The collapse of King & Wood Mallesons' European arm offers a cautionary tale to firms intent on merging misaligned entities under the Swiss verein model
IN 2008, SJ BERWIN was ranked 14th among the top 50 firms in the UK. It boasted revenue of about $350 million and profit per equity partner exceeding $1.3 million. In 2013, SJ Berwin hooked up with King & Wood Mallesons, using a Swiss verein structure to create the first combination of top-tier practices in Asia and Europe. SJ Berwin became KWM EUME, embracing the European, United Kingdom and Middle East practice of KWM. In 2016, KWM EUME collapsed and, in January 2016, went into administration.
For law firms with global expansion ambitions, there’s a lingering question following on the speedy, vivid collapse of KWM EUME: does the debacle speaks to the inherent advantages or the inherent disadvantages of the Swiss verein, the legal structure of choice for the flood of major international law firm combinations in the past five years?
KWM may have been sold something of a bill of goods by SJ Berwin, a firm suffering from a host of issues that pre-dated the merger. “Berwin was in serious trouble before it hooked up with KWM,” says Edwin Reeser, a California-based lawyer and consultant who was formerly the managing partner of Sonnenschein Nath & Rosenthal LLP’s Los Angeles office.
Arguably, to the extent that Berwin’s legacy contributed to the eventual downfall, it speaks more to KWM’s lack of due diligence in its haste to expand to Europe than to the verein structure used to form the combination. KWM has been vocal in assigning blame to European management. Critics of the structure, however, say that KWM’s failure to deal with Berwin’s issues when they reared their heads early on points to the inadequacies of the Swiss verein.
The KWM EUME verein controversy certainly reverberates throughout the Canadian legal market. In just the past few years, Norton Rose Fulbright has swallowed up domestic mainstays Ogilvy Renault LLP and MacLeod Dixon LLP; Fraser Milner Casgrain LLP is now part of Dentons’ global juggernaut; and DLA Piper entered the Canadian market via its tie-up with Davis LLP.
These combinations, and many others around the world, were achieved by means of a structure known as the Swiss verein, an entity that allows its member firms to join internationally under a single brand without sharing revenue or profits, thereby maintaining their independent status for liability and regulatory purposes.
“The verein was originally intended for small domestic social organizations but has become a common structure for professional services firms seeking cross-border combinations who need to address thorny issues of local professional regulation that prohibit many one-firm combinations,” Reeser says. “The verein structure also avoids undue complexity and cost associated with competing rules on taxation to individual partners on worldwide operations and serves to accommodate widely disparate cultural, economic and political issues at the local operational level where participation by other verein members would be an unacceptable intrusion.”
Indeed, Nick Jarrett-Kerr and Ed Wesemann, writing in Edge International Review, call Swiss vereins the “driving influence” of international combinations because the structure “assists firms in dealing with the legal and functional hurdles of international mergers.” From this view, the international combinations in the Canada market may not have happened — or at least not yet or on the scale that they did — but for the facilitating verein structure.
Soon after the Norton Rose Fulbright merger, John Coleman, then the managing partner of Norton Rose Canada LLP, told Lexpert that a “financial merger would be a good thing, but whether it is necessary is an entirely different question.” At about the same time, Joe Andrew, Dentons’ global chair, told Lexpert that the verein “was the most efficient structure for us to achieve our goal of having a single firm using a common brand.”
Still, critics — with K&L Gates LLP’s former chairman Peter Kalis the most vocal among them — insist that vereins are merely loose associations of separate profit pools that will never achieve the seamless service and uniform professional excellence that attracts clients to law firms that are fully financially integrated. Kalis goes so far as to maintain that vereins “ossify differences” among law firms rather than facilitating their elimination.
The financial integration marking the traditional single-profit-pool partnership, he argues, serves clients best because it allows the structuring of incentives toward an institutional goal of seamless service. “Because all contributing ships rise with the common tide, collaboration ranks atop the pantheon of firm values,” writes Kalis in The American Lawyer. “Partners, offices, and practice groups a half-planet away are joined at the financial hip, and the most obdurate among them can see, or can be made to see, the benefits to both clients and firm of collaboration and the sharing of opportunities, relationships, benefits and risks.”
To critics, then, vereins are but a Band-Aid solution designed to avoid the legal and practical obstacles to true international mergers in favour of an illusion driven by a fear of missing the tidal wave of globalization in the profession, or worse, by a desire to shore up underperforming partnerships. “The reality of the Swiss verein is that the strategic imperative of developing an international platform quickly before the market is gone is more important than full financial integration from day one,” says Tony Williams of Jomati Consultants LLP, a UK-based legal consultancy.
However that may be, the fact remains that vereins constituted five of the top 15 revenue-producing firms (Baker & McKenzie, DLA Piper, Dentons, Hogan Lovells and Norton Rose) on The American Lawyer’s “The Global 100” list for 2015. But none of them cracked the top 50 in terms of profit per equity partner (PEP). The highest-ranking verein by this measure was Baker & McKenzie, which stood 57th, followed by Hogan Lovells in 60th position, and KWM in the 80th spot. It is against this background that the fall of KWM EUME must be analyzed.
