FS Editorial; Clifford Chance & A&O Entry Set to Change Australian Legal Tradition

Perth is developing into a hot-bed of corporate work and it is flowing through to increased salaries and a generally heightened demand for talent. In the legal sphere, the increase in corporate work has seen the emergence of two major international competitors – A&O and Clifford Chance . The established Big 6 law firms are responding too. So far, we understand that graduates starting this month at three of the Big 6 can look forward to a healthy Perth pay packet:

flattening the top tier

• Minter Ellison Perth 2011 Graduate Salary – $66,000
• Freehills Perth 2011 Graduate Salary – $64,000
• Blake Dawson Perth 2011 Graduate Salary – ”not less than $60,000″

While Perth grad salaries are still overtaken by those in Sydney, they are now nudging parity with Melbourne. However, based on figures we have heard, Perth salaries quickly overtake those in Melbourne as PQE stacks up.

So what’s happening? Are we seeing a geographical change in influence? Or is the game completely changing? Today we will look at the West-Australian arrival of A&O and Clifford Chance and consider how the firm structure adopted by there new entrants is challenging Australia’s traditional law-firm model

Pressure on Tradition

It is said that in today’s era of rapid digital communication, clients are increasingly requiring better quality legal advice on a tighter timetable. Commentator Richard Susskind recently observed that the rapid digitalisation of legal services is leading to increased specialisation among legal practitioners. Such specialistation permits practitioners to provide better quality and cheaper legal advice in shorter timeframe.

But the tighter timeframe and cheaper price foreshadowed by Mr Susskind in this emergent digitalised legal era is at odds with the prevailing economic model of established Australian law firms. Major domestic firms like Mallesons and Freehills have evolved over the course of a hundred years, building on a foundation of senior lawyers and partners practicing with the support of junior lawyers and nonlegal support staff to deliver legal services to clients. By leveraging the work of their juniors, partners at these firms could (and continue to) increase their profits beyond what they stood to earn as individuals. Based on this model, Australia witnessed in the last few decades the emergence of several very large law firms:  in 1987 Stephen Jaques & Stone merged with Mallesons to create Mallesons Stephen Jaques; in 2001 AAR was formed by the merger of Arthur Robinson & Hedderwicks and Allen Allen & Hemsley; Blake Dawson was (primarily) formed in 1988 through the merger of Blake & Riggall and Dawson Waldron. The list goes on.

These mergers were made possible by the traditional law firm model:  junior lawyers learn the art of professional lawyering by working with partners on increasingly complex issues over time. Theoretically, junior lawyers learn how to become lawyers and eventually partners, but all the while costs incurred by the law firm are borne by clients who are billed for the time that young lawyers spend learning. Following several years of this leveraged development, these lawyers are traditionally asked to become partners or, as many of our posts allege, managed out of firms in unceremonious terms. This is also known at the traditional “up or out” law firm model; the “made-up” partners ensure the providence of the firm by developing new lawyers and finding the special ones who can ultimately become partner.

But this leveraged up-and-out model relies on a willingness of clients to bear the cost of junior learning. In the digitalised age of today, however, where better quality legal advice is sought more  quickly and cheaply, that willingness is waning. Astute legal commentator – and head of Marque Lawyers – Michael Bradley correctly observed a few months ago that:

Law firms have gotten as big as they’re ever going to get in our lifetimes. In fact, they peaked about 5 years ago and now they’re just going to shrink… [and] if you work in a mega firm and your face isnt in the equity partner trough yet, it’s something of an existential threat. If the firm isn’t going to get bigger, then your path to the glorious riches of partnership is reduced to a narrow and crowded lane.

These propositions are also supported by international commentators. Even some of the heads of Australia’s major firms agree. AAR CEP Michael Rose told the AFR (25/6/2010) that:

Generally speaking the top-tier firms in Australia are likely to become smaller over the next five to ten years… I would expect [AAR] to probably be smaller than we are today. We may well see a firm that has a different leverage model from the one we use now… firms like us that do more of the premium work will move to a thinner leverage model.

