The beginning of the end of 170 years of legal history happened on 15 March 2011, the day Barlow Lyde & Gilbert's highly-rated aviation team handed in its notice to move to Holman Fenwick Willan.

Until that point, Barlows had looked as if it was finally turning the corner after nearly a decade dominated by partner departures, poor financials and management inertia to regroup around its core insurance practice, a business the firm had hopes of rapidly taking international.

The resignation of the eight-partner team, one of the firm's most profitable practices and its most internationally credible business line, killed those hopes dead. "Our world changed on 15 March," recalls Barlows partner Richard Harrison. Dispute resolution partner Tim Taylor strikes a similar note: "When the aerospace team left, it was a real game-changer."

The extent to which the game changed was startling. Within a month Barlows had entered into merger talks with its arch insurance rival Clyde & Co, a deal no-one in the market foresaw or predicted. The surprise wasn't limited to the rivals, with Harrison recalling that Clydes' veteran senior partner Michael Payton was knocked sideways by the initial approach from Barlows – after all, Clydes has for years been focused on its very successful programme of international expansion rather than domestic growth.

"My innate thinking of 'Clydes v Barlows' was based on the reinsurance battles between our firms, 10 years since. I hadn't really hoisted in the extent to which things had moved on, and that those battles were history," reflects Payton.

Despite surprise when Legal Week broke the news of the talks on 3 June, by the end of July the two firms' partnerships had agreed a deal to combine under the Clydes brand. The union's significance speaks for itself: the largest-ever legal merger in revenue terms in the UK, the combined business will have a turnover of around £300m, nearly pushing it into the largest 10 firms domestically and making it the largest specialist insurance law firm in the world, with more than 1,300 lawyers.

The firm will also have huge international reach, thanks to Clydes' network of 25 foreign offices and a unique global footprint as an insurance, trade and transport specialist, which will also have one of the largest litigation practices in the UK.

Perhaps as important, the 270-partner giant will create a combined entity that addresses the needs of a fast-changing insurance market more explicitly than any of its peers. With insurers moving to reduce panel numbers, consolidate and increase their demands for firms to now carry out both high-end corporate insurance matters and high-volume claims work, Clydes argues it is ideally placed to respond. The success or failure of this calculation will probably define the shape of insurance practice for years to come.

'All the right decisions'

One of the main reasons that rivals were caught off guard by the Clydes/Barlows talks was simple: the larger firm was doing so well on its own, even if its success has often seemed to occur strangely under the radar. "Clydes has never been one of those firms that everyone thinks 'wow' – it is just one of those firms that has made the right decisions," says one partner from a rival firm.

But in truth the foundations of Clydes' meteoric rise over the last decade were laid a long time ago. Most important was an early and sustained international push on the back of its core shipping insurance business. Clydes was the first UK law firm to set up in the Middle East in 1989, moving in well before the rush to Dubai among City law firms in the 2000s. With offices in Dubai, Abu Dhabi, Doha and Riyadh, Clydes' 130-lawyer practice is now one of the largest in the region. The firm was also quick off the mark in Asia, launching in Hong Kong in 1981, and Latin America, where it set up a branch in Rio de Janeiro in 1988.

The firm has also established a small but highly profitable and fast-growing practice in the US, covering offices in New York, San Francisco and, most recently, New Jersey, which launched in February 2010. The US is a particularly interesting market for Clydes. Despite its huge size and UK law firms' struggle in recent years to penetrate North America, the country's insurance bar has never developed the kind of established, competitive specialist law firms seen in the UK. By all accounts, this has helped Clydes to make substantial progress in the US.

The firm has shown a similarly expansive form in the UK, in part building its growth over the last decade on the back of a programme of slickly-managed lateral hires. This includes the firm pulling off a well-regarded push into the construction sector last year with a large team from Shadbolt and a successful takeover in 2005 of aerospace boutique Beaumont & Son.

This expansive style is also reflected in the firm's entrepreneurial and business-like culture. Indeed, this quality is the biggest contrast with its new merger partner. Historically, many in the City insurance sector would have argued that Barlows had the more polished practitioners. Yet it plainly began to fall badly behind as Clydes' more commercial – aggressive, even – approach gained increasingly impressive results.

