The unravelling of King & Wood Mallesons’ (KWM) grand global experiment has been both sudden and dramatic.

Just over three years ago, the UK’s SJ Berwin joined forces with China’s King & Wood and Australia’s Mallesons Stephen Jacques in a pioneering deal. The first ever combination of leading practices in Asia and London was supposed to create an entirely new breed of international law firm, one that would have unrivalled access to lucrative outbound work for major Chinese corporations.

That now feels like a lifetime ago. KWM’s European arm has during the past 12 months lurched from one catastrophe to another, and is currently teetering on the brink of collapse after a last-ditch effort to prop up the beleaguered practice was rejected by its own partners.

At time of writing, the firm is heading towards a pre-pack administration. Potential saviours have emerged, in the form of Dentons, Winston & Strawn and KWM’s own Asian arm, which are in talks to buy all or part of the failing business. But the vultures are circling, too, picking off clumps of partners who are desperate to escape the turmoil and uncertainty.

The firm’s Chinese and Australian arms are largely isolated from events in Europe, as the three firms combined via a Swiss verein, a holding structure that allows member firms to retain their existing form. The structure, which has been used by almost every major cross-border law firm combination during the past five years, enabled the three practices to combine quickly and keep their finances separate. It has also meant that the Chinese and Australian partnerships have effectively been able to stand back and watch as the European practice burned.

But this isn’t just a story of a merger gone wrong. Interviews with more than 30 current and former partners reveal a catalogue of issues with the legacy SJ Berwin business, many of which pre-date the combination with KWM. (All current and former KWM partners interviewed for this feature spoke on the condition of anonymity. KWM declined repeated requests for comment.)

The business that is now KWM Europe has long been blighted, they say, by serious inadequacies of governance and management, major succession issues, greed on the part of certain powerful senior partners, a startling lack of strategic direction and a chronic shortage of partner capital.

Five partners interviewed for this feature think that SJ Berwin would have ended up in a similar situation even without the merger. KWM “got sold a bum deal”, says one.

sj-berwin-formailout-Vert-201612090833Seeking a white knight

Founded in 1982, SJ Berwin quickly established itself as a vibrant, thriving business with one of the UK’s leading practices in funds and private equity. But the firm’s reliance on private equity and real estate-related work, which partners say accounts for more than half of its revenue, left it horribly exposed to the financial crisis that struck in 2008, as activity levels in both markets plummeted.

SJ Berwin’s revenue fell 14% during 2008-09 to £184m, while profit per equity partner crashed from £801,000 to just £410,000 – one of the largest falls ever recorded by a leading UK firm.

Partners say the results, combined with a dawning realisation that the firm would struggle to maintain its market share without expanding internationally, started a hunt for a large-scale, cross-border merger. “There was a general sense that mid=market firms weren’t going to survive – we were looking for a white knight,” says one former partner.

The firm was particularly keen on a transatlantic merger and soon entered into talks with US firm Proskauer Rose. The pair spent nine months in negotiations and got “very far advanced”, according to one former partner who was close to the discussions. But the deal hit a “stumbling block” and was ultimately called off in November 2010, due to irreconcilable differences in the two firms’ profitability – and their level of capital.

SJ Berwin was massively undercapitalised. The board just kept kicking the can down the road

“Our capital contributions per partner were easily less than half of Proskauer’s – and most other firms, for that matter,” the former partner says. “We would have had to have made a huge capital increase and de-equitised a large number of partners in order to get anywhere near some form of parity to do that deal.”

This wasn’t exactly a revelation. SJ Berwin’s management had been repeatedly advised over the years by external consultants that the firm needed to bolster its capital, five current and former partners say, but instead chose to deal with the problem by deferring profit distributions, dipping into the firm’s tax reserves, and urging partners to generate more cash by billing and collecting from clients more quickly.

“SJ Berwin was massively undercapitalised,” says one former partner. “There had always been a problem with the firm just paying everything out as profit. Nothing was ever invested back into the business. The board just kept kicking the can down the road.”

This seeming unwillingness or inability on the part of the European arm’s management to decisively tackle and resolve issues is a common complaint among the partners interviewed for this feature. In fact, every current and former partner interviewed agrees that the firm has struggled for competent management since the resignation of longstanding senior partner David Harrel, one of SJ Berwin’s founding partners, in 2006.

A stroke of genius – on paper

The collapse of the Proskauer talks did little to dampen SJ Berwin’s enthusiasm to merge. If anything, there was a growing sense of urgency. By the time talks began with KWM in 2013, former partners say the feeling among the partnership was that if the firm couldn’t secure a cross-border combination, it might have to retrench in Europe and become more of a UK private equity boutique. “When the US merger fell over, it was make or break,” says one partner. “KWM was a bit of a risk, but the strategic alternatives were tough.”

