Austria’s Constitutional Court Decides to Uphold Property Rights

To everybody’s vast surprise, Austria’s constitutional court has decided not to side with the government in the infamous Hypo Alpe Adria (HAA) case. The bank went belly-up after the 2008 crisis and slowly but surely it emerged that it represented a financial catastrophe of truly stunning proportions.

Incompetence on a rarely seen scale, but also probably also fraud (although that angle has yet to be pursued by the judiciary) ultimately produced the biggest de facto (if not de iure, yet) insolvency in Austria’s history.

Hypo Alpe Adria – a giant house of cards that imploded in the course of the financial crisis.

Photo credit: hypo-alpe-adria.hr

One big problem with the HAA case was that the Austrian province of Carinthia had written deficiency guarantees on the bank’s bonds – including its subordinated debt. These guarantees amounted to more than €11 billion, which compares to the province’s total annual budget of about €2.4 billion.

As a result, the Austrian federal government initially felt compelled to bail HAA out. Alas, it soon emerged that the costs of this bail-out would balloon in a nigh endless spiral of new “discoveries” of worthless assets on HAA’s balance sheet. At first it was decided to limit the government’s – and especially Carinthia’s – potential liability by passing a new law governing the wind-down of HAA (in the meantime rechristened “Heta Asset Resolution”).

In this law, the subordinated bonds were simply declared extinguished – along with Carinthia’s “guarantees”. Not surprisingly, this blatant expropriation of bondholders was challenged in court, and Austria’s constitutional court has now decided it is indeed in conflict with fundamental property rights. As Reuters reports:

Austria’s highest court on Tuesday overturned a law that had canceled nearly a billion euros of debt owed by defunct bank Hypo Alpe Adria, raising prospects that certain creditors could get some of their money back.

The Constitutional Court’s decision dealt a blow to the Austrian government’s attempt to spread the cost of winding down Hypo, now known as “bad bank” Heta, after tax payers have already poured 5.5 billion euros ($6.08 billion) into the failed bank.

Austria took over Hypo from its former owner BayernLB in 2009 to avert a collapse and prevent potential fallout in central and eastern Europe, where large parts of Hypo’s business was based. The country’s worst postwar financial scandal has swelled Austria’s state debt and budget deficit, soured ties with BayernLB owner Bavaria and prompted a parliamentary investigation into who is to blame for the mess.

The law, which the Court rejected as “unconstitutional”, was passed last year and effectively cancelled 890 million euros of subordinated debt guaranteed by Hypo’s home province of Carinthia. It also required an 800 million payment from German state bank BayernLB.

This produced howls of protest from investors and financial institutions, who thought they had iron-clad state guarantees ensuring they would get their money back. Creditors include Austrian insurers Uniqa and Vienna Insurance as well as the World Bank and German investment funds.

“Austria now faces the difficult task to restore lost confidence with national and international investors, which can undoubtedly be described as a Herculean task,” said Liane Buchholz, managing director of VOEB, which represents Germany’s public sector banks, including BayernLB.

The court’s decision is independent from action taken by Austria’s Financial Market Authority in March to impose a moratorium on debt repayments by Heta. This runs until May 2016 and is aimed at giving the watchdog time to find a solution with Heta’s creditors.

“The (court) decision is a clear stop sign that should also trigger a rethink with regard to the ongoing moratorium,” Buchholz said. A spokesman for the constitutional court told Reuters that Vienna’s commercial court had requested it to look into whether the debt moratorium was legal. He added its investigations on average take nine months.

But Austria’s Finance Ministry said that the moratorium, affecting 9.85 billion euros worth of Heta debt, was still in place. The ministry also said the court ruling had no impact on the process of winding down Heta, which was set up last year to take on Hypo’s assets, valued at the time at 18 billion euros. Constitutional Court Chief Justice Gerhart Holzinger told reporters he expected his court to handle any lawsuits over the moratorium.”

Debt Moratorium Challenged as Well

As you can see above, the Heta debt moratorium (which was imposed after Heta reported a huge additional capital shortfall of €7.6 bn. in its 2014 annual report) is under attack as well. This is important, as the debt moratorium is the only thing that currently keeps Carinthia’s deficiency guarantees from being triggered immediately (they will be triggered the very moment Heta files for bankruptcy).

Now that the constitutional court has repealed the HAA special law in its entirety, it seems quite possible that it will also look askance at the debt moratorium. If the moratorium runs out before Austria’s government comes to an agreement with HAA’s creditors over a debt haircut, the province of Carinthia will become liable for the above mentioned guarantees – which it cannot possibly pay.

Then the province itself will have to enter bankruptcy proceedings, but there exist no legal provisions in Austrian law for the bankruptcy of an entire province. In other words, things could eventually become really interesting. How will creditors enforce their claims against the province? They could perhaps try to attach its roads and hospitals, if they can persuade a court to grant an order of execution, but somehow we doubt they would succeed in this.

Conclusion

This is certainly worth keeping an eye on. With the property rights of HAA’s subordinated creditors at least temporarily restored, the cost of the wind-down has just risen by approx. € 1bn., but this could become a lot uglier still. Heta’s wind-down is also a test case for the new European bank resolution directive, which is supposed to prevent taxpayer – financed bail-outs of banks.

Normally, this would pose no problem, but in this case the guarantees issued by the province have created a unique situation. Note that such state guarantees for financial and state-related companies exist all over Europe and are extremely large in many cases. No-one expected that such guarantees would ever be triggered – their only purpose was to (unfairly) lower financing costs. And as you can see, governments will try to wiggle out from such guarantees if they can get away with it.