Consumed – Can burning ambition from Down Under recast Herbert Smith for the global stage?

With the fall-out from the merger of Herbert Smith and Freehills subsiding, the emerging global challenger needs to galvanise its business under new leadership. Will the Australian suitor’s ambition provide the jolt needed or has Herbert Smith been absorbed?

‘I couldn’t talk about this over the phone,’ said one senior partner at Herbert Smith Freehills (HSF), with a glance over his shoulder. What could not be recounted electronically was the surprising news that HSF veteran James Palmer – widely regarded as the firm’s top City deal lawyer – had recently missed out on a place on its partnership council, the firm’s main oversight body.

It was an unusual result given Palmer’s credentials and internal popularity – typically such figures are a shoe-in for these roles. Five other London partners, including finance specialist Gary Hommel and competition partner Stephen Wisking, were up for the place as well in an open vote.

The successful candidate? Sydney-based Mark Crean, one of Freehills’ point men in its merger with Herbert Smith two years ago. According to the view of the concerned partner the result had been caused by post-merger power dynamics: there were only two candidates of legacy Freehills in contention.

The concern voiced by the senior HSF partner was understandable: a perception of a lack of representation of the London partners and even fears that such a slight may make Palmer join the list of City heavyweights to have quit the firm since the vote went live (though that seems unlikely).

Such sentiments underline the tenuous equilibrium of the post-merger HSF. The union – and the reaction to it – remains contradictory. There were clearly reasons supporting the tie-up between the Australia practice, generally regarded as the most upwardly mobile and ambitious of the country’s top firms over the preceding decade, and Herbert Smith, a firm with a proud heritage but one in danger of becoming an also-ran in the global legal market.

As a firm that had long struggled with strategic direction and performance management, Herbert Smith looked to have much to gain from combining with Freehills. On paper, the merger was clearly the strongest of the three major unions agreed by top-tier Australian firms: having a superior pedigree to Ashurst/Blake Dawson and far less daunting operational challenges than Mallesons Stephen Jaques’ tie-up with China giant King & Wood.

Yet the controversies have not gone away and a deal often touted as a call to arms for the City firm has remained somewhat divisive within Herbert Smith, triggering a series of departures among the heavyweight partners that opposed the deal. There has been much grumbling of a reverse takeover since the merger went live – unsurprising given the more pro-active stance of the firm’s Australian partners in contrast to Herbert Smith’s understatement.

While that damaging run of exits has now passed and, by common agreement, the unsettled mood has been replaced with something closer to tentative optimism, the question remains far from definitely answered as to whether the deal will fulfil its sales pitch or fall victim to a troubled gestation and a heavy load of cultural baggage.

Sonya Leydecker, the veteran litigator who last year was named co-chief executive, maintains the logic backing the deal still stands: ‘The way we see the world is that there are a leading group of law firms that are pulling away from the rest. There will be around 15 of those who will emerge as real players and we want to be sure that we’re in that number.’

Australian co-chief executive Mark Rigotti likewise argues that the firm is on course. ‘We’re two years into integration. It could have gone better but on the whole it’s gone extremely well. The challenge is that there is so much change washing through the legal market. We need to finish the job but also respond to what is going to be a different world.’

Reach for the sky

For all the controversies and doubts the Herbert Smith/Freehills union still attracts, it is easy to see why the venerable City firm chose that particular moment and that particular firm to secure the substantive merger that it had so long avoided.

The 2000s had been an uneven decade for Herbert Smith, at least after the credit crunch gripped the global economy in 2007. As one of the small band of advisers to establish itself in the City of London in the late 1800s/early 1900s, the firm had a proud corporate history. Yet it was the post-war emergence of its disputes practice under pioneers like Francis Mann and John Barker that came to define its reputation. Such practitioners turned litigation from a backwater left to clerks and outside advocates to a credible practice for a City lawyer worthy of top-line rates. To a considerable extent, Herbert Smith invented the modern idea of commercial litigation as a law firm practice line in the UK.

Success came at a cost. The over-shadowing of corporate, so total that many wrongly assumed Herbert Smith to be a disputes specialist that branched into M&A, fuelled ongoing tensions between its two core practice areas, which the firm often unconvincingly attempted to downplay.

Nevertheless, Herbert Smith’s corporate practice was on a clear upward track through the 1980s and 1990s, with influential senior partner Edward Walker-Arnott between 1992 and 2000 spearheading a period of modernisation and expansion that coincided with the emergence of the firm’s M&A practice as a genuine alternative to the City’s elite.

At the peak of its powers during the 2000s Herbert Smith, having avoided the expensive and draining international expansion of London’s big four to instead set up an international alliance with top German independent Gleiss Lutz and Benelux giant Stibbe, briefly pushed its profits per equity partner (PEP) above that of Freshfields Bruckhaus Deringer, Clifford Chance (CC) and Allen & Overy (A&O).

