After dominating the 1990s, Clifford Chance has weathered a turbulent decade and a brutal financial year. Georgina Stanley assesses if the firm can regain its former glory

It has been a tough year. But then it has been, in many ways, a tough decade for Clifford Chance (CC). Having throughout the 1990s set the agenda rivals followed – however grudgingly – 10 years ago CC achieved what appeared its crowning glory: the three-way merger with Rogers & Wells in the US and Germany's Puender Volhard Weber & Axster.

The global law firm appeared, with startling speed, to have arrived. Back in 1999, CC was by a good distance the largest law firm in the world in revenue terms and trailed only Freshfields in terms of its peers' profitability.

Fast forward a decade and CC's position looks a shadow of its former dominance. A difficult period of post-merger integration and a series of strategic reverses in the US between 2002 and 2004 slowed the firm's growth and drained some of its confidence. A rebound from 2005 to 2007 restored growth but then a severe recession gripped the world in 2008. The result was the near collapse of the banking system – humbling much of CC's client base – leaving the firm looking more like the laggard of the magic circle rather than the group's pace-setter.

Results for 2008-09 saw CC emerge as the worst performer among its peer group by a large margin, with the firm losing its crown as the largest UK firm by turnover. At the same time profits per equity partner (PEP) fell by 36.6% to £733,000, standing at almost half of those of Freshfields Bruckhaus Deringer and trailing its old finance rival Allen & Overy (A&O).

Other ominous signs have included yet more turbulence and departures at its US practice and the loss this year of top names in Europe such as corporate specialist Adam Signy for Simpson Thacher & Bartlett and German restructuring partner Kolja von Bismarck for Linklaters.

While this is a firm that has been prematurely written off before, it is clear that CC will have to perform substantially better over the next two years if its market position as a top-tier global law firm is not to come into question. In short, CC has a challenge on its hands to reclaim its former glory.

The posterboy for the credit boom

Working out much of what went wrong for CC over the last two years is hardly rocket science. The most obvious problem lies with the firm's traditional strengths: its market-leading banking and private equity practices. A very significant percentage of the firm's revenues – estimated by one former partner to constitute 60% of its income – come from financial institutions, primarily banks and buyout houses.

Former CC managing partner Tony Williams, co-founder of consultants Jomati, describes the impact of the downturn on CC's practice as a "perfect storm". Partners within the firm share the same viewpoint.

Managing partner David Childs (pictured) comments: "In 2007, we started working on controlling costs, but everything changed in 2008 with Lehman's collapse [on 15 September]. Workloads dropped and the normal hedges for our firm – both in terms of practices and geographies – didn't work well for us. We are the leading firm for financial institutions and private equity so obviously we were more affected than the others."

While it was widely expected that exposure to banking would hit top law firms, what many failed to understand is just how cyclical CC's practice is relative to its peer group.

CC has not put as much focus on building up its mainstream corporate client-base – the clients that generate work even when financial markets are tight – leaving it heavily exposed.

Real estate, in addition, has caused problems for the firm, which has a substantially larger property practice than most rivals, still accounting for around 7% of revenue. And unlike the 2002-04 M&A downturn, when CC was quick to secure lucrative restructuring mandates, so far CC has yet to land the kind of insolvency instructions won by Linklaters and Freshfields.

While CC can hardly be blamed for not predicting an economic calamity missed by most mainstream economic forecasters, in hindsight it appears that global moves to slash interest rates in 2001 and 2002, which fed the credit boom, blinded some to the underlying imbalances in the firm's practice.

Cheap and plentiful credit, boosting as it did banking, private equity and property, in retrospect did much to revive CC's fortunes after profits slumped to a low point of £562,000 by 2004. The suspicion is that this left under-lying issues unresolved that have come back to haunt the firm.

The business model of CC has only sought to magnify the cyclical nature of its practice with the firm operating a lower profit margin than rivals – currently at 24.5% – and a higher leverage of equity partners to lawyers. While leverage at the magic circle varied in 2008-09 from 3.4:1 at Slaughter and May to 4.5:1 at A&O, at CC it was 6:1.

