OREANDA-NEWS. The Austrian constitutional court's decision to overturn a law intended to bail in junior debt of Heta Asset Resolution increases the likelihood that the Province of Carinthia will attempt to negotiate a distressed debt exchange (DDE) with guaranteed creditors of the bad bank, Fitch Ratings says.

Tuesday's ruling found that the HaaSanG law, intended to bail in EUR1.6bn of Heta's junior debt, is unconstitutional because it applies only to debt due before a certain date, meaning junior creditors would not be treated pari passu. The court argued that doing so would violate the basic right to ownership (in this case, creditors' claims) protection.

The importance of this principle in countries such as Austria and Germany means maintaining a level playing field within each class of creditors will be essential to ensure effective bank resolution. Resolutions governed by a comprehensive framework such as the European Bank Recovery and Resolution Directive (BRRD) are more likely to achieve this than case-by-case legislation such as HaaSanG.

The court also found that guarantees provided by Carinthia cannot be repealed retrospectively by isolated legislative measures, even if, with hindsight, it is evident Carinthia would have never been financially able to honour its guarantees.

The ruling only covers HaaSanG, which came into effect in August 2014. It does not relate directly to Austria's implementation of BRRD. The junior debt will therefore probably instead be included in a much wider bail-in of the rest of Heta's debt planned under BRRD. But the BRRD bail-in is also likely to be subject to a future court ruling, and the court's decision that guarantees could not be repealed in the HaaSanG case indicate it could take the same line on attempts to bail in other guaranteed debt under BRRD.

In addition to the guarantees on junior debt, Carinthia provided guarantees on EUR10.2bn of the senior debt of Heta, a wind-down institution that is legal successor to failed Hypo Alpe Adria. Carinthia would not be able to honour these guarantees as they are greater than its annual revenue. Austrian Finance Minister Joerg Schelling recently suggested that Carinthia should negotiate a debt write-down with Heta creditors in exchange for an agreement to give up all claims against Carinthia.

We believe the court ruling makes it more likely that Carinthia will propose such a DDE, but there would be significant challenges, particularly as creditors may now see those guarantees as more valuable. But a DDE could also be more attractive to creditors than resolution under BRRD as it would enable them to avoid a protracted formal resolution process and remove uncertainty.

The memorandum of understanding intended to settle legal disputes between BayernLB, Heta and Austria is not affected by the ruling.