(Updates with details, quote from hedge fund lawyer, paragraphs 5-11)
By Edward Krudy
NEW YORK, Feb 6 (Reuters) - A U.S. federal judge voided a controversial law that allows some of Puerto Rico’s public corporations to default on their debt, saying in a ruling late on Friday that the U.S. commonwealth’s so-called Recovery Act contravenes federal bankruptcy law.
The decision in the U.S. District Court has implications for around $20 billion of debt potentially affected under the act. That includes $9 billion of debt outstanding at the Puerto Rico Electric Power Authority (PREPA), which is currently in restructuring talks with bondholders.
“The Recovery Act is preempted by the federal Bankruptcy Code and is therefore void pursuant to the Supremacy Clause of the United States Constitution,” Judge Francisco Besosa wrote in the ruling.
“The Commonwealth defendants, and their successors in office, are permanently enjoined from enforcing the Recovery Act.”
Puerto Rico, which is struggling with debts of more than $70 billion, passed the Recovery Act in June. The law was intended to ring-fence the government from a potential bankruptcy and give the corporations a framework for restructuring their debt.
U.S. law expressly forbids Puerto Rico’s government and its entities from restructuring their debt under Chapter 9 of the U.S. bankruptcy code, the section that deals with U.S. municipal bankruptcies and was used in the case of Detroit last year.
Three of PREPA’s bondholders, Oppenheimer Funds, Franklin Templeton, and the hedge fund Blue Mountain Capital Management, sued Puerto Rico last year.
Besosa’s ruling essentially vindicates their position that, under the U.S. Constitution, the federal law takes precedence over state law as well as Puerto Rican law.
“We are gratified by Judge Besosa’s ruling,” Matthew McGill, attorney for Blue Mountain Capital Management, said in a statement on Friday. “We look forward to working with PREPA’s stakeholders to develop a sustainable path forward.”
It is unclear if Puerto Rico will appeal against the ruling.
A spokesman for Puerto Rico’s Government Development Bank (GDB), the commonwealth’s fiscal agent, could not be reached for comment. (Editing by Paul Tait)