By Karen Brettell

NEW YORK, June 26 (Reuters) - Holders of U.S. investment grade debt may find they are not as protected as they think against some risks that can reduce the value of their bonds, if a dispute between Tyco International Inc. (TYC.N: Quote, Profile, Research) and bondholders is settled in the conglomerate's favor.

Tyco is being sued by the trustee of its bonds, The Bank of New York and a group of bondholders who argue that the company is breaking terms and conditions of the debt by not offering to buy back the debt at what they argue is its full value.

Investment grade corporate bonds often have covenants that can require companies to buy back the debt at a price that includes future interest payments in certain events such as restructurings or mergers or acquisitions, which can radically alter a company's credit profile.

"The court will need to rule one way of the other, and the entire high grade market is standing by wondering how much new structural risk will be injected into their markets be the de facto gutting of the merger and sale language," CreditSights analyst Glenn Reynolds said on Tuesday in a report.

"The action by Tyco if successful would open up overnight a target-rich environment among multi-industrial names for more of the same abuse," Reynolds said.

Tyco tendered for its debt as part of it plan to spin off its electronics and health care divisions into independent companies by the end of June, but said in May that the majority of U.S. bondholders did not accept the tender offer. For details, see [ID:nN11433205]

A group of Tyco's bondholders said on Monday that they had joined a lawsuit filed by the bond trustee against the diversified manufacturer.

"Tyco has honored its obligation to its bondholders and made a fair offer," Tyco spokesman Paul Fitzhenry said on Tuesday. The lawsuit "breaks no new ground," he said.