptcy enters a major new phase.

The justices left in place a January 2019 lower court ruling that found that bondholders who own nearly $3 billion of debt issued by Puerto Rico's Employees Retirement System have a legitimate claim on the pension fund's assets. The justices refused to hear an appeal by Puerto Rico's federally created financial oversight board of that ruling.

The Financial Oversight and Management Board of Puerto Rico on Sept. 27 filed in federal court in New York a proposed plan of adjustment for the bankrupt island's core government debt, which includes an unfunded pension liability of more than $50 billion. The plan called for an independent reserve trust for pensions and a maximum 8.5% cut for retirees who receive more than $1,200 in monthly benefits.

The pension fund litigation dates back to 2017, when the board initiated Puerto Rico's bankruptcy and challenged claims by bondholders on those assets.

U.S. District Judge Laura Taylor Swain, who is handling the matter, had ruled that the bondholders "do not possess a perfected security interest" over property pledged by the retirement system to pay the debt. The judge's ruling pointed to the use of an incorrect version of the pension fund's name in financing statements.

The Boston-based 1st U.S. Circuit Court of Appeals reversed the ruling, deciding that "the bondholders met the requirements for perfection beginning on December 17, 2015."

In its petition to the high court, the board argued that the appeals court's reversal threatened "the ability of creditors across the nation to engage in secured lending" by treating the incorrect name issue as an unique circumstance.

Bondholders told the Supreme Court in a filing that the board was expending "untold resources pursuing any argument, however frivolous, to avoid the legitimate claims of U.S. creditors." After running out of pension assets, Puerto Rico's government turned to a "pay-as-you-go" system in which all public pension costs are paid through its general fund annually.

The court took its action on Monday on the first day of its new nine-month term.

On Oct. 15, the Supreme Court is due to hear arguments in another case involving the Puerto Rico oversight board over whether the board's members were lawfully appointed.

(Reporting by Karen Pierog; Additional reporting by Lawrence Hurley)