It was a false dawn – partly because the 265-partner firm’s high fee-earner/partner leverage and avoidance of international investment flattered its position. Walker-Arnott’s dynamism had been followed by a safe and steady term under Richard Bond.

A 2004 leadership election – a break with consensus appointments – was billed as defining the choices facing the firm but resolved little. The firm’s mercurial head of litigation David Gold assumed the senior partner role, triggering an unhappy period. Gold’s many critics argued he was too impatient for a brief requiring consensus and failed to build a coherent approach to the necessary chore of taking a more active hand in managing partner performance.

One former partner, now with a US law firm, argues that Herbert Smith’s disputes team effectively held back the firm’s development: ‘Back in the ‘80s it was, without a shadow of doubt, the leading litigation firm in the UK, but it was dealing with big and ugly litigation in English courts and not recognising that the market was changing. The senior guys were saying: “Don’t you worry about that.” But they’ve been proved wrong. Others have stolen a march because they are much more international. Herbert Smith has good pockets but it doesn’t have as good a spread as Freshfields or CC.’

The failure to manage the partnership was a major issue in a firm that had limited powers to expel under-performing partners without a vote and culturally shied away from such tactics. When partners asked to consider their position refused to go quietly – the firm was often at a loss.

There was a wider cultural issue. While Herbert Smith lawyers were well known for their technical polish, the individual drive and ambition evident at some larger firms varied widely between teams and individuals. Conservatism had always been an issue at Herbert Smith; the firm held an anguished internal debate in the mid-1980s about dropping ‘& Co’ from its name.

Comments one current partner on managing out underperformers: ‘Ten years ago, we used to mess around and if someone said: “I’m not happy to go”, we were shit. It used to drive me up the wall.’ Nevertheless, there were considerable exits between the end of 2009 and early 2012 – with such departures heavily focused on corporate and banking. It is understood that around 20 partners were managed out during this period.

Though the re-introduction of the managing partner role in 2008 with David Willis was well received – Willis being far more detail-oriented and increasingly charged with the job of managing out poor partners – there was considerable bad blood towards Gold, particularly from corporate, with some accusing him of leaking stories about the firm.

In December 2009 competition partner Jonathan Scott was named as senior partner in a vote against CIS managing partner Allen Hanen and disputes partner Tim Parkes. Scott at first seemed not quite sure what he had let himself in for and some argued the defeat of Hanen, as the most progressive and strategic of the candidates, was a missed opportunity at a key moment.

Scott soon had plenty to keep him busy. In contrast to the early 2000s slump, this time corporate stumbled badly, going on to fall nearly £20m behind budget in the 2010/11 year as litigation sped ahead. In addition, profitability in corporate plunged. The firm’s deal practice had long been geared toward big-ticket deals and was always relatively expensive. As the market contracted, it became apparent Herbert Smith lacked the volume of mid-tier work needed to sustain it amid the gloomy market conditions.

While its productivity had on occasion exceeded disputes during boom periods, by 2010/11, corporate’s profits had plummeted to under £500,000 per partner, roughly half that of litigation at the time. The core M&A group in London, the 35-partner heart of the corporate practice, had even dropped to just under £600,000 profit per partner. The tensions between the two practices – which had been kept in check for years – were increasingly evident.

Moving finally to address the big issues that had been so long avoided, Scott and Willis in the spring of 2011 launched the Project Blue Sky review, which was led by Hanen. PwC was also called in to review its business, with utilisation rates found to be well below the average for peers.

A report presented to the firm in May 2011 painted a picture of a culture of low achievement; ‘Collegiality appears to be an excuse to mask widely different levels of contribution’, was one particularly damning comment in the report.

This angst-ridden debate brought the situation with its international alliance to a head – Gleiss and Stibbe were finally pushed to either accept a merger or end the alliance. Both firms announced their decision to split in November 2011. Meanwhile, Herbert Smith was losing a steady stream of prominent partners, among them corporate crime head Peter Burrell to Willkie Farr & Gallagher, capital markets partners Jim Wickenden and John Moore, to A&O and Morrison & Foerster respectively, and a team of Paris litigators to A&O.

Given that Herbert Smith historically had a loyal partnership and lost few of its ranks to rival firms, such departures were keenly felt. Comments Palmer: ‘We don’t like losing people but it’s about how you respond to it. We’d lost about three partners in our history and were the firm that was famously loyal and then we became the firm that people were being prised from.’

The deal

While Herbert Smith was wrestling with its strategy, Sydney-based Freehills had also been taking stock of its position after a flurry of international advisers hit the Australian market (see ‘Harbour kings’).