Perhaps most surprising about Clydes is that it has often been ahead of the times and yet in many ways seemed thoroughly traditional as a partnership. It has in Michael Payton what appears to be the archetypal senior partner, bringing polish and old school charm to his brief. Payton has a passion for racing and is still hugely proud that the memorably-named horse Nuclear Debate which he owned a stake in was elected Champion European Sprinter in 2000, making him the fastest racehorse in Europe (a "once in a lifetime" horse, recalls Payton). He is also certainly one of the longest-serving heads of a major law firm, having led Clydes for 27 years.

Despite longevity and flair, Payton remains hugely respected within Clydes as a driven and charismatic leader who has continued to push the firm's development. And Payton also gains valuable operational support from Clydes' well-regarded non-lawyer chief executive Peter Hasson, also a longtime Clydes man.

The firm's current board is made up of Payton, Hasson, litigation partners James Burns and Ben Knowles, construction head John Morris, shipping partner David Bennet, US head Michael Knoerzer, Middle East head Jonathan Silver and Asia managing director Michael Parker.

This governance structure by all accounts has delivered admirably for the firm, achieving that difficult balance of continuity and renewal that often eludes law firms. One senior figure at a rival top 50 firm comments: "Three key reasons Clydes has been a success: it is very strongly led. Even though Payton has been in management for a long time – if it ain't broke, don't fix it. Second, clearly the profit model is working, although it has borrowed quite a bit to invest, so is carrying liabilities. Third, international. It invested at the right time in the right places. It managed to hedge its bets quite well between international options, while the UK economy has suffered."

Despite its thrusting reputation, the firm has so far proved adept at people management, rarely losing partners despite its heavy lateral recruitment. Legal Week Intelligence research has consistently found the firm also has well engaged associates.

The collective fruits of its efforts are clear: the firm has more than doubled its revenues since 2000, while its profits per equity partner (PEP) of £605,000 sit comfortably ahead of the top 50 average of £535,500. The firm is easily one of the top relative performers in the top 50 over the least decade.

Meanwhile, next door…

For much of the last 10 years, the contrast between Clydes and its EC3 neighbour could not have been more stark or less flattering. Being able to trace its roots back to 1841 and once regarded as the top brand in the City insurance market, Barlows has struggled to execute a clear strategy for years after avoiding major international expansion and instead making an ill-fated attempt to build its corporate, finance and technology practices in the late 1990s and early 2000s.

The scale of its problems became clear in 2006, when it was one of only two top 50 UK law firm to post a decline in revenues while the group as a whole averaged a 13% rise. Problems were worsened by a low-key leadership team of managing partner Kennan Michel and senior partner Richard Dedman, which left a handful of influential partners to define its direction and 2007 saw the loss of big-name litigators Clare Canning (pictured) to Mayer Brown and Chris Warren-Smith to Fulbright & Jaworski.

The first serious attempts to grasp the problem came in 2007 with the appointment of non-lawyer Clint Evans as its first chief executive and then the 2008 election of professional indemnity partner Simon Konsta as the new senior partner on a platform to shake the firm up. Though progress was often stuttering, efforts were now being made to usher in a clearer focus to the business and more robust management, an approach built on in 2009 when former Allen & Overy knowledge management head David Jabbari stepped up from the chief operating officer role at Barlows to take on the chief executive role from the departing Evans.

Through 2009 and 2010 a total of 12 partners were asked to leave the firm, partner pay was moved to a more flexible merit-driven model and associate lockstep was abandoned. The firm also resolved to refocus around its insurance core. Part of this involved launching in Manchester in 2009 to help bolster its volume claims business – a move that raised eyebrows given the firm's upmarket City credentials. That strategy gained a huge boost in 2010 when the firm secured an ambitious deal to take on Halliwells' Manchester insurance business for a price tag of £2.5m. The well-regarded move brought in 230 staff in Manchester and a total of 17 partners and was forecast to bring in around £17m in extra revenue.

With financial performance improving and signs that a corner had been turned by early 2011, Konsta and Jabbari were putting forward ambitious plans to take the business international. Though this element was often downplayed, the core aim was to secure a merger with a sizeable US practice. Earlier this year informal discussions had been held with the US practices Bryan Cave and Sedgwick.

