The State of Law

When life gives you subprime lending, make lemonade

It wasn’t so long ago that mergers and acquisitions were the axes around which London’s legal universe evolved. Indeed, elite UK law firms spent 2006 and the first half of 2007 basking in the radiance of record-breaking M&A activity. According to Thomson Financial, deals in 2007 tallied $4.5 trillion, up 24 per cent from 2006, itself a record year.

By midsummer 2007, however, the picture had changed dramatically. As the US credit crunch sent predictable reverberations throughout the international legal market, big corporate tie-ups became scarcer, and deal volume dropped. By January 2008, it was clear that markets were battling rough weather. Transactional activity fell, and deal value for worldwide acquisitions value plunged 24 per cent in the first quarter of 2008, compared to its standing a year earlier. Deal volume plunged as well, with M&A stalwarts like Clifford Chance even reporting a drop (from 98 transactions in the first quarter of 2007 to just 60 a year later). Naturally, certain firms felt the pain more than others, and those leveraged in structured finance were particularly hard hit. But even as the credit crunch took its toll on banks, the legal industry still managed to achieve growth and Magic Circle firms garnered the double-digit revenue growth seen before the crisis hit.

Nevertheless, many firms took the lesson, changing direction and strategy. As big-ticket deals, leveraged buyouts and private equity mandates withered in the wake of the subprime crisis, law’s bigger players forayed into the still active middle-market. Other outfits found work rescuing suffering investment banks, as sovereign wealth funds came galloping to their rescue, couriering emergency cash. London litigation giant Herbert Smith, SJ Berwin and US-based Bingham McCutchen even geared up for bank-on-bank court fights. The Bear Stearns buyout, government orchestrated to prevent the investment bank’s total collapse, also generated work for a number of US-based law firms. Many firms turned their profit aspirations to emerging markets, in the hopes that growth in these regions would mitigate slack business on the home front.

Credit-crunching the numbers

In the face of upheaval, UK firms managed to keep their trajectory, with the top firms scoring double-digit growth in both turnover and profits per equity partner. Despite its exposure to a floundering structured finance market, Clifford Chance posted 11 per cent growth in turnover and saw PEP increase by 13 per cent for the year 2007-2008. Other Magic Circle firms fared even better. Freshfields Bruckhaus Deringer’s PEP surged by 39 per cent, crossing well over the £1 million threshold—and that wasn’t just the result of tighter equity rolls, slashed in a 2006 restructuring. After all, the firm’s turnover also jumped 19.5 per cent, shattering the £1 billion benchmark. Hovering just outside the Magic Circle, Herbert Smith recorded a PEP rise of 25 per cent, which catapulted the firm into a clique of seven UK firms that have surpassed the £1 million PEP milestone (among them, Ashurst, Linklaters, Freshfields, Clifford Chance, Allen & Overy and Macfarlanes). Other firms posting significant revenue growth for 2007-2008 include Bird & Bird, CMS Cameron McKenna, Dundas & Wilson, Field Fisher Waterhouse, HBJ Gateley Wareing, Norton Rose, Stephenson Harwood and Veale Wasbrough. Meanwhile, as US firms published their 2007 results, it was clear the M&A boom had elevated the legal market there to new heights. Among top US firms with sizeable London contingents, Sullivan & Cromwell tallied an enviable $3.1 million in partner profits, with Simpson Thatcher & Bartlett coming in at $2.9 million. In terms of revenue, Skadden, Arps, Slate, Meagher & Flom led the field with $2.2 billion, while Latham & Watkins followed closely behind with a revenue figure of $2.01 billion.

Profitability aside, it is, of course, uncertain just how much the legal industry has cause to worry. US firms are more vulnerable to a potential economic downturn and, as UK firms continue to thrive post-crunch, industry observers suggest that City firms’ broader exposure to emerging markets provides some protection, come balance sheet time. That said, US-based firms have traditionally performed better through slumps, because of their wider spectrum of practice areas and access to the huge American market, a money pot that can more than make up for these firms’ rather myopic geographical reach. In the end, law firms’ revenue figures are not prompt reflections of current economic conditions, and it is simply too soon to gauge what effect roiling markets will have on the legal world.