Herbert Smith, short of viable options for strategic growth and intent on building on its strong Asia network, had been sizing up Australia. It had held initial talks with Blake Dawson before the firm moved to pursue its tie-up with Ashurst and also held tentative discussions with Clayton Utz.

However, it was Freehills that made the approach to Herbert Smith towards the end of 2011. The Australia firm’s partnership needed little convincing of the case, with it fielding a team including chief executive Gavin Bell, chairman Crean and partners Rebecca Maslen-Stannage, Martin Shakinovsky and Robert Nicholson on the talks.

HSF’s team was led by Willis, Scott, M&A partner Stephen Wilkinson, litigator Philip Carrington and corporate partner Ben Ward.

The talks moved on quickly, relatively early clearing the key question of whether the union should be executed with a single profit centre. Co-chief executive Mark Rigotti sums up the mood in Australia: ‘If you’re an oil and gas guy in Melbourne or Perth then you absolutely needed this merger as you were just getting slaughtered by all the international oil and gas firms flying in from Texas.’

Apart from a much-needed cultural infusion of ambition, Freehills was large enough to nearly double the City firm’s income, providing more resource to back global investments and critical mass in Asia.

But while Freehills’ practice – built on a strong corporate/disputes axis with a notable tilt towards energy and infrastructure – was a good fit for Herbert Smith, with its can-do style having driven it to the top of Australia’s highly-competitive market, the merger was a far harder sell the other way around.

Litigation was far less enthused about the merger than corporate. Heavyweight litigators Ted Greeno, Kevin Lloyd, Parkes and Tony Dymond opposed the merger, arguing Freehills would drag down the firm’s profitability once the Australian commodities boom ran its course and questioned the need to be in that market, given how saturated the jurisdiction had become.

Corporate partner Malcolm Lombers, who now sits on HSF’s partnership council, drafted a memo against the merger that gathered over 50 signatures, including the names of influential partners Lloyd and Greeno, who each controlled over £5m in annual billings.

The core and most rational argument put forward by those against the merger was that despite issues with profitability, Herbert Smith had clearly outperformed its London peers on organic revenue growth in the post-Lehman period. On this reading the firm – having hiked revenues by 44% between 2007 and 2012 on the back of its buoyant disputes practice – should have instead turned its mind to tougher performance management and raising profitability. Supporters of this view often said such a strategy would have ultimately positioned the firm for a US deal, which an Australian tie-up would make less likely.

Aside from Scott and Willis, prominent supporters of the merger included Palmer, corporate partner Scott Cochrane, securities partner Alex Bafi, senior real estate partner Ian Cox and energy finance partners John Balsdon and Mark Newbery. Despite the misgivings in disputes, department head Leydecker, intellectual property litigator Mark Shillito and arbitration specialist Paula Hodges were among those in favour.

One former partner who signed the memo comments: ‘The letter was not intended to be shared with the entire firm but much to the irritation of those who had signed it, it did become known to the whole partnership who had signed it. It even became known to the Freehills partners, which worsened the divide.’

The wider publication sidelined the rebels and put pressure on those thinking of joining them in voting against the merger. Management vetoed a plan to produce a paper outlining reasons not to merge and a second memo planned by Lombers failed to materialise.

One senior partner who has now left the firm comments: ‘Rather than debate, management saw it as their duty to get the merger over the line, which meant the decision was taken by a very small number of people and reminds me of a Camp David tryst.’

Cox, now UK and US managing partner, offers a counter-point shared by many: ‘The merger was not just the right merger for us but a catalyst for reinvigoration of the Herbert Smith partnership. It was affirmation, for people internally and externally, that the firm was ambitious. The merger caused us to look at what we had been doing on our own for the previous five years and realise that we weren’t doing some things as well as we could have been.’

With a number of influential figures being pressed to support the deal, according to several accounts, the vote narrowly crossed the 75% threshold in June 2012. Rightly or not, several partners believed that Herbert Smith’s well regarded 210-lawyer Asia practice – which was broadly supportive of the deal – had effectively voted as a block.

Comments one former partner: ‘Asia seemed to have a three-line whip and voted as a block for the merger. I know that a lot of them had real misgivings about it. It was the Asian vote that carried it.’

In contrast, Freehills easily secured the higher 85% hurdle to back the merger, with more than 90% supporting the union. Reservations aside, the tie-up was ratified on 28 June. The deal was to go live from 1 October 2012 with a single profit pool with a plan to later unify the remuneration system, which differed between Herbert Smith’s lockstep and Freehills’ more merit-driven model. Legacy Herbert Smith equity partners were asked to put in around £20m to align the businesses and boost its capital structure.

The union created a 460-partner firm, with revenues projected to be over £770m, and around 2,400 lawyers. Herbert Smith’s PEP of £840,000 was higher than the US$1.06m equivalent for Freehills at the time for the 2010/11 financial year, though the Australian firm had maintained a lower leverage than its UK counterpart’s 7:1 ratio, effectively narrowing the gap.