The merger was a brilliant idea, a stroke of genius – on paper

That’s not to say partners went into the KWM combination without a great deal of optimism. The deal was sold successfully to the partnership largely as an opportunity to transform the firm, which at that stage was still a mid-sized, London-centric business with a smattering of European offices, into a truly global practice with a large, international client list. “It was a brilliant idea, a stroke of genius – on paper,” says one former partner.

There were some successes during an “initial honeymoon period” of around nine months. Ties started to form between the private funds practices in Europe and Asia, for example. But things soon started to go wrong, partners say, as increasingly the firm’s global management adopted an Asia-fits-all approach.

china-currency-crisis-2-Article-201609090335While King & Wood’s strong relationships with Chinese state-owned entities did result in referrals for the firm’s European practice, three former partners say they were told on multiple occasions by management to carry out the work at a heavy discount, of up to 80%.

These partners say this reduction was then not taken into account when it came to annual appraisals and individual remuneration. “We were told that we’d have to do the work at knockdown rates because it was an important client for the firm in China and we couldn’t afford to upset them, but we’d then get a kicking for not doing the work as profitably,” says one partner who claims to have been told to work at a significantly reduced rate for a Chinese client. Two former European partners say they were also told not to chase Chinese clients for unpaid invoices.

In 2015, the firm launched a new global website that replaced the three firms’ existing online presences. Three former European partners say the new website placed undue emphasis on Asia and Australia. Currently, more than half of the 21 sector and practice group pages on the firm’s website do not list any European partners among the key contacts. “We were always reminded that we were the lesser link in the chain of three,” says one former KWM London partner. “Asia was running the show.”

Aside from a few secondments, partners say there was generally little meaningful interaction between practices in Europe and those in the firm’s Asian arms. One former partner, echoing comments made by three others, says that Australia had a “total lack of interest” in the combination while China was “largely absent”.

If I sent work to other KWM partners, it would be out of my numbers. It was better for me to send it to another firm

This lack of integration was partly caused by a remuneration system that partners say didn’t just fail to incentivise cross-selling between offices, it actively discouraged it. The firm worked with a system under which the credit on any given matter was generally awarded to the partner who physically signed the invoice. Three former partners say that this effectively encouraged partners to refer work to rival firms, rather than other KWM partners. “If I sent work to other [KWM] partners, it would be out of my numbers at the end of the year,” says one former London partner. “It was better for me to send it to another firm, as I’d then still be the one invoicing the client, so I’d get the credit for everything.”

The situation was exacerbated, partners say, by a lack of alignment between the firm’s management, which was trying to promote cross-verein initiatives, and its remuneration committee, which was focused on individual performance. “There was a complete disconnect between what management said we should do and what the remuneration committee would reward us for doing,” says another former partner.

Identity crisis

It also started to become clear that there were fundamental differences between the practices and client bases of the firm’s European arm compared to those in Asia and Australia.

Stuart Fuller came in and said: ‘This is what the firm is going to be. If you don’t like it, get out’

Partners say SJ Berwin went into the merger with KWM anticipating that investment would be made in its core practices – namely funds and private equity – in order to expand them across the firm’s global platform. Instead, partners say the firm’s global management became increasingly aggressive in its demands for the European practice to refocus on areas that were important to China and Australia. “It was very clear that China and Australia were in charge and that they wanted a certain type of law firm that was very different to [SJ Berwin],” says one partner. “They wanted to remold us into an M&A firm with capital markets and project finance capability, which we didn’t have.”

Stuart FullerThe issue came to a head in early 2016, when then global managing partner Stuart Fuller (pictured) held a series of meetings with the firm’s European partnership. “He came in and said: ‘This is what the firm is going to be. If you don’t like it, get out’,” says one former KWM London partner who was present at the meetings. “There was a sense that China and Australia wanted to build the law firm that they wanted and have London pay for it.”

This culminated in March 2016 with a significant restructuring of the firm’s European arm that saw the number of its practice groups cut from 17 to just three – corporate, funds and finance; dispute resolution and regulation; and real estate. It also involved widespread layoffs, with about 15% of partners in the region told to leave the firm.

It was the second time the firm’s European partnership had been cut within the space of 12 months. A previous review, in mid-2015, had focused on performance management in an attempt to boost the firm’s profits and had resulted in the departure of more than 15 equity partners who were underperforming or close to retirement.