Freehills CEP Gavin Bell predicts that the size of his firm will remain steady for the next five years:

I dont think it will be radically different in size

Statistics also appear to show that leverage is decreasing. According to the AFR (10/12/10) the breakdown is as follows:

1. AAR = 4.5 (up from 4.1 in Jan 2010)
2. Freehills = 4.1 (up from 4.0 in Jan 2010)
3. Mallesons = 3.9  (down from 4.6 in Jan 2010)
4. Blake Dawson = 3.4 (down from 3.5 in Jan 2010)
5. Clayton Utz = 3.4 (down from 3.5 in Jan 2010)
6. Minter Ellison = 3.0 (down from 3.2 in Jan 2010)

Mallesons’ leverage ratio changed dramatically last year; partner numbers remained stable while non-partner fee earner headcount plunged from 851 to 723. We believe the change was directly related to calls from Clifford Chance to be “leaner and meaner” for a merger to proceed. Instead, Clifford Chance went with a completely different approach.

De-Leveraged Competitors Emerge

It is against this backdrop of changing client demands and the slow response from major firms reported above that two entirely new-look firms have arrived in Australia. Those firms, A&O and Clifford Chance, were welcomed to Australia with a mixture of fanfare and consternation. For example, Clayton Utz Chief Executive Darryl McDonough referred to the arrival of A&O as “a minor bump”, but he nevertheless circulated a firm-wide email responding to the arrival of Clifford Chance a couple of weeks ago.

The issue McDonough glossed over in responding to the A&O emergence is that the host of new, young partners who had been developed through the up-or-out Clutz model and were taken by A&O, left a significant gap in the firm’s model. The relevant partners – likely to have either still been paying off an initial capital investment in the Clutz partnership (which is amortised across partnership draws in the first few years and “cashed out” subject to conditions like it was for Grant Fuzi), or patiently waiting for their equity points to accumulate to increase draws – were supposed to be an integral part of the Clutz partnership succession, ensuring its providence. Instead, they traded several years of time spent waiting for their Clutz partnership draws to increase, disregarded their partnership charter of discerning and nuturing the “ups” and managing the “outs”, and walked into a much higher A&O profit entitlement. Recall the A&O triple jump?

We understand that A&O is working with a significantly lower leverage ratio than all of Australia’s major firms. We believe it is approximately 2 lawyers to every 1 partner. And clients, who don’t have to subsidise junior lawyer learning, are responding too. According to BRW (8/10/10):

The Perth office [of A&O] has secured advisory and transaction-based work for a number of clients in energy and resources, including Fortescue Metals Group, Japanese financier JBIC, Aquarius Platinum, Nexus Energy, as well as financing for BHP’s offer for Canadian resources company Potash Corporation. The firm is also beginning to penetrate the industrial and corporate markets through mergers and acquisitions, including advising UBS on the proposed Stella Travel and Jetset merger.

Meanwhile, Lawyers Weekly reported last year that:

Fuzi is unwaveringly confident that A&O will succeed in what it has set out to do, and cites a steady stream of big deals – in excess of $10 billion worth in three months, with more to come – and a constant barrage of job applications as being testament to the fact the firm’s strategy is already working.

Clifford Chance’s Perth office will initially be staffed by the seven partners comprising Cochrane Lishman Carson Luscombe. We understand also that Clifford Chance Australia will have a leverage ratio of approximately 2.

The De-Leveraged Succession Issue

If you’re a client with high-end transactional work, the options appear to us to be:

1. retain a “top-tier” firm, subsidise junior lawyer development and receive advice slower; or
2. retain “flat tier” specialist firm like A&O or Clifford Chance and liaise directly with a partner and get answers quicker and probably cheaper.

The clear issue with retaining a flat tier firm is that senior partners might be stuck doing junior work. Clients would thus be paying big dollars for work that should be cheaply performed. However, this issue can be overcome by outsourcing and increasingly it will be. In 2010, the US lost approximately 35,000 legal jobs offshore and Forrester Research estimates this will increase to 79,000 by 2015. With all the noise around outsourcing legal work in Australia, chances are that major domestic firms will also lose work to lower cost jurisdictions. So if a new de-leveraged model is going to result in clients receiving cheaper and faster advice with the assistance of outsourcing, what will stop clients leaving the top tier?

The only thing we can think of is the issue of succession. If these flat tier firms dont have as many junior lawyers, there is less opportunity to sort the “ups” from the “outs” and less margin for recruitment error. Which gets us back to the point we raised at the start of this post – graduate and junior lawyer salaries in Perth are growing. The new arrivals depend on recruiting the best to survive and competition for the talented juniors is now very fierce. Where flat-tier firms fail to develop “ups”, they can (and will) simply pick off the best young partners from top-tier firms. Genius, really!

So there you have it; the legal game appears to be changing. But will the Big 6 be quick to respond?

Send the Firm Spy your news and views!