Bondholders may sue Iceland over failed banks

A global group of bond investors have threatened the Icelandic government with legal action after being demoted below depositors in recouping funds from the country's shattered banking system.

Bondholders in Landsbanki, Kaupthing and Glitnir were relegated behind depositors in the queue of creditors as part of emergency legislation during the Icelandic financial meltdown in 2008.

In a move which could delay efforts to recoup billions of pounds of UK taxpayer funds held in Iceland, the bondholders argue the government's move was unlawful, the Guardian reports.

The paper says any litigation could frustrate the Treasury's efforts to persuade Iceland to reimburse the compensation it paid to British savers after the collapse of Landsbanki's Icesave internet brand.

A group of about 100 heavyweight institutions - including fund managers and banks - are understood to be in the group. Royal Bank of Scotland is thought to be involved.

Tim DeSieno, a partner at Bingham McCutchen, the US law firm representing the bondholders, says the group may be forced to sue Iceland to reverse 'depositor priority'.

"The assumptions that inform any Icesave deal then may all go out the window, and any deal to pay the UK would no longer work," he says.

"We think our cause of action is strong, though it would likely drag through the courts for a lot of years, which itself would be damaging for Iceland."