An attempt by Austria to slash the cost to taxpayers of Hypo Alpe Adria bank, a high-profile European casualty of the financial crisis, by imposing losses on some bondholders has been thrown out by the country’s top judges.

In a ruling that came as relief for investors who feared a precedent would be set for other European bank failures, Austria’s constitutional court on Tuesday declared illegal a law that would have “bailed in” €890m in subordinated debt.

The act would have breached the constitution by reversing guarantees given to bondholders by the province of Carinthia as well as treating investors unfairly, the court ruled. The law would be “repealed in its entirety”, the judges said in a statement.

Introduced last year by Michael Spindelegger, then finance minister, the law created alarm in Austria and elsewhere in Europe amid fears investors would question the value of guarantees given by other regional governments — for instance in Germany.

However, investors’ relief could prove shortlived as Austria’s authorities press ahead with plans to wind up the bank under recently introduced national legislation, which has become a trial run for as-yet untested EU rules that set out who should foot the bill when banks go bust.

Hypo Alpe Adria was nationalised in 2009 after ambitious international expansion plans went badly wrong. When in March it was revealed that Heta, the “bad bank” created to dispose of non-performing parts, would need a further €7.6bn in state aid, the government in Vienna refused to provide additional funding. The bank was put into resolution, and Heta suspended bond payments.

The Austrian law highlighted the pressures on European politicians to limit the impact of bank failures on stretched government finances. Mr Spindelegger “needed something to show the electorate he would prevent taxpayers bearing the cost”, said Josef Christl at Macro-Consult, a Vienna-based financial consultancy. “It was a political decision, not economically or legally based.”

Tuesday’s constitutional court reversal was “a good decision for bondholders but it’s embarrassing for the government. This was not a law you would have expected from Austria and a lot of PR damage has been done,” added Franz Schellhorn, director of the Agenda Austria think-tank.

Creditors which would have been affected included Vienna Insurance Group and Uniqa, Austria’s two biggest insurers, which have put potential losses at €79m and €35m. Uniqa welcomed Tuesday’s decision and said it would continue to defend its rights “by every means,” including under the moratorium imposed by the authorities.

The Austrian finance ministry “took note” of Tuesday’s ruling but said it would not disrupt the government’s plans for winding up Heta. The setting up of the “bad bank” was in line with the constitution and the ruling would have no direct effect on the moratorium on debt payments, the ministry added.

Germany’s VÖB association of public banks said that the law would have led to incalculable costs by undermining investor confidence in Austria. The country now faced “the considerable task of winning back the lost trust of national and international investors — which could be regarded as a Herculean task”, said Liane Buchholz, the VÖB’s managing director.

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