The majority of partners interviewed say the first restructuring was carried out in a relatively open and sensitive manner: The partners who were affected left the firm in waves over a 12-month period in order to disguise their termination from prospective future employers. But the second cull was shrouded in secrecy. “All of a sudden, all these partners had just gone,” says one partner who saw colleagues within his practice area leave without warning.

The firm’s real estate practice was particularly hard hit in 2016, with more than half of its partners either asked to leave or de-equitised, according to four current and former partners. (Some partners in other departments, including corporate, were also de-equitised, while others saw their profit share reduced.)

It didn’t make sense where the axe was ultimately brought down. It created a culture of fear

One former partner says that he was told in no uncertain terms by management that real estate was “no longer a core practice”, although the group acted for some of the firm’s most important clients, including British Land and the Crown Estate.

Outside of real estate, many partners say they were left scratching their heads over what they saw as the randomness of the 2016 cuts. A number of high billers were among the casualties. “It didn’t make sense where the axe was ultimately brought down,” says one former partner. “It created a culture of fear and left everybody in the firm thinking ‘that could have been me’,” says another.

Five former partners who weren’t affected by the layoffs say that some of the partners even appeared to have been pushed out as part of a managerial ‘vendetta’ directed at outspoken or dissenting partners.

A current KWM source says the reshaping was designed to refocus the practice on SJ Berwin’s historic strengths, rather than making changes for the benefit of Asia or Australia. All partners were assessed based on a number of criteria, including their client base and billings, and final decisions on who would be laid off were made by the partnership board, the source adds.

paris2_616x372Defections in Paris

Worse was still to come. With the dust still settling on the restructuring and with morale already severely dented, the firm was rocked in early April by the unexpected departure of the bulk of its Paris private equity group to Goodwin Procter.

One partner recalls his response to the news: “Oh shit.” He adds: “It was an absolute hammer blow.”

Almost all of the partners interviewed for this story identify the loss of the six-partner team, which included Paris managing partner Christophe Digoy and private equity star Maxence Bloch, as one of the key turning points in the firm’s fortunes. Five former partners said the mass defection prompted them to leave the firm.

The group was one of the firm’s most profitable practices, with annual billings of around £8m. But other partners say they decided to leave the firm at that point because Bloch, in addition to being one of KWM’s top billers, was also the European arm’s representative on the firm’s global board, appointed to the role in 2013. Partners say that Bloch had supported the restructuring initiatives, so his sudden departure suggested there was more going on behind the scenes. “It made us all wonder: ‘What does he know that we don’t?’” said one partner. (Digoy declined to comment. Bloch did not respond to requests for comment.)

Not everyone was surprised, however. Three former partners say that KWM Paris, alongside other high performing European offices such as Munich, had become frustrated with subsidising a London practice that they claim has seriously underperformed for at least two years. “The other offices had to shift large amounts of profit to London just for the office to survive,” says one former partner. “It led to a lot of frustration among continental [European] partners.”

The Paris private equity group’s move actually prompted KWM to file a lawsuit against Goodwin and corporate partner Richard Lever, who left for the US firm in 2015. (Goodwin and Lever declined to comment.)

Expensive real estate

The hits kept coming. At one of KWM Europe’s biannual partner meetings, held in London in May, partners were given shocking new information about the firm’s financial arrangements that dated back to the renovation of its London office a decade earlier.

In 2005, SJ Berwin agreed to a deal with the landlord of Queen Street Place in which the firm would cover the cost of the renovation itself, in return for a significant reduction in rent for the first 10 years of the lease. Four former partners say they were told that the firm had spent more than £30m on the refurbishment, and had made the “unusual” decision to cover the sizeable outlay with cash, rather than a loan. This virtually drained the firm’s cash reserves and ultimately forced it to start using short-term bank debt as working capital, the partners add.

“When the financial crisis hit, there was no cash left, so the firm had to borrow to pay its costs,” says one partner who was present at the meeting. “The CFO said it was a bad decision [to have not taken on a loan to cover the renovation costs], but said there was nothing we could do about it now.”

The firm’s occupancy of the building neatly illustrates its changing fortunes. At first, SJ Berwin occupied the entire four floors of the building. In 2009, the firm’s banking and financial services team was moved up from the first floor in order to make way for Goodwin Procter, which sublet space that was subsequently passed to Bates Wells Braithwaite. Then, in 2015, KWM sublet the entire top floor of the building – more than 23,000 sq ft – to financial intelligence company Mergermarket. KWM now occupies just over two floors.

The firm’s financial condition had deteriorated to such an extent that two former partners say they were informed on numerous occasions by the accounts department that they had to delay the payment of invoices for items such as office supplies, including paper. Some suppliers ended up insisting on being paid upfront. In mid-2015, the firm undertook a cost-saving drive that covered every area of the business and even saw it renegotiate its internal food supply contracts.