That US merger again

Hindsight was not entirely necessary to predict another issue that would dog CC: its unsettled US practice. By consensus, CC had made considerable ground in the US after a five-year period after the Rogers & Wells merger that had been disrupted by an ill-fated Californian launch, disputes regarding pay and strategic dissent. As such the US practice, particularly in banking and corporate, had built up a stable of promising younger partners and looked set fair for better times as the firm entered 2007.

As such CC was unlucky when the severe economic storm battered the practice before it had yet to fully find its new direction. There were early signs of trouble in October last year when CC announced it was making 20 litigators redundant in a market where most US law firms were aiming to expand. The practice was also heavily affected by the partnership restructuring but it has also seen a number of partners choosing to walk out. Some 18 partners left in New York between March and July alone – equating to around a quarter of the local practice.

High-profile departures include global litigation chief Mark Kirsch, who was one of three CC litigation partners to join Gibson Dunn & Crutcher.

That the firm's struggles in the US have been costly to its ambitions and finances is unquestioned – US revenues have fallen from a post-merger high of around 23% to just 11% in 2008-09. Yet the firm talks a confident game on the state of its US transactional practice, arguing it has retained virtually every senior lawyer in corporate that it wanted to over the last two years.

On litigation, Childs concedes that the markets have not lived up to hopes but argues – and he is not alone in this view – that the US disputes market is set for radical change that will clamp down on the kind of lucrative litigation US law firms have grown accustomed to. If you subscribe to the view that US corporates are ready to rein in litigation costs, the firm's recent turbulence, while hardly ideal, looks less of an issue.

Partnership – smaller and hopefully better

One question that certainly can not be avoided is the fundamental issue of whether CC has sufficient quality in its partnership ranks for a firm of its standing and ambition. Only the most rabid CC-bashers would deny the firm has a fantastic stable of partners – the issue is whether it has the consistency to match its key UK and US rivals. By the same token, only obsessively on-message CC partners attempt to argue that the firm couldn't have been more selective in building its partnership in recent years.

Indeed, many believe CC should have undertaken the kind of restructuring Freshfields pushed through in 2006 when markets were in its favour.

This reticence saw CC go into the downturn probably overweight and with a very large salaried partner count. At year-end 2009 CC had 639 partners – well over 100 more than even its largest magic circle rival.

But one of the strongest reasons to believe CC is set for a revival is that its partnership restructuring, though it initially received less attention than Linklaters or A&O, is actually more far-reaching, giving the firm the chance to relaunch in leaner form.

As one partner comments: "We have now gone through the exercise of cutting away a lot of fat, but that fat could have been cut long beforehand."

Childs himself comments: "In hindsight, yes, we could have gone earlier and it would clearly have had a faster effect on our costs but it would have been a brave firm which started making redundancies in May/June 2008."

There is another reason CC has struggled to keep its partnership trim: despite its well-earned reputation for pioneering the global law firm model over the last decade, CC has maintained a more consensual approach to management and governance than its UK peers.

Indeed, this tension between the firm's thrusting ambition, so evident in the 1990s, and a partnership that has become ambiguous about the extent to which it wants to be managed has slowed the firm in recent years.

The most obvious illustration of this was the 2001 election of Peter Cornell as managing partner ahead of Peter Charlton, in what was seen as a protest vote from an unsettled partnership (even though Cornell is generally regarded as having made a decent fist of his term). But it was also evident in fudging over the firm's partnership model and slow progress in reshaping its US practice.

The introduction of a three-tier structure for its equity partnership in 2005 is another key example. Having finally gotten a vote through on the three-tier lockstep allowing for a lower ladder for national partners and a higher scale intended for those in the US, in reality few national partners sit on the lower tier while no-one is currently on the top ladder.

Some others criticise a management structure involving a large management committee and partnership council in addition to various other committees for being unwieldy, taking too many good partners from fee earning.

