Keep Calm and Carry On – Cyprus’ lawyers face up to the worst

Beware the Ides of March: for two weeks earlier this year, the world held its collective breath as Cyprus teetered on the brink. What began with Cypriot banks closing their doors to prevent a run ended with recently installed president Nicos Anastasiades signing a bailout deal with the Troika that he hopes will save the country from bankruptcy.

Anastasiades walked into the crisis with his eyes open. Cyprus, which has been in dire straits following successive ratings downgrades last year, sought financial aid and support in June, and entered negotiations with the International Monetary Fund (IMF), the European Commission and the European Central Bank. However, Cyprus was unlikely to face the embarrassment of bankruptcy negotiations until its six-month tenure of the EU presidency ended last December. Inertia prevailed until the new government was elected in February, tasked with saving the nation’s economy. Not since the violent partition of the island in the mid-1970s has the country so dominated world headlines.

For Cyprus’ business leaders, including its lawyers, the E10bn eurozone bailout of its banking system leaves the nation’s long-term reputation as a global financial centre in tatters. In order to raise the outstanding E5.8bn necessary to qualify for the bailout, Laiki – the country’s second largest bank – will close, with depositors holding more than E100,000 facing huge losses. Laiki will be dissolved into a ‘bad’ bank containing its uninsured deposits and toxic assets, with the guaranteed deposits being transferred to the nation’s biggest lender, Bank of Cyprus. The remainder of the funding will come from tax increases and privatisations.

If all goes to plan and the economy recovers in the coming years, it has been widely reported that Cyprus will still be saddled with debt equal to 100% of its GDP by 2020. All of this leaves domestic businesses and law firms suffering more than most.

Speaking from Limassol, Elias Neocleous, partner and head of corporate and commercial at Andreas Neocleous & Co, comments: ‘The heat has been inflicted on the Cypriots – most of the pension funds are held with these two banks. International clients bank with international banks – none of which have been affected.’

He argues that if the crisis leads to an exodus of companies out of Cyprus, it should increase work for local firms. ‘There will be lots of restructurings and liquidations that will give rise to legal work,’ he says. ‘Things may seem terribly bad right now but there are also opportunities.’

Stavros Pavlou, senior and managing partner of Patrikios Pavlou & Associates, confirms he has been asked to assist Goldman Sachs, Deutsche Bank and a number of high-end institutions on issues related to the banking crisis. He has also been asked for advice from associate firms, such as Freshfields Bruckhaus Deringer and Herbert Smith Freehills in London. And it is that local knowledge which he says Cypriot firms can continue to put to good use.

Chryssafinis & Polyviou, based in Nicosia, is one of the firms advising the Bank of Cyprus. Stella Kammitsi, head of corporate, says that over the coming months all law firms should expect a lot of work in their litigation departments. She adds: ‘We are advising the bank on everything from the simple, everyday legal matters to the more complicated, such as compliance with capital restrictions requirements and insolvency ratios, in line with EU directives and guidelines, shareholders’ rights and share capital composition of the bank.’

The routine day-to-day advice includes employment and pension advice, as there may be redundancy programmes following the dissolution of Laiki Bank. Pambos Ioannides, managing director of Ioannides Demetriou, is representing the doomed Laiki on the restructuring.

Kammitsi adds that the government of Cyprus is advised by the attorney general Petros Clerides and no external firm has been officially instructed.

But recent events in the banking sector will certainly shrink the legal market, according to Anastasios Antoniou, name partner of the law firm Anastasios Antoniou LLC. ‘Cyprus has lost its credibility in terms of its tax and jurisdictional advantages, so I see a major shift in the coming weeks and months as to what [law firms] will offer,’ he says.

The comments above reflect the fear and optimism evident among the country’s firms when Legal Business asked for views on how the legal market will shape up in the short term. At its extreme, Neocleous believes some of the smaller Cypriot firms will collapse. Of the country’s 250 law firms, many of these are family-run, while 150 are small firms with just one or two lawyers.

‘We will see a major reshuffle of the legal market and small to medium-sized firms will merge or close down,’ he says. ‘You will have economies of scale in place, and a lot of clients want the comfort of dealing with a very big organisation.’

‘It’s early days but some firms might not be able to make it,’ he adds. ‘They may have to close. They have lost money in the banks, liquidity has been affected – that’s been the case with a lot of firms, including ours.’

Laying the blame

Cypriot law firms are unapologetic about blaming Cypriot banks and the previous government for the over-exposure to the Greek debt crisis that led to the country’s current woes. Certainly a nation with a banking sector seven times the size of the economy was likely to be vulnerable. The new government under Anastasiades was elected in late February with a clear mandate: to save Cyprus from insolvency. One of its first acts was to introduce capital controls that prevented depositors from leaving Cyprus for several weeks.