BarclaysCapital drain

Partners say the firm’s lender, Barclays, was initially happy to extend fairly significant lines of credit at extremely low interest rates, and the firm extended its overdraft facility in July from £20m to £25m.

But in August, Barclays finally lost patience and threatened to “pull the plug”, as one former partner puts it. Barclays, which did not respond to a request for comment, demanded that KWM Europe grant it a debenture over the firm’s assets in order to provide the bank greater security against its lendings.

A document filed with Companies House shows that the agreement, signed on 27 July, covers all of the firm’s securities, goodwill and uncalled share capital, intellectual property and current or future trade debts. Barclays also imposed several restrictions on the firm, with KWM required to gain Barclays’ “prior written consent” before it can “sell, assign, lease, license or sub-license, or grant any interest in, [the firm’s] intellectual property rights”.

One former partner who was still at the firm at the time describes the agreement as “draconian” and says he was “shocked” that it was carrying so much debt. “How [the firm] managed to do a restructuring in March and be in such dire straits in July, I’ll never know,” he says.

Barclays also pressured the firm to finally take steps to boost its capital, which had been decimated by the continued exodus of partners. KWM Europe did introduce a policy in 2013 to withhold 5% of annual profits as capital, after then managing partner Rob Day produced what one former partner describes as an “extraordinarily detailed report” on the issue. But this partner, echoing the sentiments of others, says it was “too little, too late.” A current KWM source says management had made a number of attempts to increase the firm’s capital since 2013, but that any moves were blocked by a small group of senior partners.

How the firm managed to do a restructuring in March and be in such dire straits in July, I’ll never know

At first, the firm tried to claim that the quickening stream of exits was largely related to the two restructurings. But this line became progressively harder to push as the losses mounted.

Partners say the removal of so much capital from the business – KWM Europe’s partnership agreement requires the firm to repay capital to departing partners within 30 days – put the firm’s finances under severe strain.

A solution appeared to have been found when partners voted nearly unanimously to approve a recapitalisation plan under which they would inject £14m of their own money, at between £80,000 and £240,000 for equity partners. Salaried partners were also asked to contribute capital for the first time in the firm’s history, at around £60,000 each.

But any relief was shortlived. In what many partners consider to have been the straw that broke the firm’s proverbial back, the recapitalisation plan collapsed following the unexpected resignation of four senior partners, including Day and Michael Halford, head of the firm’s marquee investment funds practice. The quartet collectively generated around £9m in annual billings.

KWM’s Asian arm then stepped in and offered to bail out the European practice, but only if partners in the region agreed to meet the original capital requirement and commit to remaining at the firm for at least 12 months. Just 21 of KWM’s 130-strong European partnership – barely 16% – backed the deal, despite having being told by the firm, which had received advice on the issue from CMS Cameron McKenna, that they might have to repay two years’ worth of profits if they refused.

KWM london Up for sale

In the immediate aftermath of the failed recapitalisation, KWM’s outlook appeared bleak. Partners ran for the exits, while clients appeared to be preparing for the worst. A KWM source with knowledge of the situation says British Land told the firm to collate and prepare all of its files and save them onto USB memory sticks, in case it went under. Another key client, Marks & Spencer, asked the firm to provide its legal team with daily updates on its situation, the KWM source adds.

The firm’s new regional managing partner Tim Bednall and regional senior partner Michael Cziesla are leading an 11th-hour search for a merger partner. The firm has set up a data room in preparation for potential suitors seeking to analyse the business.

It is an unenviably tough pitch: many of KWM Europe’s best lawyers have already left and any merger partner would have to take on the firm’s sizeable debt, currently standing at some £35m. It would also have to assume the firm’s other liabilities, including the hugely expensive lease for its London office. Two former partners say the 10-year discount term is now due to expire, which will see the rental cost increase by about two thirds, from £41 per sq ft to around £70 per sq ft.

It is perhaps unsurprising, then, that every one of the partners interviewed for this story says they believe the firm will fail to secure a rescue deal and is likely to end up in a pre-pack administration, an insolvency process that would involve KWM Europe negotiating its sale to a law firm or group of firms before an administrator is appointed.

The firm has now announced that its European arm has received purchase offers from a number of law firms. A current KWM source says discussions have been “positive”, with a deal expected to be reached by mid-December. Former partners say Winston & Strawn has emerged as the “frontrunner” to take over a large portion of the business.

That any sale would be seen as a major win for KWM Europe is a sign of how far the firm has fallen. When asked about the rise and collapse of KWM Europe, current and formers partners say they feel two overriding emotions: sadness at what happened and anger that it might have been avoided.