Penny-pinching

The ships may be weathering the storm, but what about the crew? Challenging times have seen law firms cull their ranks, especially in the areas of real estate finance and structured finance. US firms wielded the biggest axes. The first high-profile cuts occurred at New York’s Cadwalader, Wickersham & Taft, which laid off 35 associates in January 2008. Other firms that made cutbacks include Dechert and Wall Street’s Thacher Proffitt & Wood. The UK market has not escaped unscathed. In November 2007, City firm Olswang nixed 10 from its real estate department, including five associates, and Clifford Chance laid off six associates in its structured finance division. Dickinson Dees cut 17 from its re-mortgage team, although the layoffs did not hit lawyers. Redundancy consultations have also reportedly been underway at firms including Bevan Brittan, Howard Kennedy, McGrigors, Halliwells and TLT. Although layoffs have not been as widespread in the UK, the spate of job cuts in America has led to fear that more are in store for this side of the Atlantic.

UK firms have not been immune to pay pressures, either. In 2008, the salary increases of recent years were tempered, and in some cases, nonexistent. Herbert Smith cited the shaky business climate for its decision to forego pay bumps for newly qualifieds and other junior lawyers. Olswang announced that it would not hike salaries for NQs, but backtracked a month later (the increase was 2.4 per cent, below inflation). Allen & Overy surprised the market with a pay freeze for associates, while Magic Circle rivals Freshfields and Linklaters offered below-inflation hikes, a marked contrast to the sizeable increases they touted a year earlier. But other firms are taking advantage of the shift toward moderate pay rises and making up ground. Bird & Bird, for example, rolled out a 19 per cent pay boost in 2008 for first-year trainees, and increased salaries for newly qualified lawyers by 9 per cent.

Amid all the anxiety about stagnant salaries, however, it’s worth noting that a 2008 survey by the Association of Graduate Recruiters found that trainee solicitors are the highest-paid graduates in the UK, beating investment bankers by more than a thousand pounds on average (median salary for starting trainees is £36,500, whereas I-banks pay graduates £35,000). As they gain in experience, however, lawyers fall behind their banking friends in pay. According to a Legal Week article citing research by The Route City wealth club, the average lawyer in the City pulls in £572,800 annually—not bad, you might think, but that’s only if you don’t cast a green eye over the pay cheques of your banker and trader neighbours, whose average pay exceeds £1 million.

Gloom, but not doom

Some firms still managed to close major transactions despite the gloomy market conditions. On the M&A scene, the mining industry is proving the largest source of billion-dollar deals in 2008. Chief among these is the proposed merger between two Australian mining giants: City firms Slaughter and May and Linklaters grabbed lead roles in BHP Billiton’s $147 million bid for Rio Tinto Group. The bold consolidation move fuelled others, as aluminum producers bought into Rio Tinto to gain influence. The buy-ins by Alcoa and Aluminium Corporation of China generated instructions for UK powerhouses Clifford Chance and Macfarlanes, as well as New York outfits Wachtell, Lipton, Rosen & Katz and Cleary Gottlieb Steen & Hamilton. London lawyers are also getting a piece of the action in another of the year’s biggest deals, InBev’s proposed $52 billion grab for brewing rival Anheuser-Busch. The Belgian brewer tapped Sullivan & Cromwell for the effort, and Anheuser-Busch called on its regular counsel, M&A giant Skadden. Meanwhile, Magic Circle firms Allen & Overy, Clifford Chance and Linklaters have all stepped in for the financing.

Other headline-grabbing deals in the UK include the nationalisation of troubled mortgage lender Northern Rock, a process that pulled more than a dozen, fisticuffs-happy law firms into the fray. A number of City firms took on representation of various private sector bidders, including frontrunner Virgin Group, which was advised by Allen & Overy. Taking the bank to full nationalisation was Slaughter and May, as it helped the government put together a bid that met European Commission regulations. Other firms taking part in the feeding frenzy include Freshfields, which counselled Northern Rock, and Linklaters, which advised Northern Rock’s executive chairman on the formation of the company’s new board. Nabarro and White & Case took up cudgels for major Northern Rock shareholders fighting nationalisation.