But securing this ambition proved more problematic than expected. For one, it swiftly became apparent that insurance law generally carries less status in the US than in the UK and has not created a similar band of specialist practices. This made it hard to find a suitable practice. The choice was further narrowed in that Barlows' management had hopes of remaining the senior partner in a deal. Harrison comments: "We were initially looking at growing and finding a way through a merger to be the more dominant brand, but we didn't want to be taken over by a US law firm and become their London end."

But it was the resignation of Barlows' market-leading aviation team, which included key partners such as Giles Kavanagh and Richard Gimblett, which killed off Barlows' hopes of securing a credible international merger.

International capability had long been an issue for the aerospace team. Barlows had been close to taking the Abu Dhabi office of a major US law firm in the summer of 2009, an initiative led by the aviation partners, before the partnership "got cold feet", in the words of one former Barlows man.

Barlows' lack of progress internationally left the team frustrated. "Holman has international in its DNA and Barlows doesn't, really," reasons one former partner. Options were now narrowing quickly for Barlows.

The gamble

The original idea for what became the UK's largest merger was not the result of an extended strategic review – it was hatched in the back of a taxi-cab soon after the aviation team had announced its resignation.

Recalls Jabbari: "We were on our way back to the office together, having just been talking about a possible merger with another firm, and I said to Simon [Konsta]: 'What about Clyde & Co?' He gave a quizzical stare, because you don't think about merging with your rival, but then he said: 'Do you know what – that's not a bad idea.'"

It probably helped that Barlows approached the deal in a brutally pragmatic frame of mind. One partner comments: "One of the first things Simon Konsta said to us was: 'If you can't live with the fact that the name will probably go, then we shouldn't enter into talks.'"

With Taylor and Payton already old friends, the initial approach was easy, and in April Taylor, Konsta and Payton met in the glamourous surroundings of the Costa Coffee branch on Fenchurch Street.

Barlows was aware that it was putting a lot at stake, even by just raising the possibility of a deal if its old rival didn't go for it. "The risk we ran with approaching Clydes is that they would then just try to take our best people. But Michael Payton was interested from the off," says Taylor.

Interested, yes, but Payton confesses that he was totally caught off guard. For one, Clydes' ambitions were focused well away from home – it was in the middle of its (subsequently successful) bid to launch in Canada, with the takeover of Montreal insurance boutique Nicholl Paskell-Mede (NPM).

Payton comments: "The concentration for Clydes was more outside the UK – particularly the US – when this idea came about, and, of course, we were fairly well advanced with NPM, which was quite a big thing for us. But sitting down with Tim and Simon was a real educational journey and I realised how good the fit was. It was my 'eureka' moment, in a sense."

Payton was able to quickly move past the issues that would have once made the deal seem unthinkable. For one, the expected problem with conflicts proved manageable. Partly this was because of the aviation departure, which had not only bombed Barlows to the negotiating table but also taken care of what would have been hundreds of conflicts with Clydes' own top-tier aerospace team.

The withering of the reinsurance market also helped – "reinsurance is gone, there is none," says one Barlows veteran – while it soon became apparent that the firms were often acting in different areas for large insurance groups. A check of 50,000 cases only found 15 substantive conflicts.

Once both parties got over the cultural shock of doing a deal with an arch-rival, it also became apparent there was an appetite at Clydes to make good on its long-term aim of major expansion into non-marine insurance, with Barlows bringing an unsurpassed professional negligence practice as well as a large casualty and healthcare business. The union would also bring in Barlows' well-regarded and profitable employment team, creating what the firms hope will be a strong 'entry' practice for large institutional clients.

In addition, there is seen to be huge scope to take Barlows' professional liability brand global, in particular in the US, where there is high demand and a relative lack of specialist providers.

"The merger will allow us to expand our professional liability practice aggressively over the new platform in the UK, US, Middle East and Asia. We will be looking to develop our capability including through lateral hires – this is a huge and exciting driver from a Barlows perspective. Growth is at the heart of our plans," says Konsta.

Another supposed hurdle of the deal – the large gap in profitability – proved to be less of an issue than at first glance. Though Clydes is clearly more profitable, the huge gap between the larger firm's PEP and Barlows' £390,000 PEP is partly the result of Clydes' higher leverage, while a number of UK practices operate on roughly similar profitability.

The deal that seemed like it could not happen swiftly became a reality. A vote of both firms' partnerships on 28 and 29 July backed the union (though the deal was not formally signed until 11 October, a delay some have interpreted as horse-trading over terms under which the Barlows partners will join).

