(Adds reaction from bankruptcy expert)
By Karen Pierog
Jan 13 (Reuters) - The U.S. Supreme Court on Monday declined to take up a dispute that has roiled the $3.8 trillion U.S. municipal bond market over payments on special revenue bonds that grew out of Puerto Rico's ongoing bankruptcy.
The justices left in place rulings last year by the Boston-based 1st U.S. Circuit Court of Appeals, which determined that payments on certain Puerto Rico bonds secured by special revenues are not required - but optional - while the issuer's bankruptcy is ongoing.
The high court's action leaves a dark cloud over this type of debt, which could increase borrowing costs for local governments, schools and other issuers seeking to finance infrastructure projects.
Revenue bonds accounted for 61% of the $406.5 billion of debt sold in the municipal market last year, according to Refinitiv data. Only certain revenue bonds qualify as being backed by special revenues under the municipal bankruptcy code.
James Spiotto, a municipal bankruptcy expert at Chapman Strategic Advisors, said now it will be up to states to enact laws to ensure similar debt payments are made by their local governments.
"Otherwise, there's the risk that special revenues (bonds) will be treated as a more risky investment at higher borrowing costs," Spiotto said.
Credit rating agencies have already placed several special revenue bond ratings under review that in some cases led to downgrades, including to water and sewer bonds from Cleveland and Dallas.
There was no immediate comment from Assured Guaranty Corporation and Ambac Assurance Corporation, which sought the high court's review. The bond insurance companies had sued Puerto Rico's federally created financial oversight contending that payments on Puerto Rico Highways and Transportation Authority bonds from pledged toll and other revenue should not be halted during the bankruptcy.
The 1st Circuit upheld the litigation's dismissal by a federal judge hearing Puerto Rico's bankruptcy, which was commenced by the board in 2017 in an attempt to restructure about $120 billion of the U.S. Caribbean island territory's debt and pension obligations.
The bond insurers argued that the lower court's decision conflicted with the "settled understanding" of the municipal bankruptcy code and protections for special revenue bonds and would impede the ability of municipalities to finance critical infrastructure such as sewers and roads.
The board argued that requiring bond payments would undermine its "exclusive right" to propose a restructuring plan that would lead to Puerto Rico's bankruptcy exit.
Reporting by Karen Pierog; Editing by Will Dunham