But Pavlou says recent measures have been just a sticking-plaster solution. ‘We need to learn to live without the large banking sector and devise structures for the client which allow them to bank wherever they feel most secure,’ he says.

‘It’s early days but some firms might not be able to make it. They may have to close.’
Elias Neocleous, Andreas Neocleous & Co

Cyprus has established itself as a hub for European professional services, such as accounting, actuarial and legal services. But this reputation is at risk, with Moody’s recently maintaining Cyprus’ junk rating, and senior credit officer Sarah Carlson was widely quoted in March as saying: ‘The system’s profile as an offshore financial centre is unlikely to survive this crisis.’

She added that the financial crisis in Cyprus ‘will have profound long-term negative consequences for the sovereign’, and that ‘the sovereign will remain at risk of default and exit from the euro area for a prolonged period’.

Neocleous says that the ‘greatest fear’ for clients is that Cyprus would leave the eurozone, but he thinks now the bailout has been agreed, it is unlikely.

Local firms have suffered the fallout from the downgrades since last summer but George Pamboridis, partner at Pamboridis, says: ‘It’s much worse this year. It’s giving a very bad name to the country as an international business centre.’

However, many remain hopeful that structural reforms will keep Cyprus out of the headlines going forward. Emilios Lemonaris of E C Lemonaris Law Office in Nicosia comments: ‘In my opinion, lawyers flourish when the economy flourishes – not during a crisis. The first professionals to sense the crisis were the lawyers.’

No firms have reported redundancies yet but many are preparing themselves for the worst. Michalis Kyriakides, partner at Larnaca-based firm Harris Kyriakides, confirms the firm has 16 lawyers and took on another two associates in 2012. ‘We did not have any redundancies and are recruiting throughout the year,’ he says.

Neocleous, who has offices in several countries, says growth is still on the cards but is tempered by a changing environment. ‘Last year we were on a recruitment spree, but now we may have to downsize, or we may have to reduce salaries or do both,’ he says. ‘Obviously we need to take steps to make sure we are above board and offer good services to clients.’

In the event of the worst-case scenario, where Cyprus reverts to becoming an agricultural or tourist backwater like Sardinia or Crete, Neocleous would not rule out leaving the island. ‘If that materialises, we may have to look for another roof or host country to service our clients,’ he says. ‘If that very extreme scenario takes place, we will have to make huge decisions.’

Unsurprisingly Cypriot law firms are experiencing pressure on fees. Existing clients are already unable to pay their bills and others are quick to ask firms for discounted rates. ‘The general economic crisis has pushed fees down, and people are now bargaining, and will push the hourly rate down,’ says Achilleas Demetriades at Lellos P. Demetriades Law Office in Nicosia. ‘Our policy is to ask for 50% of our potential fee up front.’

George Pamboridis says: ‘When clients ask your price, if you say “between E10,000 and E12,000”, you hear: “I have an offer of E5,000 – will you match that?” – and you have to say yes or no. It’s not a pleasing environment to work in.’

Positive outlook

Despite the crisis, some firms are already reporting substantial deals for 2013. Pamboridis’ most recent deal was acting alongside DLA Piper in advising Saudi-based Arabsat in the purchase of satellite unit Hellas Sat from Greek operator OTE for E208m in February. The deal is scheduled to complete in the second half of 2013.

‘Although the banking situation is in flux, the reasons why people turn to Cyprus for corporate structures remain the same.’
Pavlos Aristodemou, Harneys

‘There has been a lot of new business, not only within the banking sector but with big projects,’ he adds. ‘For instance, there’s going to be a new casino in Cyprus. Someone needs to undertake and draft new legislation to monitor the regulation of the gambling industry for the licensing and the tendering. It’s a whole new field and the government needs expertise on it.’

Fittingly, given that Cyprus was recently described by French finance minister Pierre Moscovici as having a ‘casino economy’, the newly appointed Cypriot minister for tourism, George Lakkotrypis, has asked the Cyprus Tourism Organisation to update a 2007 study it undertook on the viability of casinos in the country. According to local reports from Cyprus, the government is working on a bill that would allow the opening of casinos. Neocleous confirms that the government is going ahead with this proposal.

The financial crisis in Europe has caused an increase in the number of claims by clients against financial institutions. This has had a positive knock-on effect for law firms, and many of them expect litigation to increase over the next year. Last year Patrikios Pavlou posted record profits, according to Stavros Pavlou who comments: ‘This was mainly from fees from foreign clients instructing us on dispute resolution matters.’

However, he adds: ‘I fully expect it to be lower this year, but we have not yet encountered any clients who are considering their position in Cyprus.’

