Junior bondholders in Allied Irish Banks (ALBK.I) will take the Irish government to court on Thursday over its plans to slash the value of their investments in a test case of Ireland's tough stance on burden-sharing.
Dublin is hoping to cut around 5 billion euros from a 70 billion euros bill for bailing out its banking sector by imposing losses of up to 90 percent on junior bonds in AIB, Bank of Ireland (BKIR.I), Irish Life & Permanent (IPM.I) and EBS Building Society [EBSBS.UL].
But two bondholders in AIB, Aurelius Capital Management and Abadi Co, are challenging the court order issued by Finance Minister Michael Noonan imposing losses of between 75 and 90 percent on 2.6 billion euros of AIB's subordinated debt.
Noonan, who has faced criticism for not imposing losses on banks' senior bondholders due to opposition from the European Central Bank (ECB), is using sweeping new legislation to execute the losses, which are designed to ease the burden on taxpayers.
The legislation, which was passed by the previous government in December amid controversy over its wide scope, gives Noonan powers to radically overhaul the financial sector in the aftermath of a devastating property crash.
Legal experts said the scope of the law and the fact that bondholders would likely have lost all of their investments had the government not stepped in to save the banking sector from collapse meant that Aurelius and Abadi faced an uphill battle in court.
"Without the bailout, they would have been wiped out," said Sandeep Gopalan, head of the law department at the National University of Ireland, Maynooth. "In this climate the court is unlikely to intervene on the side of the bondholders."
Carlos Abadi, director of Abadi & Co Securities, said the Irish government's order imposing losses on AIB's junior bonds violated their property rights.
"We believe we have solid and cogent grounds for claims and that we are confident we will be given a fair hearing," he said.
"There is a general consensus that bondholders do recognise the necessity of some kind of burden-sharing. What holders object to is the means by which Ireland is attempting to extract that burden-sharing."
Abadi said the hearing was scheduled to run for four days. The High Court will then make its decision, but there is the possibility the case and any subsequent appeals could hold up the government's burden-sharing plans.
The deadline for most of AIB's junior bondholders to notify the bank whether they accept the buyback is June 13.
A decision in favour of the bondholders could disrupt the government's burden-sharing plans while a thumbs-up for the state could deter other investors from challenging it.
"This legislation was breaking new ground, so any in-depth analysis of the law in this area is similarly breaking new ground," said Nollaig Murphy, a partner at Maples and Calder law firm in Dublin.
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