Until the financial crisis in 2008, Berwin was among the UK’s most successful practices, focusing on investment funds, private equity and real estate. The 2008 crisis, however, undermined these practices, which as reported by The American Lawyer, made up more than 50 percent of the firm’s billings. Revenue fell 14 per cent in the 2009 financial year, and PEP dropped by almost 50 per cent. Partners began seeking a merger.
Negotiations with US firm Proskauer Rose LLP failed. One former partner told The American Lawyer that Berwin’s capital was less than half of Proskauer’s: a merger would have required large capital infusions and some partner de-equitizations. Capital underfunding, partners said, was a chronic problem, with little by way of profit invested back into the law firm. “In fact, every current and former partner interviewed agrees that the firm has struggled for competent management since the resignation of long-standing senior partner David Harrel, one of SJ Berwin’s founding partners, in 2006,” The American Lawyer states.
When KWM came along, Berwin management saw an opportunity to evolve from a mid-size London-based firm to a global practice with an international roster of clients. But, echoing the worst fears of the verein structure’s critics, things started to go wrong as the combined firm’s global managers sought to impose an Asian culture on legacy Berwin. As well, global management sought a new European focus on practice areas important to the firm’s China and Australia arms, contrary to the expectations of legacy Berwin partners, who foresaw an investment in European core practices that would further their global expansion.
A review of KWM’s website as the firm moved toward insolvency near the end of 2015 revealed a shocking lack of European partners listed among the firm’s key contacts. International referrals did come, particularly from China. However, according to The American Lawyer, KWM EUME was forced to do the work at discounts of up to 80 per cent, and was then blamed by global management for its lack of profitability. Overall, former partners told American Lawyer that Australia had a “total lack of interest” in the European operation and China was “largely absent.” Instead of promoting cross-selling, entrenched billing practices discouraged cross-selling by crediting only the partner who signed the invoice.
As reported further by The American Lawyer, matters came to a head when then global managing partner Stuart Fuller met with the European partnership. “He came in and said, ‘This is what the firm is going to be. If you don’t like it, get out,’” one former KWM London partner who was present at the meetings told American Lawyer. “There was a sense that China and Australia wanted to build the law firm that they wanted and have London pay for it.”
What followed, in March 2016, was a restructuring of KWM EUME. Its 17 practice groups shrunk to three: corporate, funds and finance; dispute resolution and regulation; and real estate. Some 15 per cent of the European partners were dismissed, and significant staff layoffs ensued. To make matters worse, former partners maintain that the restructuring process lacked transparency.
Then lightning struck: six lawyers comprising the bulk of the Paris office’s private-equity group, once the firm’s most profitable, left for Goodwin Proctor. Among the six was Paris managing partner Christophe Digoy and Maxence Bloch, one of the firm’s top billers and a member of the firm’s global board who had supported the restructuring initiative. The defections led to the departure of five more partners.
In May, the partners of KWM EUME discovered that, since 2005, the firm had spent some $47 million on refurbishing its London premises. The expenditures emptied the firm’s cash reserves, forcing it to turn to short-term debt for its working capital. According to The American Lawyer, things got so bad that the firm had to delay payment of invoices for office supplies. By the summer of 2015, the firm’s overdraft stood at about $40 million.
In July, the firm’s lender, Barclays Bank, got impatient, forcing the firm to provide a debenture over the firm’s assets and demanding that KWM EUME boost its capital. The firm responded with a recapitalization plan, agreed to unanimously, that would have seen partners inject more than $22 million into the firm. But the plan collapsed in October when four senior partners, including managing partner Rob Day and Michael Halford, head of the prestigious investment funds practice, resigned.
At that point, KWM Asia offered to bail Europe out, on condition that the European partners met the capital requirements to which they had previously committed and agreed to stay at the firm for at least one year. But only 16 per cent of the 130 European partners voted in favour. By December, 40 more partners had resigned.
As clients started to panic, KWM Europe sought a new merger partner — an uphill battle in light of KWM EUME’s $70-million debt, the expensive lease on its London premises and the departure of many top lawyers. The search for a new combination, then, came to nought. In December, KWM EUME began negotiations toward a “pre-pack” administration, an insolvency process that contemplates the sale of KMW EUME to other law firms before an administrator is appointed. At press time, several firms had expressed interest but no buyer had emerged.
Would the outcome have been different if KWM was truly a merged firm rather than a verein? As Williams sees it, the KWM saga demonstrates both the strength, in terms of the ability to put a combination of law firms together quickly, and the weakness, in terms of the lack of financial integration, in the verein structure. “A fully integrated firm just has to make things work,” he says. “It’s sink or swim, and it doesn’t have the ability to merely stand back and watch. The firm as a whole has to work it out.”