Given the turbulent run-up to the union for Herbert Smith and that the firm had already been seeing a steady stream of departures prior to the deal going live, it was braced for fresh losses. They certainly arrived. In total, 59 partners have departed the firm since July 2012, not including normal retirements.

There was another factor at play – legacy Herbert Smith had some of the toughest exit terms in the City under the partnership deed drawn up by its aggressive litigators, which had led to a protracted stand-off when property rainmaker Chris de Pury quit the firm in 2007 for Berwin Leighton Paisner (Herbert Smith had threatened to enforce a 12-month covenant on top of a year’s notice). So effective had these measures been that many rivals had been put off targeting its partners but the new merger agreement overhauled the terms, cutting the notice period from 12 months to six, making it easier for partners to quit at a vulnerable moment. Although these changes only officially came into force this summer, they became de facto terms on sealing the merger.

While there were considerable numbers of managed exits from Herbert Smith’s top-heavy partnership, there were also clearly some damaging losses. Financial services regulatory chief Martyn Hopper left for Linklaters, Lloyd and Dymond quit for Debevoise & Plimpton, co-chair of corporate fraud and asset-tracing Simon Bushell joined Latham & Watkins and Hong Kong-based Tim Mak moved to Freshfields.

Perhaps the most symbolic departure was that of Greeno – one of the public faces of Herbert Smith’s disputes practice, who last spring quit for US disputes leader Quinn Emanuel Urquhart & Sullivan. While the legacy Freehills side has largely avoided such losses, Quinn Emanuel was also the benefactor of probably its most significant loss, Sydney-based litigator Michael Mills, who quit last year to launch a local practice for the US firm.

The departures were less damaging in corporate, which was still going through the tail end of its rationalising, though the loss of Will Pearce to Davis Polk & Wardwell and energy specialists Paul Griffin and John Geraghty to A&O, were clearly disappointments. Such was the extent of the departures, HSF ended up re-pitching to BP, one of its key clients, to ensure it did not lose its work. It took until the end of the 2013/14 financial year for the losses to run their course.

After the earthquake

It was clear that the merger vote had reignited old tensions in the firm between corporate and disputes. The attempt to build up not only corporate but a sizeable finance team (with mixed results outside the energy sector) had limited the scope of disputes to pursue certain cases, particularly against major banking groups and created substantial levels of conflicts.

In addition, the once aggressive style of the firm’s litigators was particularly ill-suited to finessing such tensions. The pressure to decline instructions and shift its style clearly generated resentments in litigation. Given the firm’s historic reputation as the City’s go-to claimant practice for high-end litigation, the repositioning of Herbert Smith over the last 15 years to a degree clipped its wings, conceding ground to an expanding legion of disputes specialists such as Quinn Emanuel, Enyo Law and Stewarts Law.

Shillito, head of disputes for the UK and the US, comments: ‘We won’t just sue anyone. We have to do the usual conflict checks and how that fits with our client base and we come to a mature decision as to whether it’s the right thing to do for the firm, taking into account all of the different legal, regulatory and commercial conflict points that would come up. As you get to be a larger firm it tends to narrow those that you can sue because the conflict problems increase with the size and scale of the operation.’ ‘The upside of scale is that you get more work from a wider pool of network clients.’

Another challenge is that Herbert Smith no longer enjoys the pre-eminence it once had in disputes, with larger City rivals such as CC, Freshfields and Hogan Lovells increasingly building up their practices to either narrow or entirely close the gap Herbert Smith had established, depending on your viewpoint.

The arbitration boom had further eroded Herbert Smith’s contentious position. Its arbitration practice is well regarded but not in the same class as elite players like Freshfields and Wilmer Cutler Pickering Hale and Dorr, with critics typically contending its generalist approach and City-centric focus has held it back, aside from Asia. Likewise, many contend the firm is relatively light on banking disputes – a key market.

This tension over the treatment of litigation was aggravated by those who argued that department head Leydecker was more focused on firm-wide consensus and her role as an administrator than representing the views and interests of litigation.

Fears also exist within the firm that the loss of certain client-facing litigators will hinder growth in the long-term. That test will soon arrive, with big-ticket work won by Lloyd and Greeno, including acting for Ernst & Young as administrators to bankrupt Canadian telecoms group Nortel and the defence of Bernie Ecclestone in a $145m claim brought by German media group Constantin Medien respectively, coming to an end. This supposed lack of star quality is underlined for the firm’s critics by the fact that former Herbert Smith lawyers John Reynolds and Chris Pugh are now heading the disputes groups of White & Case and Freshfields respectively, while banking litigator Christa Band, who left in 2009, is now prominently established at Linklaters.