One ex-partner comments: "Management has got power but it is quite difficult to use.
The structure is overly burdensome and that needs to change pretty quickly."

All this could be about to change, however, as the firm is in the first stages of examining ways to streamline its governance.

Childs himself concedes: "We are very keen to make sure we are not too top-heavy and are looking to slim down management structures. It is a difficult balance as we want to remain consensual, but at the same time the events of the last two years show we are going to be more directional going forward."

Despite the difficulty of making quick decisions with this governance and culture, Childs himself is generally well-regarded. His term as managing partner is viewed as having made strides in injecting more discipline into the partnership despite institutional constraints on such moves.

Childs is also generally spoken highly of by managing partners in other firms, many of whom view managing such a sprawling beast as CC as an unenviable task.

There will be much attention now on whether Childs intends to stand for a second term this autumn as his tenure expires in April 2010. On balance, he is expected to take another run, though nothing can be taken for granted after such a turbulent period for the firm.

Fighting talk

But whatever reverses the firm has faced in recent years, Childs is convinced that CC is now ready for a fightback. The firm did pick up some sizeable mandates in 2008-09, with its finance team advising on the restructuring of Cemex's debt as well as the financing of InBev's $52bn (£32bn) acquisition of Anheuser-Busch. And new client wins over the last year include Chevron, Cemex, Spain's leading construction group Fomento de Construcciones & Contratas as well as the International Petroleum Investment Company.

Certainly partners within the firm are sounding more upbeat than was evident at the start of the year. Mark Campbell, head of finance, comments: "We are starting to see a gradual increase in new lending and big infrastructure projects and, given that lending has been at historically low levels for the last 18 months, my expectation is that there will be growth. We are now the right size for the current level of business and are well-placed to grow. I'm pretty confident."

And there are reasons to accept such comments as more than wishful thinking. For one, the inherent cyclicality of the firm's practice strongly suggests it will see a bigger bounce than most rivals. Current indications are that CC is set for an improved performance after a solid run in the first four months of its 2009-10 year. Corporate head Matthew Layton argues: "Morale is very good and I am delighted with the pipeline at the moment. Partners are very motivated to go out and grow the business."

CC also retains a generally loyal partnership, an essential quality for a law firm that wants to retain its best talent when PEP falls well behind rivals. While it was painful, there is also little evidence that its partnership restructuring has seriously damaged this quality, an achievement for which the firm deserves due credit.

The firm is also generally credited with sensitively handling its global programme of job losses, which claimed around 350 jobs over 2008-09.

Regardless of grievances over money, many within the firm are repeating the same mantra – one bad year will not break the firm and it will return to form.

And, crucially, the firm has years of heavy investment in its international network, creating the kind of gulf that it would be very difficult for any challenger below it to bridge. There still remains a very large gap between magic circle laggard and chasing pack leader, which insulates its position.

And the international market offers CC some of its most promising opportunities. In particular CC is looking to secure a commanding position in Asia. Mainland China and India remain key priorities for the firm, the latter being bolstered by its alliance deal with leading Indian firm AZB and Partners.

Even ex-partners remain generally positive, with one commenting: "Fundamentally, the business is still fantastic, it has full service capability and it is still the best worldwide brand. I have no doubt they have the client base and the people to come back."

Jomati's Williams agrees: "I would not bet against a good bounce. They have taken out costs, reduced headcount and it looks like they're having a better run

of work. It is still up in the air but I think they have taken significant action and it will prove to be sufficient."

The bottom line, despite some of the more hyperbolic claims made regarding the firm's current difficulties, is that CC is almost certain to get the time and space to address its problems, providing it chooses to act.

But having a chance to once again become a pace-setter for its breed will require real action on two fronts that have so far been avoided. Firstly, CC must make a serious and sustained effort to expand its client base outside financial institutions, or face a future in which it will have a more volatile and less profitable practice than its key rivals.

Just as importantly, CC will have to reconcile itself culturally to update its governance to usher in a more centrally managed and less consensual style. Otherwise it will likely cede more ground to rivals who have borrowed CC's playbook from the 1990s and improved on it. One former partner is blunt on this point: "The problems are not the people or the client-base but structural. CC was so close to getting the model right but they lost it."