Litigation nation

Litigation departments can find some (cold) comfort in the slack economy and the free flow of blame. In December 2007, British banking giant Barclays filed suit against Bear Stearns, alleging fraud, conspiracy and breach of fiduciary duty, and accusing the Wall Street bank of misrepresenting the performance of its hedge funds. Linklaters stepped up on behalf of Barclays, a longstanding client—which later prompted another longstanding client, JPMorgan (who bought Bear Stearns in March), to drop the firm from its list of preferred advisers. Other notable bank litigation included an Office of Fair Trading suit, filed against eight banks over allegedly unfair overdraft charges. Defendant banks included big guns Barclays, Lloyds TSB, HSBC and Royal Bank of Scotland—all of which pulled in an equally heavyweight roster of law firms, including Linklaters, Addleshaw Goddard, Slaughter and May, and Simmons & Simmons. In another high-profile case, DLA Piper and Herbert Smith squared off in a battle between British Sky Broadcasting and Electronic Data Systems; BSkyB sued EDS for some £400 million, claiming misrepresentation in the installation of a billing system.

The last year has also seen law firms’ dirty laundry make it into the courtroom. In 2007, Freshfields won a £4.5 million age discrimination claim brought by a former partner, who took retirement when a change in the firm’s pension scheme threatened to reduce his benefits. In a key test to new UK discrimination laws, the Central London Employment Tribunal found Freshfields’ pension scheme to be “proportionate” and balanced. The suit was one of two brought by former partners who left under the pension overhaul. Meanwhile, Hammonds faces a courtroom tussle with former partners; the firm alleges that the defendants violated a partnership agreement by refusing to pay back anticipated profits. And considering the global context, it’s not surprising that some firms also faced mortgage-related lawsuits. Eversheds fields the largest of the high-profile claims, a £20 million suit brought by building society Nationwide, deemed one of the largest against a major UK firm. In the High Court case, Nationwide argues that Eversheds gave negligent advice regarding an allegedly fraudulent deal for a £14.3 million loan for a building in Wales that was actually worth less than £1 million. In other malpractice claims, the Cheshire Building Society filed a £10 million claim against Cobbetts for an alleged overvaluation of property.

The world is our headquarters

London law firms are sticking more tacks on the world map, as emerging markets become the new focus for revenue growth. In greater numbers than their US rivals, UK firms are heading to Eastern Europe and the Middle East, and continuing to grow their presence in Asia. Norton Rose will launch its fourth office in the Middle East, which is currently experiencing a deals bonanza. Eversheds, Lawrence Graham and DLA Piper are also entering the region, and Freshfields is beefing up its presence. The strategy has already paid off for firms like Herbert Smith, which cites Dubai as a major contributor to its positive 2007-2008 results and will expand with an Abu Dhabi office. Thanks to recent launches in Qatar, Kuwait and Saudi Arabia, Denton Wilde Sapte now has eight offices and more than 100 lawyers in the region. US firms are getting in on the action as well; Latham & Watkins, for example, has plans for offices in Doha, Abu Dhabi, and Dubai.

Central and Eastern Europe continue to be viable targets for expansion-minded UK firms. CMS Cameron McKenna was one of the first UK law firms to set up shop in the region and, in March 2008, opened its doors in Kiev. Russia is particularly attractive, as the country’s economic metamorphosis spurs a surge in corporate work. London’s less restrictive investment market is attractive to Russian companies seeking capital and has been the host of choice for Russian IPOs. In a reverse migration, western companies riding the oil boom are also headed to Russia. Catering to these new needs, Simmons & Simmons launched a new Moscow office in November, and other major US and City firms are increasing staffing in the Russian capital as well as expanding across Eastern Europe and the Baltic states. Linklaters, conversely, made a somewhat perplexing move in 2008 by spinning off its offices in Budapest, Bucharest, Bratislava and Prague into a new law firm (while still claiming the offices were “highly successful”).