However, for all the sniping aimed at the firm from ex-partners, by consensus disputes has not only performed robustly since the banking crisis, it has continued to perform credibly since the wave of senior departures between 2011 and 2013. The practice generated PEP of around £1.3m and revenues of over £300m in the last financial year and is currently running ahead of its budget for 2014/15. Internationally, it has been buoyed by Herbert Smith’s launch in the US, while by consensus the transactional departures that have had a negative impact on the legacy firm’s Asia network, have had no impact on its muscular Asia disputes team.

The firm has created its first head of disputes in London for years in Parkes, a move that should strengthen the group’s position within the firm further still, and the division between the arbitration and litigation teams has disappeared with the exit of some senior partners, creating greater crossover between the groups.

One example of this is a case for longstanding client Chevron in an arbitration against Indonesia. The firm is also advising The Royal Bank of Scotland (RBS) on three investor claims in the UK courts stemming from a 2008 rights issue, and there are clear signs that it is beginning to attract more banking work, having been appointed to the legal panels of Société Générale, Citibank, RBS and Lloyds in recent years. The litigation ranks have also received the most strengthening during partner promotion rounds in 2013 and 2014, with 16 associates elevated in total.

Asia, where Herbert Smith had arguably the strongest disputes practice of any international firm, has been boosted by the merger with more than 100 legacy Freehills lawyers having been relocated across the region. Hong Kong-based Justin D’Agostino, who became global head of the firm’s disputes group in May, says: ‘We’ve taken what was an incredibly strong Asia disputes practice and taken the market-leading disputes practice in Australia and created an Asia-Pacific powerhouse. In the old days we had this fantastic platform but when we needed depth or needed more bodies, we would look west to London for that resource, but we can now look south – within the same timezone – and use specialisms you can’t necessarily carry in Asia.’

The firm’s Asia practice, already armed with arbitration work from the firm’s major institutional clients, including a tax dispute for BP worth over £100m, has made quick gains in capturing the banking clients the firm so ardently desires. Arbitration partners Jessica Fei in Beijing and Brenda Horrigan in Shanghai have also managed to secure work from major state-owned entities in China.

Development of the firm’s white-collar and government investigations practice has helped the wider contentious group to deepen its relationships with RBS, Lloyds, Goldman Sachs, UBS, Credit Suisse and JPMorgan Chase, with a Securities and Exchange Commission investigation into the latter’s hiring strategy in Asia the standout mandate. The firm has boosted its ability to attract more of this work in the UK by hiring Deutsche Bank’s global head of compliance Andrew Procter in June and its disputes-led launch in New York is a major selling point globally as the long arm of US regulators continues to shape global enforcement. The arrival of SEC prosecutor John O’Donnell in June and Cooley’s head of financial litigation Scott Balber in October 2013 to head the group adds weight in a key area.

While rivals will typically bemoan the loss of old disputes heavyweights like Gold, Greeno and Charles Plant – the firm cites a City roster of prominent players that includes Parkes, Alan Watts, Gary Milner-Moore, Damien Byrne Hill, John Ogilvie, Shillito and Hodges. In addition, James Baily is cited as effectively handling much of the high-end energy disputes work for clients like BP and Chevron that Greeno previously oversaw. The firm’s ambitions of breaking into the arbitration elite also received a symbolic boost this year with Hodges and Matthew Weiniger both being awarded QC status, prominent recognition for two of the firm’s key arbitrators.

Shillito comments: ‘One of the really encouraging things after we had partners leave us after the merger is that we then had our best year ever. You might have expected us, when we lost one or two names, to have a dip. We didn’t. We got stronger. That’s a testament to the strength of bench we’ve got here. It’s been a personal pleasure to see some of those, who were a little bit younger than some of those who left us, blossom and keep that work.’

Disputes is also conceded to have benefited from the 2011 launch of its Belfast support arm, which was initially heavily focused on document review. The Belfast operation, which the firm is now aiming to extend more widely across the firm, has not been without its teething issues but is nevertheless widely viewed to have been a success internally.

Promisingly, the resilience in the disputes team has been matched by a continued revival in the City corporate team, which has dramatically improved its profitability from the depths of its 2010/11 performance to get team PEP approaching £1m. (The London M&A group has already surpassed the £1m threshold.)

There is also positive news post-merger in the two key strategic international markets HSF has targeted for growth. The US and Germany have been the firm’s two biggest priorities for international expansion, with nearly half of all the 32 lateral hires made by the firm since July 2012 having come in those jurisdictions. While many rivals have struggled in New York, HSF’s eight-partner disputes offering is profitable and is receiving a large amount of investigations work for major banks. A wider review of the firm’s US strategy is now taking place, with one of the options on the table being an office on the West Coast. Rigotti comments: ‘We need a US story. We have a partial US story with our New York disputes office and so we’re looking at our strategy there and that’s at a really early stage. Everything is being thought about, from alliances through to full merger.’

