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The breakup of merger talks between O'Melveny & Myers and Magic Circle firm Allen & Overy came as a surprise to some partners of the U.S. firm who were confident in the last several weeks that the merger would occur, sources told ALM.

American Lawyer affiliate Legal Week reported Monday that the two firms had finally called an end to their talks almost 18 months after they became public.

In light of the scuttled deal, multiple sources said they expect some O'Melveny lawyers will leave the firm. That's because some lawyers at the Los Angeles-founded firm were encouraged to stay on through the merger, while others had anticipated more business as a result of the combination.

Now those incentives are gone, and confidence in management is shaken. "I strongly suspect there are a number of people who are dispirited," one of the sources said.

Legal market observers confirmed that it's natural, after any protracted merger talks, to see some level of attrition by lawyers disappointed with the result.

O'Melveny management notified lawyers about the failed talks through a voicemail message shortly before the firm issued a public statement, according to a source who was briefed about the message.

The announcement came as surprise for some of O'Melveny's most senior lawyers, highlighting how the merger discussions were opaque to the partnership through the end, some sources said. Some lawyers even turned away business due to potential conflicts under a combined firm.

Some important partners inside the firm, within the last month or so, were "pretty confident that it was going forward," said one source, and partners appeared to be taking the merger "as a matter of course."

In a statement to ALM on Tuesday, an O'Melveny spokesman said the "negotiations concluded on Friday and by the following day (Saturday) every attorney and staff member was notified."

The spokesman added that, throughout the merger talks, partners received regular updates "through many town halls, video conferences, office meetings and voicemails," as well as at other partner meetings. O'Melveny also created a webpage with merger-related documentation for partners so they could review information and raise questions or concerns, the spokesman said.

One legal industry observer believed the failed merger discussions meant O'Melveny was more likely to merge in some form or capacity with another firm, even though the firm is healthy on its own. O'Melveny saw record increases in profits per equity partner and net income in 2018, with both figures growing at over 12 percent.

"The firm will be OK," said one source, but "they can't be very happy" about the merger result.

Law firm management consultant J. Mark Santiago noted O'Melveny & Myers just invested significant time and resources into an unsuccessful merger, and, as a result, the firm probably won't want to do any other deal immediately.

"And they shouldn't," Santiago said. "They should embark on a reflection period of what do we want, what went wrong and how do we move forward so this doesn't happen."

The O'Melveny spokesman declined to comment on firm strategy and said he would not speculate about the possibility of lateral departures.

Skeptical Response

American Lawyer affiliate Legal Week reported that people at both firms stressed that the main reason for the breakdown in discussions was the current adverse macroeconomic conditions, including a reduction in U.S. interest rates and foreign exchange rate volatility.

But just as in the U.K., observers of the talks in the U.S. were skeptical those were the main challenges to the merger, because the same market issues have existed for months, and the firms knew about Brexit challenges when the merger talks were first reported.

Larry Watanabe, a San Diego-based recruiter at Watanabe Nason who places partners and practices groups in Am Law 200 firms, said "there has to be more behind" the breakup.

"While the current foreign exchange issues are causing a fair amount of tension due to unnecessary trade war escalation, the markets have been fluctuating for some time and are not materially more significant now than they were a year ago," Watanabe said.

Some observers believed the contrast between A&O's lockstep pay arrangement and O'Melveny's merit-based compensation system were too much of a hurdle to overcome.

Compensation differences—between lockstep in the U.K. and merit-based pay systems in the U.S.—can seriously complicate merger talks. In past trans-Atlantic law firm talks, some firms have decided to integrate their pay systems, such as Hogan Lovells, and others did not, such as Womble Bond Dickinson, ALM previously reported.

Law firm management consultant Kent Zimmermann said in trans-Atlantic mergers he and his colleagues have advised on, it often makes sense to have a period of transition during which the approaches to compensation, capital, governance and other elements "are feathered together."

"We usually have a good sense of what the major issues are [including challenges] early in the discussions," said Zimmermann, of the Zeughauser Group.

Still, he added, "growth is hard, whether it's substantial lateral growth or mergers, domestic mergers or trans-Atlantic mergers of size," Zimmermann said. "If they were so easy, a lot more firms would have already done them."

The failure of Allen & Overy and O'Melveny & Myers to consummate a deal may not be isolated to those firms. It could have a ripple effect throughout the industry.

Zimmermann said for those firms that are already in trans-Atlantic merger talks and have identified the value of the deal, he sees those discussions continuing.

But for others, including a number of U.S. firms that have considered a trans-Atlantic merger, they are in a "wait-and-see posture," pending the outcome of Brexit and the uncertainty over a recession, he said.

For those firms that haven't started discussions, this may add to their hesitancy to start any, he said. "It will cause them to say, 'wow, those guys couldn't get it done. Could we get it done?'" Zimmermann said. "This may give them some pause."