It’s unsurprising that over the past year, litigation is an area where many law firms are doing well. Ellinas at Areti Charidemou & Associates also reports strong performance in litigation. He comments: ‘The only sector that has faced some problems during the last year was banking. I would say last year was good for us as a law firm and the same I believe for professional services in general.’

Others, such as boutique firm Anastasios Antoniou, predict a shift towards specialised services. The firm has three pillars – competition, energy and intellectual property. ‘We are not broad on the practice areas, we are really narrowed down,’ says Antoniou.

Russian ire

The main challenge for law firms in Cyprus is hanging onto existing clients who have left or are planning on exiting the country as soon as possible. Many of these come from Russia – Cyprus is the largest beneficiary of Russian investment in the world and this was a major contributing factor to the size of the island’s banking sector. The vast majority of Cypriot law firms count at least 20% of their business from Russian sources.

The bailout package has left Russia furious, as depositors with Bank of Cyprus face the prospect of losing up to 60% of their savings. According to a recent briefing from Goltsblat BLP on whether depositors would be able to get their money out of the Cyprus banking system, Russians are believed to have around E20bn deposited in Cypriot banks. Well before the Cypriot banks closed their doors and capital controls came in, there were numerous reports of Russians clearing out their Cyprus accounts and loading barrels of cash onto private jets before flying off to seek more favourable climes.

Yuri Botiuk, a partner on the Russian desk at Pinsent Masons, says: ‘The effect of this will destroy Cyprus as an offshore jurisdiction for the former Soviet Union.’ He adds that claims will be made against the country and enforcement of arbitral awards could be sought against assets held by the state of Cyprus outside its own sovereign territory.

‘I’m sure there will be lots of claims – actions against the two Cypriot banks, the European Union, and the European Central Bank,’ says Neocleous. ‘These are difficult times: relationships with clients are being tested – especially with those who have lost money.’ However, he adds that none of his Russian clients have deserted the firm yet.

An exodus of Russian clients from Cyprus would also throw into doubt the new protocol to the 1998 double taxation treaty between the two countries that took effect in January. The agreement means that dividends received by Russian shareholders from Cypriot subsidiaries would not be subject to Russian corporate tax.

There are fears that Russia may yet pull out of the double taxation treaty and sever future ties with the sovereign state. Botiuk suggests some Russians believe the appointment of the current Cypriot president was an ‘integration ticket’ to bring Cyprus closer to the EU at the expense of Russia. ‘Companies and people who lose money in Russia will remember who was behind this,’ he says. ‘It is therefore a good time for the non-euro UK to roll out the red carpet for the Russians. The true beneficiaries may be the Chinese and South Koreans who compete directly with Germany to sell the heavy machinery that Russia needs.’

However, Savvas Savvides, a partner at Michael Kyprianou & Co, believes that Russian investors will still invest in Cyprus. ‘Even though they lost their faith in the banking system, Cyprus remains a country with a very low corporate tax and low income tax, so clients will not leave us,’ he says.

There are understandable fears rippling through law firms who have strong ties with Russian clients, and they are doing all they can to maintain those relationships. This includes servicing those clients even if they leave Cyprus. But, the country can turn around its fortunes quite quickly, as Ireland did, according to Harneys partner Pavlos Aristodemou. ‘Although the banking situation is in flux, the reasons why people turn to Cyprus for corporate structures remain the same,’ he says. ‘Just like Irish banks had a problem but the corporate structures remained unaffected, we believe the same shall apply here.’

Harneys, which has a 17-strong presence in Cyprus trading as Harneys Aristodemou Loizides Yiolitis, put out a Q&A on the banking crisis that stressed that an important distinction should be made between the Cypriot banking system and its corporate vehicles. It said: ‘Corporate structures are not affected by the banking crisis. Holding structures in particular which are the most popular type of Cyprus structures remain unaffected as tax on dividends and treaty extraction and withholding taxes remain unchanged. Cyprus companies may operate bank accounts out of Cyprus without implication on their tax resident status in Cyprus.’

Aristodemou comments that although migrating companies out of Cyprus is a perfectly legitimate option, it is not something the firm would encourage. ‘As a law firm, our preliminary advice to clients is not to make any decisions until the position is clear. Secondly, we are advising clients to distinguish between a banking crisis and what can happen to corporates. I would hope that other firms are doing the same.’

He adds that the initial shock should be followed by more careful examination based on tax treaties, company law and other fundamentals. ‘There is no reason for a Cypriot company to relocate when it can choose banking in a separate jurisdiction until the banking system in Cyprus is stabilised.’

Harneys is the only international law firm in Cyprus and it established a special banking practice group in late March to advise clients on the legal implications of the crisis. Based in the Cyprus office with additional members in London, Hong Kong and the BVI, the group has been advising clients on all issues related to the imposition of capital controls and bank restructuring as well as the legal position of ongoing financing and derivatives transactions, and Cyprus tax treaties.