Being underweight in continental Europe meant that rather than pitch for the entire mandate, M&A chief Stephen Wilkinson chose to pass the local German work on BSkyB’s £7.4bn deal to buy European sister companies Sky Deutschland and Sky Italia from 21st Century Fox to Hengeler Mueller rather than the firm’s own office.

Wilkinson strikes a realistic note about the extent that the firm is now playing catch-up in Europe: ‘I’m sure [the end of Herbert Smith’s alliance] did have some sort of impact but if everything had been working totally smoothly and delivering what we needed in the long term we probably wouldn’t have ended it. No one turned around and said: “All those deals from Gleiss and Stibbe have dried up.”’

The firm is viewed as having ushered in some credible recruits in Germany in the wake of recruiting Gleiss Lutz’s head of corporate Ralf Thaeter last April at the end of the alliance’s one-year non-compete period. The firm initially opened in Frankfurt and Berlin and since hired SJ Berwin’s head of real estate Hans Thomas Kessler, Norton Rose Fulbright corporate partner Nico Abel and Mayer Brown finance partner Kai Liebrich. Thaeter was soon handling a £5.2bn merger between Tui Travel and Tui in Germany.

That momentum has continued into 2014, with the arrival of Freshfields corporate partner Dirk Hamann in September, the most high-profile hire to date. Leydecker comments: ‘They’re two of the busiest offices in the network but we need more partners and more fee-earners. In a couple of years’ time we will probably have a third German office.’

With Germany and New York in many ways exceeding expectations, the firm’s international network has been further buoyed by a run of success at its Madrid office, which launched in 2009 with a double hire from Linklaters, building rapidly following mandates from the Spanish government that include a multibillion-euro arbitration claim over its removal of solar panel subsidies.

While the Netherlands and Italy are the obvious gaps, both are problematic for international firms and heavily lawyered. As such the firm’s current stance of focusing its efforts in limited key strategic jurisdictions is hard to question.

These successes aside, it is conceded that the continued slowdown in the Australian economy has impacted on its wider Asia-Pacific business, with dramatic falls in the utilisation of its Australian corporate practice after the merger – falling as low as 65% according to one account – offsetting a strong contentious performance in the region.

Financial results issued for its first full year in 2013/14 showed the firm with revenues of £800m, with net income of £232m and a PEP of £741,000. While a direct comparison to the previous year is hampered by the seven-month trading period, the firm said this represented 5% growth, suggesting the previous year’s revenue pro-rata was £760m, slightly down on the two legacy practices. Profits per point were up 10% from around £9,100 to £10,000, though PEP remains considerably below the three years preceding the merger at Herbert Smith (see box, ‘The five-year PEP picture’) and well below the £1m+ figures achieved by the entire Magic Circle currently.

An awful lot of people managing

If concerns regarding a slowing Australian economy fuelled the deal’s critics, the inevitable run of post-merger integration provided material for the many Herbert Smith partners culturally inclined to grumble about excessive management and claims of a reverse takeover.

Much of this can be dismissed as inevitable in a large deal, though it was clear there was a considerable distance culturally between the Freehills and Herbert Smith partnerships, with the Freehills crowd grabbing the opportunity to play on the larger stage post-merger with gusto. For example, Melbourne-based partner Mike Ferraro, who was last year named head of corporate, ruffled a few feathers in his robust dealings with the City deal practice.

A media reception last summer made the differences in approach of the Freehills partners with the more reserved Herbert Smith crowd abundantly clear but in many regards the more pro-active stance of Freehills seemed exactly what the legacy City firm needed. Freehills was known for being sophisticated in its client development, while in contrast Herbert Smith had never been one of the most operationally sharp law firms in the Square Mile.

The firm reached a key point when David Willis and Gavin Bell last year announced that they were to stand down as co-chief executives, opening the way up for a successor. Litigation head Leydecker, UK managing partner Cox and Hanen were viewed as likely contenders to fill the role.

In the end it came down to a two-horse race between Leydecker and finance partner Rigotti, who had held a succession of senior roles at Freehills and, like Leydecker, sat on the executive board. Having both pitched to HSF’s partnership council and adviser Egon Zehnder as a single head, the pair were at the last minute asked to consider taking on the brief as a joint role. The pairing was put to the partnership for ratification in a vote in December 2013.

With Rigotti viewed as focusing more on client initiatives, Leydecker holds a more internal role, building on her role as disputes head, where she had overseen the launches in New York and Germany and the Belfast support hub, three initiatives viewed as successes.

In a London partnership that still has something of the boys’ club about it, Leydecker continues to divide opinion, particularly in the firm’s City heartlands, with her tendency to default to bland management speak (‘the buzzword is network connectivity’) not appealing to partners wanting more spike and personality in their leadership.

