Puerto Rico bondholders launched what one attorney called an `uphill battle' against the United States government to recover their money.

Through a lawsuit in U.S. Court of Federal Claims, several investment funds are seeking the payment of $3.1 billion in principal and interest in Puerto Rico Employment Retirement System bonds. The suit is the first against the U.S. government proper, though some suits have already been filed against the Puerto Rico Oversight Board.

Chapman Strategic Advisors managing partner James Spiotto said he thought the Puerto Rico Oversight Board wasn't a federal entity.

In Altair Global Credit Opportunities Fund (A), LLC et al. v. The United States of America, the plaintiffs are trying to get at the federal treasury, said Chapman Strategic Advisors managing partner James Spiotto.

Their arguments rely on two main claims: that the Bill of Rights’ Fifth Amendment bars the taking of private property without just compensation and that the Oversight Board is a federal entity.

With the latter claim the litigants will have an “uphill battle,” Spiotto said. Just because the federal government created the board doesn’t make it a federal entity. The Puerto Rico Oversight, Management, and Economic Stability Act explicitly states that the board isn’t part of the federal government but instead part of Puerto Rico’s government.

Spiotto noted by way of example that the U.S. Postal System, it isn’t part of the federal government, even though the federal government created it.

In their complaint filed Wednesday, the plaintiffs say the board is a federal entity because it was created by the federal government, still enjoys federal benefits and collaborations, and is still under federal oversight and, occasionally, control.

The plaintiffs acknowledge PROMESA’s language saying the board isn’t part of the federal government, but say that in 1995 the Supreme Court decided in Lebron v. Nat’l R.R. Passenger Corp. that, quoting the Altair plaintiffs, “such statutory disclaimers do not speak to whether an entity is the federal government for constitutional purposes.”

In the plaintiffs’ complaint, they state “under the test set forth in Lebron, the Oversight Board is a part of the federal government for constitutional purposes.”

Spiotto said a key issue in the case was whether the board was acting for the federal government or for Puerto Rico. He said he thought it was acting for Puerto Rico and thus shouldn’t be considered part of the federal government.

He also said the U.S. Court of Federal Claims judge may agree that the federal government actions were illegal but rule that the bonds should be paid from the pledged collateral – the Puerto Rico employer contributions.

He said if the plaintiffs succeed in this suit other Puerto Rico bondholders would launch similar suits and possibly win. “Creativity becomes contagious,” he said.

The Altair complaint alleges that the board is a federal entity that encouraged, directed, and even forced Puerto Rico to default on the ERS bonds. It was the board that directed the stream of employer contributions away from the bondholders and into the General Fund, the bondholders allege.

“Because the Oversight Board is so clearly a part of the federal government, its actions are themselves the actions the United States,” the bondholders state. “Thus, when the Oversight Board takes actions to confiscate private property – such as the multi-billion dollar collateral package securing the ERS bonds – it is a compensable taking by the United States.”

The ERS bonds, issued in 2008, had their first monetary default on July 1, according to Fitch Ratings. The default followed a bill the Puerto Rico legislature passed in late June diverting the employer contributions away from bondholders.

In mid-July Title III Judge Laura Taylor Swain approved an interim agreement for all ERS bondholders whereby they will get $14 million in interest payments through at least Oct. 1. The July 1 payment was to be made in mid-July.

In the Altair lawsuit, in addition to the payment of the bonds’ principal amount and the accrued interest, the bondholders are seeking their attorneys’ fees and costs.

Attorney John Mudd said he thought the Altair case had a “good chance of succeeding.” The Lebron case was similar to this one, he said.

On Thursday the litigants filed a “notice to inform” in the primary Title III bankruptcy case for Puerto Rico. In the notice they told Swain they intend file an adversary claim concerning their bonds against Puerto Rico and the board in the Title III case.

If Swain rules for the Altair plaintiffs in this future filing, then that may render the case against the federal government irrelevant, Mudd said.

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