Solus Alternative Asset Management is suing Blackstone-owned hedge fund GSO and US homebuilder Hovnanian, asking the court to stop what it claims is a “fraudulent scheme” involving credit derivatives tied to the company.

The case was filed on Thursday in US federal court in Manhattan.

Hovnanian had agreed to a debt refinancing deal with GSO that includes provision for it to deliberately miss a payment on some of its debt, which the hedge fund hopes will trigger a payout on the company’s credit-default swaps.

The deal has already been criticised by credit derivatives traders, who say if it goes ahead, it would make a mockery of a financial product designed to trigger when a company is in distress — Hovnanian’s debt and equity show no sign of turmoil.

Solus stands to lose out on the other side, having sold protection on the company. The fund manager also led a rival group that pitched an alternative refinancing to Hovnanian.

A hearing in the case has been set for January 25. Solus, represented by law firm Quinn Emanuel, has called for an injunction to halt any deal struck by Hovnanian with a provision for it to try and trigger a credit event on its CDS, which would stall the deal with GSO on its current terms.

According to the complaint:

“To prevent the irreparable harm to Solus and to the market that will ensue from Defendants’ scheme, Solus seeks a narrowly targeted injunction preventing Defendants from orchestrating a sham payment default and requiring Hovnanian to correct its tender offer disclosures to, among other things, fully and accurately describe the true economic motivations for, and consequences of, the transaction.”

Both Hovnanian and GSO have hit back against Solus, saying that they intend to fight against the allegations of wrongdoing. Hovnanian had warned in a regulatory filing connected with the deal that the decision to accept GSO’s terms opened up the company to legal challenges.

“Their claims are wholly without merit and we will defend against them vigorously,” a Blackstone spokesperson said.

A Hovnanian spokesperson added:

“We believe the allegations by Solus are entirely without merit and will defend these claims vigorously. At Hovnanian, we are always guided by our duties, obligations, and responsibilities as stewards of the Company. We take these obligations very seriously and decided to pursue this refinancing transaction because it best positions our company for continued future success. We strongly believe that we have acted properly at all times and that any attempt to block this transaction will not be successful.”

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