Meanwhile, firms have been boosting their presence in Singapore, as the city-state opens up its domestic legal market to foreign firms. Outfits that had a presence in the country had been prevented from practising local law except via a joint venture with a Singaporean law firm. Newcomers to Asia include private client-focused Withers, which has launched a Hong Kong office. South America also beckons: Skadden has set up shop in São Paolo, following various New York firms as well as UK giants Clifford Chance and Linklaters who have established presences in Brazil.

As UK firms branch outward, foreign-based firms continue to unfurl their awnings in London. US litigation boutique Quinn Emanuel Urquhart Oliver & Hedges announced its designs on the City legal market with a raid on Kirkland & Ellis, which netted the firm a key litigation and restructuring partner. The Los Angeles-based firm specialises in litigation aimed at financial institutions, and intends to take advantage of the likelihood of credit crunch litigation, while capitalising on the Magic Circle’s reluctance to take banks to court. Other debutantes to the London scene include Canada’s Gowling Lafleur Henderson. The Ottawa-headquartered IP and IT giant launched a City office, its second abroad after Moscow, with a Clyde & Co poach. India’s Fox Mandal Little has also unveiled aspirations for a London launch.

Practice, practice, practice makes perfect

Deal frenzy made corporate lawyers the hot commodities in recent years, but according to a 2008 Legal Week survey, 54 per cent of lawyers now claim litigators are equally valued. Clyde & Co, which has been growing its commercial litigation practice in London, tied its double-digit growth to a rebound in demand for litigation services. Mid-market firms report that litigation instructions are making up for downturns elsewhere. Although corporate law is still among the top practice areas, insolvency and restructuring are catching up. Indeed, statistics compiled by Freshfields point to a 54 per cent surge in UK companies going into administration during the first quarter of 2008. Smaller practice areas are also paying off big. Several City outfits are making a push for lucrative Islamic financing deals: Clifford Chance and Denton Wilde Sapte, for example, handled a $2.5 billion Islamic convertible bond, the first of its kind, whereas Allen & Overy represented underwriters on a $750 million Islamic bond. Practice areas least in demand, according to Legal Week’s survey? Property and the once-hot capital markets.

Taking it to the public

As law firms seek new ways to raise capital, recent UK legislation is rapidly changing the landscape. Approved by Parliament in late 2007, the Legal Services Act will allow non-legal businesses to take stakes in law firms. As companies (ie, insurers) consider the acquisition of law firms, firms are themselves pondering initial public offerings. The prospect of law firms listing on a stock exchange became a reality in May 2007, when Australia’s Slater & Gordon became the first law firm in the world to go public. The personal injury firm raised $29 million in its IPO. For UK firms, the notion of a public listing opens the possibility of raising capital for bolder expansion moves. Although Magic Circle firms will not show up on stock markets any time soon, small and mid-sized firms may find the new capital raising opportunities attractive. But even if UK firms do begin to list publicly, ownership by outsiders promises to open new questions about conflicts of interest.

Meanwhile, firms in England and Wales, where the law takes effect, will face new competition as non-law firms begin offering basic legal services. Personal injury powerhouse Irwin Mitchell has positioned itself to take advantage of the Act’s provisions; already established as an advocate for the “man on the street” and at the forefront of commoditised legal services, the firm has now linked up with the Automobile Association and RAC to offer services such as wills.

Sartorial judgments

In May 2008, the lord chief justice appeared on Vogue’s web site—yes, Vogue—donning the new standard-issue robes to be worn starting in October 2008. Designed by Betty Jackson, the new “Continental-style” black robes are an attempt to give judges a more modern look. Judges will also eschew the centuries-old practise of wearing wigs for civil and family proceedings. The wardrobe adjustments are more than just an effort to catch up to the times—they are also expected to save money. Eliminating a newly appointed judge’s wig allowance, now at £2,595, will save the government £300,000 a year.