In August of 2017, Mark Brodsky’s Aurelius Capital filed a constitutional challenge to the board overseeing Puerto Rico’s bankruptcy. This week, that board returned the favor — in a fashion.
In a surprise development, the oversight board created by the Puerto Rico Oversight, Management, and Economic Stability Act — known as Promesa — filed an objection in federal bankruptcy court Monday night claiming that more than $6 billion of the bonds owned by Aurelius and other hedge funds were issued unconstitutionally and should be thrown out of the bankruptcy proceedings.
While hedge funds owning different types of bonds have been bickering back and forth about the constitutionality of each other’s debt, this is the first time the Promesa board has taken any action in court as Puerto Rico seeks to restructure its approximately $70 billion debt load.
In addition to Aurelius, other hedge funds singled out in the objection are Autonomy Capital, Brigade Capital Management, Mason Capital Management, and Prisma Capital Partners. Aurelius, Autonomy, and Brigade declined to comment. (Mason and Prisma did not respond to requests for comment. )
The oversight board’s special claims committee — along with the unsecured creditors’ committee — argue that the claims are invalid because they exceed the debt limit set forth in Puerto Rico’s constitution, which would include all of the general obligation (GO) bonds issued in 2012 and 2014. The challenge also argues that the debt violates Puerto Rico’s balanced budget requirement of the constitution.
The 2014 bond offering was huge — $3.5 billion — and targeted to hedge funds. On Wednesday those bonds were trading between 48 and 49 cents on the dollar, after falling as low as 45 cents on Tuesday.
Until this week’s filing, those bonds traded between 55 and 60 cents on the dollar for much of 2018. These bonds were one of 2018’s best bets as they doubled in value, after the selloff that occurred following Hurricane Maria and President Donald Trump’s offhand statement on Fox news that the debt would be “wiped out.”
Arguments about constitutionality are nothing new in the raucous Puerto Rico battle.
Shortly before the hurricane hit Puerto Rico in 2017, Aurelius filed a claim in the bankruptcy court, arguing that the way the board was initially chosen in 2016 violated the appointments clause of the U.S. constitution because its members were chosen by President Obama but did not get Senate confirmation. The lawsuit was thrown out this summer by the judge overseeing the bankruptcy, but Aurelius has appealed that decision.
Within months, Aurelius had sold 25 percent of its GO holdings and owned $417.1 million worth as of the court filings from last fall.
The constitutionality of debt came up in an earlier case. In 2016, Aurelius and other GO bondholders argued that another type of Puerto Rico debt, so-called Cofina, which is backed by Puerto Rico’s sales tax, was unconstitutional.
The GO bondholders sued the Cofina bondholders, saying the debt was structured to avoid Puerto Rico’s constitutional limits on borrowing and siphoned off revenues that should be available to pay the Commonwealth’s GO bondholders.
“Invalidating Cofina is, we believe, key to resolving Puerto Rico’s debt issues,” an individual close to the GO bondholders group told Institutional Investor in 2017.
But last summer, the GO bondholders dropped their case against the Cofinas, which allowed the latter group to cut a deal with the government of Puerto Rico and the Promesa board. It is expected to be approved by the federal bankruptcy judge this month.