In contrast, Rigotti already appears to have won considerable support in London, reflecting perhaps a personable style and outward approach, which is all the more striking giving the complaints of an Australian takeover. Against that, Leydecker’s supporters maintain that the diplomacy obscures a solid strategic viewpoint and an ability to think long term.

Palmer comments: ‘Rigotti brings this obsession with clients and that’s what law firms need to have. You’ve got to keep your foot in the outside world. You add that focus to Sonya, who is also very much a strategic thinker.’

Asked what he would have done differently about the merger, Rigotti comments: ‘It would have to be some of the investment phase of the integration, such as getting people together at conferences, getting people working in different places and all the stuff that binds people together. We slowed that down a bit due to the circumstances we found ourselves in. If we knew the markets were going to come back so strongly we would have kept the pace on that. It’s the classic pivot, if you invest more you get more progress further down the line. We could have put a bit more into the people side of the business.’

Leydecker admits that ‘immediately after the merger there was a feeling that there were an awful lot of people managing’ and reasons that it was because ‘there was an awful lot to do’. Internal politics and the need to appease partners from both sides of the marriage led to co-heads of practices but Leydecker and Rigotti have rapidly addressed that with a management shake-up that has left each practice with one ultimate leader, a move which will also free up others to concentrate on fee earning (though there remains a multitude of job titles). The partnership council has also shrunk, as per the merger agreement, from 13 to 11 this summer, resulting in a leaner management structure (see box).

‘There’s a feeling there that people want less management but they want to be managed by partners who have been successful practitioners,’ adds Leydecker. ‘I would like to see more work moved to business services. It’s a cultural change for people to let go of things. People say there’s too much management but if you say to them: “Okay, you’ll no longer deal with this, we’ll delegate it to business services,” then they often feel that those tasks are the badge of a partner. There’s a tension there in law firms and you can’t do away with that completely. It’s a transition.’

With Scott’s influence having waned in recent months as he approaches the end of his tenure as senior partner, Rigotti and Leydecker are set to be joined at the top of management by one of the four partners running to replace him: Palmer, Crean, Hanen and Parkes. The race will resurrect the rivalry for management positions between London’s Palmer and Sydney’s Crean, with a full partnership vote set to take place at the start of November, ahead of the firm’s annual partnership meeting. The process has been accelerated by Scott’s decision to step down three months before the end of his five-year term and retire, after 35 years at the firm, in January 2015. His replacement will head up the influential partnership council and Scott’s exit is symbolic as he is the last remaining senior member of legacy Herbert Smith management to have led on the merger, with David Willis having already retired.

That Crean is the only Australian partner in the running could count in his favour, as it did in the race to make the partnership council earlier this year. Palmer and Parkes are two of the longest-serving partners of legacy Herbert Smith, having made partner in 1994 and 1987 respectively, and will have strong support in London. Parkes, the only litigation partner in the race, also had a successful spell as head of Herbert Smith’s Asia arm prior to the merger and should be able to count on support from within that region. With Parkes on the partnership council alongside Crean and Hanen on the firm’s executive committee, Palmer is the only lawyer in the race for senior partner not to currently hold a management position. One partner at the firm comments: ‘It’s dead straightforward. One man, one vote. It’s so straightforward that we wouldn’t be able to get it wrong.’

If the move towards post-merger leadership has appeared relatively sure footed, there was less sign of unity over the wrangling regarding the post-merger compensation system. Despite pledging to adopt the same model, which was expected to ditch Herbert Smith’s rigid eight-year lockstep in favour of a merit-driven system closer to Freehills, the firm was yet to agree a model for its 313 equity partners well over a year after agreeing the original deal.

Under Freehills’ system, up to 40 points could be awarded on top of a core ladder running to 120, meaning that top-performers could earn over £1m before the merger. In comparison, top-earners in Herbert Smith’s flatter system took home £933,000 for the 2011/12 year, despite then having higher PEP than its counterpart of £840,000. The City firm’s equity ladder ran from 43 to 100 points for full equity partners, with a large contingent of fixed-share partners expected to serve up to four years before getting a chance for full equity.

Four proposals floated last autumn failed to win support, with London partners rejecting more radical measures to overhaul the partnership, including proposals to introduce discretionary gates, in October last year. The firm eventually opted for what seems a workable fudge. Partners in December 2013 backed a move that, although called a ‘global managed lockstep’, operates two distinct points ladders. Australia has a 43-130 point ladder, with a gateway at 78 points, with the rest of the firm operating on legacy Herbert Smith’s 43-100 point range.

The new system also allows for 5% of profits to be handed out at the discretion of a remuneration committee, a measure expected to reward outstanding performance from young and mid-level partners. Up to 30 points can be awarded to an individual, currently worth around £300,000.