Given its size and stronger performance in recent years, as expected the terms of the union reflect that Clydes is very much the dominant partner. The union, which goes live in less than two weeks (1 November), ditches Barlows' brand entirely. Around 15 partners from Barlows were asked to leave the firm as part of a bid to bring up the profitability at the smaller firm, particularly hitting Barlows' commercial and reinsurance teams.

Payton and Hasson will retain their existing roles in the combined firm, with Barlows' Jabbari set to take up a new post as chief operating officer. Konsta will not initially take on a management position at the combined firm, but will be handed an elected seat on the board alongside Jabbari and Barlows' highly regarded employment head Rob Hill.

Partners with at least five points on Barlows' 12-point ladder will join the senior equity, with the remainder joining the junior equity rank. The deal also includes a three-year lock-in, with Barlows' senior equity partners facing financial penalties of up to £180,000. The terms are structured so that Barlows' equity partners opting to leave during the next three years will be required to pay between roughly £30,000 at the junior end through to £60,000 at the top for each year of the lock-in they do not serve at the newly-merged firm.

This means that senior partners choosing to leave immediately could face a payment of £180,000, while junior equity partners opting to do the same could face a £90,000 bill. The move is justified as helping to underwrite the substantial costs of integrating the two businesses, which is estimated at £5m just for merging IT and infrastructure.

For some, the loss of the Barlows brand is a sadly symbolic statement for what was until recently one of the City's proudest legal brands.

Taylor comments: "The reaction to the loss of the Barlows name depends on who you ask. Some people who were Barlows born and bred of course are naturally more attached and there is a strongly held view that in some markets the Barlows brand had real value. But for people like me it doesn't make a scrap of difference. There is also a real financial case for just changing it in one go."

The consensus is that losing the name is an astute move if Barlows is to make a break with a recently troubled past and also to reflect the basic reality that it is the junior partner in the deal.

'Barlows will thrive'

Despite being secured in conditions that critics dub a firesale, the irony of the deal no-one predicted is that many believe it has huge potential. For one, few dispute the core logic that the combined firm is in tune with a fast-consolidating insurance industry.

Likewise, major clients polled for the piece strike a positive note to the union – crucial, given insurance companies' notorious lack of patience with disruption in their advisory teams.

As important, Clydes brings considerable experience in managing expansion, having executed a series of bolt-on mergers and team hires. The unambiguous terms of the deal, which leaves Clydes in the driving seat, probably bodes well in terms of organisational clarity. The expectation of many is that Barlows, which despite its struggles, retains some exceptional lawyers, will do well as part of a larger, more stable and internationally potent platform. Indeed, unions with good but struggling firms have often proved successful by neutralising the faction-fighting that can dog law firm mergers.

Jabbari sums up the pragmatic mood: "Despite the very great successes of the last 12 months in reversing the decline in the firm's profitability, we were faced with quite a bit of fire-fighting at Barlows. This is not a Barlows-specific problem but one for all smaller firms trying to retain their best people in the face of moves from predatory larger firms. This merger turns the tables: we are now firmly one of the predators, not the prey!"

One former Barlows partner agrees: "The talented and aggressive partners at Barlows will probably thrive in the new firm if they are given a chance to do so."

Those forecasting problems still question if Clydes will remain committed to the Halliwells legacy volume claims practice, though the firm has pledged to increase investment in the business and it would seem a useful addition to a huge insurance law empire. Some also question whether Clydes' chief executive Peter Hasson will give his Barlows equivalent Jabbari much space to move beyond integration work. But these remain secondary issues.

The combined firm will be heavily internationally focused, with talk of expanding into the US energy market with a branch in Houston. By common agreement, however, there is little appetite for a largescale US merger. Clydes' Knowles comments: "It wouldn't make any sense for us to look at a merger with a major US firm. A lot of the people we have recruited from firms in New York have come out of them to get a lot more focus on their insurance practice."

The firm has also not finished with Canada. Burns, who is heading up the firm's local operations, has openly said that the firm intends to look west to Calgary and Vancouver in due time to take advantage of opportunities in the energy, mining and marine sectors.

Other plans high on the agenda include taking Barlows' casualty business global, with the possibility of setting up some European alliances on the table. Barlows Manchester head Kevin Finnigan says: "The potential to grow Manchester/London casualty is unique. I'll never see it again in my professional life. We are looking at creating a pan-European solution for insurers to cater for their casualty work and talking to clients about how they want us to set this up."