If, after the events of the last year – not to mention the last decade – the firm is not yet ready to address these points, it is hard to see when it ever will. It is certain that its rivals will not be waiting around for it to see the light.

But then, many inside understand this urgency. As one partner comments: "Everybody in the firm is hurting quite a bit from the last year. But, even so, I do not see why we cannot come back. One bad year is ultimately one bad year… for me, next year and the year after will be critical."

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Restructuring the partnership – no half measures

On 4 February CC announced a major review of the size and shape of its partnership. Details of the review were announced a month after the firm became the first in the magic circle to unveil a London redundancy programme affecting up to 80 lawyers and two weeks after it emerged that Linklaters was to restructure its partnership.

The shake-up was more far-reaching than that from Linklaters or the restructuring later announced by A&O on 19 February with CC initially proposing to put more than 10% of its equity ranks at risk. Given that many felt the firm's partnership had grown over-sized and suffered from patchy quality, few would disagree that such drastic action was needed.

Also unlike its rivals, CC opted to take a consensual approach to its shake-up, with partners given the opportunity to vote on the restructuring. This was not without risks, as a 'no' vote would have severely undermined the position of the firm's management. As it was, CC secured the consent of 86% of the partnership- significantly more than the 66% required – with the cull capped at 15% of the equity.

With a number of partners also leaving for reasons unrelated to the restructuring, the global partnership will shrink by 18% between April 2009 and April 2010 – falling from 637 to 524, excluding the firm's 17 new partner promotions. Equity partner numbers will shrink by around 15% to roughly 350 by the same date.

Those leaving – whether salaried or equity – are all thought to be receiving one year's pay, putting the estimated cost of partner payouts alone as significantly higher than A&O's total costs of £46m. While the cost of the restructuring at staff level is reflected in the 2008-09 results, the cost of the partnership overhaul has been taken from accounting reserves and has therefore not had an impact on profits per equity partner (PEP). It is expected to impact on future cash flows but not PEP.

The way the restructuring was handled has, perhaps inevitably, divided opinion internally. While some partners are pleased to have been given a say, others have argued that it meant everyone was disrupted for a longer period of time than necessary.

One partner told Legal Week: "There was a lot of consultation and in a sense this was good as it meant people felt they were involved. But it also meant people took their eyes off the ball, which may have destabilised us a lot more. On balance, it may have been better to have more management power used."

However, managing partner David Childs remains confident that the consensual approach was the right one. He says: "We regard ourselves as a very collegiate partnership and it seemed to me that we should only do something like this with the support of the partnership. While it may have been distracting at the time, there's no doubt it was the right thing to do."

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Corporate – part of the problem?

CC managing partner David Childs makes no secret about the firm's desire to expand its corporate client base beyond its private equity stronghold. But it is equally clear that corporate head Matthew Layton (pictured) has a challenge on his hands if the firm is to achieve this goal.

Obviously, the firm is well-known for its buyout practice, which works with the likes of Permira, CVC, Blackstone and Kohlberg Kravis Roberts & Co. Under the leadership of respected operators like Layton and James Baird, the firm was on the ground floor of Europe's developing private equity scene in the 1980s through the legacy Clifford Turner. It is widely regarded as Europe's top private equity practice, with no real peer. However, with buyout activity severely constrained since the credit crisis two years ago, the impact on CC's corporate practice has hit harder than any other City firm with the exception of Travers Smith. Even looking beyond private equity, many of the corporate mandates it has won since the credit crunch have involved the firm's other area of dominance: financial institutions. CC advised Barclays, for example, on its purchase of some Lehman Brothers assets, the sale of BGI to Blackrock and the proposed sale of iShares to CVC.

But, as CC discovered to its detriment during the last financial year, the firm lacks the close relationships with major corporates of its magic circle peers. Even arch finance rival A&O has maintained a prolonged drive to expand its non-banking client base, a campaign that has yielded results in recent years.

