Bondholders clash with councils over £5bn Iceland cash

Bondholders who lost money in the Icelandic banking crash are poised for a legal battle with UK councils to renew their right to claim back £5bn they lost, the Telegraph has reported.

Local authorities lost around £1bn when Icelandic banks Landsbanki, Glitnir and Kaupthing failed in October 2008, and are still waiting for the bulk of the losses to be given back to them.

However, bondholders owed $4bn (£2.5bn) - including hedge funds Arrowgrass, GLG and Varde - are fighting against the priority status given to local councils and the bail-out scheme by one of the banks, Landsbanki. A test case is due to start on Thursday in the Supreme Court of Iceland.

As it stands, bondholders will receive nothing, while UK public bodies are likely to recover nearly all of their money back when Landsbanki's assets are fully liquidated.

Unhappy with the current situation, holders of Landsbanki debt argue everybody should get around a third of their money back.

But local authorities' argue retaining "priority creditor" status could save taxpayers as much as £400m, critical during times of tough austerity, according to Baroness Eaton, the chairman of the Local Government Association.

Bondholders are expected to retaliate by arguing the emergency law passed by Iceland, which prioritised some creditors over others, is wrong. Represented by international law firm Bingham McCutchen, the bondholders expect to take the case to the European courts for international judgement.

Consumers also lost out when Icesave, an online svaings account operator owned by Landsbanki, collapsed. The UK Financial Compensation Scheme was forced to borrow Treasury money to bail out the 200,000 UK savers who had money invested in the bank.

A spokesman for the UK Financial Services Compensation Scheme said: "We're pleased that the matter is going before a court and that the issue will be resolved. It's been almost three years now."