To be sure, KWM Asia did step in — albeit very late in the game — and offer to bail Europe out. But as Reeser points out, KWM Asia held all the cards, and it was perhaps no surprise that EUME partners turned down Asia’s offer. “In the verein structure, partners in separate arms of the firm are under no expectation or pressure to contribute to the rescue of another arm,” he says. “The whole purpose of joining by way of a verein is to avoid responsibility for other’s misfortunes or bad management. There was nothing in it for Europe in the rescue plan.”
The only interest KWM would have had in preserving EUME was to protect work inbound to China from Europe, the UK and the Middle East. “The sole incentive for Asia was to retain some of the high referral partners in Europe so that they didn’t scatter to organizations that have their own referral relationships,” Reeser says.
Failed law firms, according to Williams, have experienced a “weakening” of the “glue,” as he calls it. “Every firm has something that make the partners stay together, work well together and give clients the right experience,” he says. “That something, whatever it is, is the glue that keeps people committed and encourages them to go the extra mile.”
The glue may weaken for a number of reasons, including generational change, the nature of the business, the mix of partners, the mix of homegrowns and laterals, remuneration issues or changes in leadership. “Whatever that glue element is, it is the key,” Williams says.
On this analysis, there is a cogent argument to be made that because failure has no direct monetary impact on a verein’s successful arms, due diligence and cohesive management may not be as focused as they might be in a fully integrated firm. “One of the features of Swiss vereins is that each firm in each jurisdiction more or less runs itself with its own structure,” says Sean Larkan, an Australia-based principal with Edge, an international legal consultancy. “This makes it even more imperative to ensure one is bringing the right calibre people and firm on to the bus and to ensure there are no lurking issues which have not been fully identified.”
Berwin’s underfunded capital, for example, was clearly of less concern to KWM than it was to Proskauer Rose, which as noted earlier, had previously explored a merger with Berwin. A full merger would surely have provoked more detailed examination of the high cost of the London lease and the immense sums spent in refurbishing the London premises. It’s also likely that a remuneration system that rewarded cross-referrals and benefitted the firm as a whole would have been more likely to develop. A truly merged firm might have had a greater interest in transferring Berwin’s practice strengths to Asia and Australia and adapting its strategy to include European sensibilities. Finally, cultural tolerance and alignment, as opposed to hegemony, might have been in greater evidence.
“The advantages of a Swiss verein, which is to say the independence of the member firms, can also give rise to disadvantages, such as difficulties in achieving consistency in standards, systems, cultures, structures, contributions and brand understanding and support, and getting there in a verein structure requires very good leadership, management and active and ongoing involvement from both sides,” Larkan says. “The so-called cultural glue and loyalty that sometimes keeps mobile partners in an integrated firm is not present to the same extent in a verein, particularly where financial and other structural issues arise.”
These are difficulties, however, that can be overcome with the correct strategy, as exemplified by the success of the Big Four accounting firms: although they pioneered Swiss vereins, most of them no longer inhabit that structure — but the fact remains that none of them is or has ever been a single profit-sharing pool. As Brad Hildebrandt and Lisa Rohrer put it in Hildebrandt Baker Robbins’ Law Vision Blog: “At the end of the day, the financial details of integration behind a merger are much less important than the ability of the global firm management to effectively execute the strategic rationale of the union.”
As it turns out, a survey conducted by Legal Week in January, about the time the firm formally went into administration, found that 55 per cent of the more than 100 former KWM Europe partners who responded blamed local leadership both before and after the merger as being “most responsible” for the collapse; 45 per cent cited partner “self-interest.”
Indeed, Dentons’ Joe Andrew has pointed out “that there are as many types of vereins as there are organizations who use that structure,” with many bearing “little resemblance” to each other. The Dentons verein, for example, has a number of agreements that, in Andrew’s words, “bind us to each other as firms and to the verein.” And as Christopher Pinnington, Dentons Canada’s Chief Executive Officer saw it when interviewed earlier by Lexpert, “What really counts is strength of leadership and the alignment of culture, vision, values and strategy throughout the firm.”
Still, Richard Godden of Linklaters in London, who has been an advisor on a host of major law and accounting firm combinations that have taken many different forms, ranging from loose associations to vereins to full-blown mergers, says that fully integrated firms have a leg up when it comes to seamlessness and unity. “I won’t go as far as to say that a verein can’t be as seamless as a unified firm, but if you’re trying to be seamless and doing it through a network or a verein, you start 30-love down,” he says. “At the same time, just because you’re an integrated firm doesn’t mean that your structure alone ensures seamlessness.”
Godden cautions law firms looking for associations or combinations not to focus primarily on structure. “Commercial requirements precede structure, although a number of clients seem to think it’s the other way around,” he says. “There are an infinite variety of things that lawyers and accountants may be trying to achieve. I ask them to tell me what they want to achieve, and then I advise them as to the most appropriate structure.”
To be sure, law firms of all shapes and sizes have failed. It’s probably unfair to foist the blame for KWM’s misfortunates on their choice of the Swiss verein as a firm structure. But it’s not unfair to post KWM’s failure as a warning beacon pointing to the verein’s hidden dangers.
Julius Melnitzer is a freelance legal-affairs writer in Toronto.