(Adds details of 'Ad Hoc' creditor group)
NEW YORK, July 23 (Reuters) - A hedge fund with over $400 million in Puerto Rico bonds has joined a legal challenge against a law that allows the U.S. Commonwealth to restructure some of its debt, hiring one of the most prominent lawyers in the United States to argue its case.
New York-based BlueMountain Capital Management filed a lawsuit in the district court of Puerto Rico on Tuesday, claiming that the new law, known as the Recovery Act, runs counter to both the Puerto Rican and U.S. constitutions.
BlueMountain argues that the "United States Constitution and federal law preclude the Commonwealth from enacting a bankruptcy law that adjusts the debts of its instrumentalities and public entities and binds non-consenting creditors."
"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," said BlueMountain's lead counsel Theodore Olson.
Olson's involvement in BlueMountain's lawsuit is a sign of the high stakes nature of the case. Olson, of law firm Gibson, Dunn & Crutcher, is one of the highest profile lawyers in the country. He was solicitor general from 2001 to 2004 under U.S. President George W. Bush after helping Bush win legal arguments over the contested 2000 election.
BlueMountain's suit follows a similar action by mutual fund companies Franklin Templeton and OppenheimerFunds who filed a lawsuit on June 29. Municipal bond funds run by those firms say they hold $1.7 billion in Puerto Rico debt. Puerto Rico says it will vigorously defend the law.
The act has drawn support from some creditors who believe it is a way to stabilize the majority of Puerto Rico's debt while helping to make the island economically viable.
A group calling itself the 'Ad Hoc Group' said on July 17 that it would support Puerto Rico's restructuring efforts and offered to provide Puerto Rico with provisional financing. The group is made up of Brigade Capital Management and Fir Tree Partners, among others, and says it holds $3 billion in Puerto Rico bonds among assets of more than $60 billion.
Puerto Rico has around $73 billion in debt and is struggling to kick-start a moribund economy and reverse its shrinking population trends. The Commonwealth insists it needs the law to make its public corporations self-sufficient.
The Recovery Act, passed in late June, allows some of the Commonwealth's public corporations to restructure around $20 billion in debt. The electric authority PREPA is considered to be a likely candidate to use the law. BlueMountain said it holds over $400 million of PREPA's $9.3 billion of debt.
"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," BlueMountain said in a statement. (Reporting by Edward Krudy; Editing by Chizu Nomiyama)