(Adds statement by MBIA CEO)
NEW YORK, April 6 (Reuters) - Third Avenue Management LLC, the investment firm run by veteran investor Martin Whitman, has sued two MBIA Inc (MBI.N) units, alleging the bond insurer's recent move to split its business was "illegal" and has hurt debt holders.
Third Avenue filed a complaint against MBIA Insurance Corporation and MBIA Insurance Corporation of Illinois on Monday in the Delaware Chancery Court, according to a statement by the New York-based firm.
MBIA Chief Executive Officer Jay Brown said in a statement that changes at the company "should not have been a surprise" and the company would defend the complaint vigorously.
In February, MBIA announced it would place its municipal bond insurance business into a new unit, separate from its structured finance business, in a bid to rebuild operations that were shattered by the subprime mortgage crisis.
Third Avenue said it bought surplus notes issued by MBIA Insurance Corporation in February 2008 based on the entity's balance sheet.
But the bond insurer's recent decision to transfer about $5 billion in cash and its entire profitable domestic public finance business to the Illinois unit has damaged Third Avenue's investment in the notes, the firm said.
"We are now being improperly denied the benefit of our investment," said Whitman, Chairman of the Third Avenue Funds, in a statement.
"MBIA has stripped that business away from us and left us with a run-off portfolio that is likely worthless," Whitman said.
Third Avenue is asking the court to unwind the transfers or award appropriate monetary damages.
Last month, a group of hedge funds filed a class-action lawsuit against MBIA, saying the business split breaches the insurer's covenant of good faith and fair dealings with its policyholders by stripping assets from the unit that provides structured finance insurance.
MBIA's Brown said that a year ago he stated a corporate objective of separating the structured and municipal businesses.
"Nor were our actions illegal since they were approved by the New York State Insurance Department," he said. "The Illinois Division of Insurance approved all transactions entered into by MBIA Insurance Corp. of Illinois." (Reporting by Anupreeta Das; Editing by Bernard Orr and Muralikumar Anantharaman)