As such FTSE client rankings from Hemscott are unflattering (though probably slightly unfair given the international defusion of CC's practice). CC's corporate rankings for the third quarter of this year show that CC is listed against only seven FTSE 100 clients – a full 10 corporates fewer than A&O, and significantly behind first-placed Slaughter and May and Linklaters, which were listed against 25 clients apiece. The firm's 170-partner corporate practice, which billed around £375m in 2008-09, is now considerably smaller than Freshfields or Linklaters and only slightly larger than A&O.

For many critics, CC's biggest mistake was failing to fix the roof while was the sun was shining. In other words, it did not start the long slog of building lead corporate roles with major non-bank companies back when sponsor-driven work was driving its M&A team.

Layton responds that CC is less focused on FTSE clients due to its global model, pointing out that the firm's global practice acts for 25% of the 2,000 largest global corporates, including 30% of the FTSE. The intention is to expand this number substantially both in the UK and internationally. While private equity will remain important it will inevitably make up a smaller percentage of corporate's revenues.

A new plank of this strategy will be refocusing its practice around 13 key sector groups. They are: leisure; investment management; consumer goods and retail; insurance; communication, media & technology; transport and logistics; industrials, real estate, energy & infrastructure; healthcare; sovereign wealth; banks & financial institutions; and private equity.

However, CC faces several challenges if it is to turn strategy into reality. Firstly, many rivals are already operating along similar lines and, secondly, it will require shifting corporates from established advisers – a notoriously difficult and lengthy proposition with large companies.

And the firm must achieve this with a team which, some would argue, is lacking in senior names, especially in London. By numbers the practice is obviously sizeable – standing at some 47 partners in London (including competition and funds). Yet it remains light on marquee names on public M&A. As such, the departure of Adam Signy to Simpson Thacher & Bartlett in May was seen as a symbolic blow, even though Signy had been distanced from top clients in recent years.

Guy Norman has been by far the most prominent partner over the last year – guiding Barclays through a series of transactions – and David Pearson and David Pudge are also well-regarded. In addition, the funds team is highly-rated – particularly Jason Glover – though this team's work is closely linked to private equity. Critics contend that the firm is particularly underweight with up and coming corporate partners in London. This is debateable. CC makes much of its desire to focus on the team rather than foster a star culture. However, it will not have been lost on the market that Slaughters, Freshfields and Linklaters have built superior corporate teams with deeper benches despite all being committed to lockstep and having more conservative cultures than CC. The danger is that such a reluctance to develop, project and promote its next rank of stars will be seen as a defensive move or could see the firm fail to win its fair credit – credit which can help attract clients and talented lawyers. Many corporate lawyers would also contend that team brands in City law are, to a considerable extent, still sums of highly regarded individuals.

CC's corporate practice, however, does unfairly suffer when viewed through the prism of the Square Mile. The strength CC will doubtless be looking to build on over the next decade will be in cross-border work, where it remains a formidable player. By the standards of a top global law firm, CC is solid and accomplished rather than spectacular in Western Europe, with the exception of its top-tier Spanish practice. Nevertheless, its real selling-point comes from the range of its network, which very few can match. Just as important, CC can point to real muscle in key emerging markets with highly regarded teams servicing the Middle East, Russia, Central and Eastern Europe and the wider Asia region.

CC has also underlined its reach in cross-border corporate work in recent weeks with a string of flagship mandates. Key deals include advising US food group Kraft on its unsolicited £10.2bn bid for Cadbury's, acting for Deutsche Telekom on talks to merge its UK T-Mobile with Orange and an instruction from French conglomerate Vivendi on a $2.3bn (£1.76bn) bid for Brazilian telecoms business GVT.

Despite the weaknesses in CC's corporate practice, for sheer cross-border reach, and in particular emerging market positioning, the firm remains one of the strongest legal advisers for global M&A. If it is willing to seriously address its shortcomings, it should cement its position as one of the handful of truly global M&A practices.

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