The compromise is that HSF’s Australian partnership was allowed to award additional remuneration to a small band of star performers and laterals to retain partners through its widened points ladder. It was an inelegant solution but generally considered workable, though there will likely be pressure to phase it out in the medium term, particularly if the Australian legal market continues to face gloomy conditions.

Palmer sums up the mood regarding the end of a pure lockstep: ‘I was a die-hard lockstepper for old Herbert Smith at the size we were but we were reaching the cusp of it becoming difficult. The idea that you are all motivated by the pot in the middle when your contribution is 1/450 doesn’t work.’

If the remuneration seems relatively settled, there is continued griping about how the firm accounts for currency movements available elsewhere and the impact of lower profitability and recent falls in the Australian dollar, though management counters convincingly that there are a lot of misconceptions about the firm’s cash management. With much of the money being paid out locally rather than funnelled through a centrally-distributed reserve, Rigotti observes: ‘The currency risk is considerably less than people assume.’

Another partner is more forthright: ‘That’s all bullshit. We have an adjustment mechanism. I suspect some of the people who are uncomfortable don’t even realise how it works. There’s no exchange rate issue. It’s a myth.’

HSF against peers – The Legal 500 rankings
	Herbert Smith Freehills		Allen & Overy		Freshfields Bruckhaus Deringer
Region	Recommendations	Top tier	Recommendations	Top tier	Recommendations	Top Tier
Asia	59	31	55	22	51	19
LatAm	3	0	4	1	2	1
US	0	0	9	0	8	1
EMEA	50	12	167	81	127	46
UK	69	25	62	24	57	19
TOTAL	181	68	297	128	245	86

‘You need a catalyst’

Of all the high-stakes deals struck by London’s chasing pack firms over the last five years, the creation of HSF remains the hardest to assess in that there remain compelling reasons to have done the deal… and to walk away. While Lovells and Ashurst were facing a status quo that wasn’t much worth preserving, Herbert Smith could conceivably have continued on its own.

The firm’s robust organic growth in recent years was well above trend and its top-tier disputes practice had left it well positioned for the choppy post-boom conditions. Yet, a decade of ineffective management, strategic dodges and a partnership too tolerant of poor performance had to a considerable extent squandered those assets.

Viewed two years on, it is easy to see how the Freehills union provided many answers to those ills in expanding its resources, bringing a fresher energy and global repositioning.

If a major London practice was going to unite with a top-tier Australian player, Freehills was the prize catch; it not only had the ideal practice match for Herbert Smith, but brought exactly the fresh thinking the City needed to renew itself.

Yet it remains a finely balanced point. No matter how strong the cultural sell or exciting the Asia-Pacific rhetoric, critics’ claims that Herbert Smith acquired at the top of the Australia market in a moment of lost confidence still hold weight. It also cannot easily be ducked that a firm aspiring to be a genuine global player, which already needed to raise its profitability, has made the problematic move of aligning with a large, less profitable practice in a less lucrative market.

That reality will bring with it substantial challenges that cannot be easily dismissed, however galvanised the post-merger partnership is. It remains troubling for the firm that its current PEP is still materially behind what Herbert Smith had achieved in recent history (Rigotti responds that raising profitability is a major objective).

The legacy Freehills partners have also achieved a striking degree of influence within the combined firm given that the two years since the merger have diminished the contribution of the legacy Australian practice. The likely trade-off for that influence will have to be a steady rationalisation of HSF’s Australian business to reflect its global aspirations if goodwill is to be maintained within the partnership. The firm on paper has the strongest global practice of the three major Anglo/Asia tie-ups but fulfilling the Australia-into-Asia pitch will need a lot of commitment.

Against such problems, it should be remembered that HSF has achieved considerable successes in the last two years. The roll outs in the tough markets of Germany and New York have been managed with considerable polish, while the firm’s core disputes and corporate practices have both weathered the loss of some very considerable partners with impressive resilience so far.

Palmer argues that the journey HSF has been on has reinvigorated the firm: ‘We are so much stronger than we were five years ago. The world is more competitive and you’ve got to have a group of people who want to compete. I am competitive. If we don’t win a bit of work, that’s fine, as long as we did our best to do it. If we don’t try our hardest and we lose, it drives me completely up the wall.’

Cox picks up the theme. ‘There were an awful lot of things we started doing a lot better after the merger, such as going to clients and understanding their needs better, analysing the sectors we wanted to concentrate on and prioritising where we are going to invest. All of this is stuff where you can say: “Well, why weren’t you doing that before?” but if you’ve been doing things for ten or 20 years and it’s worked quite well sometimes you need a catalyst.’

Understandable sentiments, though the point won’t be settled for years. Either way, the die is now cast. LB

tom.moore@legalease.co.uk; alex.novarese@legalease.co.uk