‘The general economic crisis has pushed fees down, and people are now bargaining, and will push the hourly rate down.’
Achilleas Demetriades, Lellos P. Demetriades

Another firm, Michael Kyprianou & Co, opened an office in Malta at the end of March to service clients who require alternative options for their banking. Savvides says: ‘We opened an office to offer alternative options to corporate clients as they were really worried about the banking sector. This offers comfort to them.’

Even before Cyprus’ banking crisis escalated, the level of foreign investment in Cyprus had dropped. A multimillion-dollar deal to develop Larnaca airport with local operator Hermes was called off in January. Andreas Neocleous & Co advised on the deal, which would have included a large commercial showroom, warehouses for Chinese goods and a conference centre. Says Neocleous: ‘If you want to destroy a deal, you need to make it public and it became public well before anything concrete had been agreed or reached. That, I think, jeopardised the deal and it fell through.’

Gas relief

As regards future growth in Cyprus, Moody’s suggests ‘at some point, the exploitation of offshore gas fields is likely to make a meaningful contribution to growth, but this is unlikely to materialise over the next two to three years’. The discovery of gas reserves in the country’s exclusive economic zone (EEZ) in December 2011 could mark the country’s transition from small hydrocarbons importer to substantial producer and exporter.

The estimated reserves, with a value of up to $80bn, cover 51,000 sq km in offshore Cyprus and are divided into 13 exploration blocks. The concession for Block 12 was won by Texan giant Noble Energy, which first discovered the reserves, in the initial licensing round.

In the second round, selected bidders included Italian-Korean joint venture ENI-KOGAS (for Blocks 2 and 3), French-Russian JV Total-Novatek (Block 9) and Total (Block 11). The licences were granted in February 2013. Costas Stamatiou, shipping and admiralty partner at Andreas Neocleous & Co, says all of the initial legal work will go to large international firms, commenting: ‘In Cyprus, the legal work hasn’t started yet.’ Savvides agrees, and says: ‘This is a new sector for Cyprus.’

Cypriot firms, therefore, are keen to offer local advice to bidders or international firms as much as they can. Ioannides Demetriou represented the Republic of Cyprus in its contract with Noble. Of the 29 bidders in the second round, Chrysses Demetriades & Co advised Cyprus Opportunity Energy consortium comprising Israel Opportunity – Oil and Gas Exploration and the Norwegian operator AGR Energy. Pamboridis works with DLA Piper’s energy practice in the US and UK, offering it local support on energy ventures in the region.

Socrates Ellinas, head of corporate at Areti Charidemou & Associates, says that energy is very much a nascent practice area for Cypriot firms, and local advisers have much to learn from their international counterparts. ‘Energy is generating a lot of interest, but law firms have to be very honest with clients, foreign investors, and energy companies. The reality is that there are no experienced professionals in Cyprus in the energy sector. This is something we will develop.’

Litigator Anastasios Antoniou, who represented Marathon Oil in its unsuccessful bid to win a licence in 2012, says firms such as Andreas Neocleous & Co have the capacity to adapt and assist multinational energy companies on hydrocarbon licences because of their size. ‘We don’t have that size but are a boutique dedicated to three practice areas, one of which is oil and gas law,’ he says. ‘Firms that have a longstanding practice can adapt to energy law demand. I don’t know if smaller firms can adapt in that manner. My guess is that energy law work, emerging from hydrocarbons in Cyprus, will be a matter for the really big offices. I see a more consolidated legal services market in the future for energy.’

Legal advice on the tendering process is critical, as the exploration of the gas fields requires billions of dollars of investment before they are profitable. Although 200 billion cubic metres of gas have been estimated in the EEZ, the fate of these reserves is in the hands of the recently elected government.

Officials in Cyprus are confident that Noble can start confirmation drilling at the Aphrodite 1 well off the southern coast this summer. Although the third round of licences has not been announced yet, updates regularly appear on the energy section of the Cyprus ministry for commerce, industry and tourism website.

‘The issue right now is not the licensing of new plots, but the political decision as to where, when and how the necessary infrastructure will be put into place for the extraction of resources and their export to other countries,’ says Neocleous.

The attitude of Russian energy companies towards Cyprus investments will be one critical issue, as will the influence of Turkey. The Turkish government claims that certain plots in the EEZ fall within its territory and its intervention may lead to extensive public international law litigation, as well
as deterring would-be investors with significant Turkish business from mining Cypriot gas reserves.

With glimmers of potential amid so much uncertainty, the country’s beleaguered legal profession remains hopeful. But to most outsiders, things look like they could get a whole lot worse before they get better. LB