There is also far more capability for the merged firm to expand its combined commercial practice – including employment and corporate – than Barlows 
could ever have managed on its own. And there will be scope to expand Clydes' commercial litigation practice, given the firm's enviable platform for serious contentious lawyers.

Obviously, with no shortage of successful and upwardly mobile UK insurance rivals – Holman Fenwick, Ince & Co, Kennedys and Reynolds Porter Chamberlain among them – Clydes will have to contend with plenty of hungry, highly-effective firms looking to take advantage from any merger upheaval. "There is going to be a hole left when Barlows is gone, which is not all going to accrue to the benefit of Clydes," says Kennedys senior partner Nick Thomas. "There's a lot of work where insurers need two, three, four different lawyers, and where Barlows and Clydes would have been two of the four they can now only be one."

But in many ways, this "Behemoth of EC3", as one partner dubs it, is seen by many firms as illustrating the wider development of the legal market, no matter how opportunistic its birth. One former Barlows veteran sums up the general reaction: "In the short-term there will be some fallout in terms of client conflicts but in the longer term they will be the biggest insurance firm. This is a microcosm of what's going on in the whole of the legal sector."

Knowles puts it in rather more basic terms: "If you are talking to a client in Russia, the Middle East, the US, etc, you can legitimately say that they must at least talk to us, because if they don't, we will more than likely be acting for the other side."

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When the going gets tough, the tough get bigger

For Clyde & Co senior partner Michael Payton, the underlying rationale behind the firm's impending union with Barlow Lyde & Gilbert was clear. "The insurance market is changing, and the merger is a first move in that context. We've tried to predict what the big national and international clients will want."

In short, the firm argues that its scale will perfectly position Clydes to face the forces reshaping the insurance industry and its key clients: namely sustained consolidation. The trend, which is expected to continue for years to come, has already resulted in larger insurers running smaller panels. Insurance companies are also often pushing down on rates in return for volume and pressing advisers to comply with more tightly controlled procurement processes, benefiting larger law firms with the infrastructure to achieve economies of scale and to manage demanding pitches. This promises to turn the practise of insurance law into something akin to banking law – a game for large, broad-church practices that can combine commoditised volume areas with bespoke, high-end instructions.

"The larger insurers are increasingly 'panelising', and reducing their panels to a small number of firms that can perform the full spectrum of the work they need both nationally and internationally. For such breadth and depth of cover," says Payton "we want to be the only show in town."

One example was seen earlier this year when Australian insurer QBE – one of Barlows' top clients – cut the number of firms on its UK claims panel from 24 to 18. And, of course, the push towards larger and more prescriptive panels in the insurance industry has already been running for 15 years. One client of both Barlows and Clydes comments: "Yes, there is consolidation and it is leading to smaller panels. The recession has been extremely tough for insurers and everyone is looking for a bit of stability where they can get it."

Aside from the cyclical impact of gloomy economic conditions, the industry is also gearing up for the introduction of Solvency II, the European Union directive that will usher in new capital standards and risk management procedures. The directive – often compared to the Basel III rules for banks – is designed to make insurers safer by requiring them to hold more capital. But the regime, due to come into effect from January 2013, is expected to reduce returns and further stoke consolidation.

Recent deals in the sector include Resolution's acquisition of AXA's UK life insurance arm for its subsidiary Friends Provident and RSA's £259m takeover of Canadian commercial insurer GCAN.

One GC at a client of both firms says: "I don't think the shift in the insurance market towards smaller panels and consolidation will take full effect for a few years because of the longstanding relationships in the insurance market. Having said that, the shift is definitely there."

It was in anticipating these developments that Barlows had shifted its strategy in the two years before its merger with Clydes. In particular, the firm moved from its City insurance roots in September 2009 when it launched a branch in Manchester to target the volume end of the market. The practice was hugely expanded in July 2010 with the acquisition of Halliwells' Manchester insurance arm, which brought in around £17m of annual revenue and key clients including Chartis, AXA and NFU Mutual.

Despite being a well-regarded practice, some rivals predict that the Manchester office will be downsized following the Clydes union. "Clydes will just take the best bits of Barlows and spit the rest out. I can't imagine what they would want with Manchester," says one rival managing partner. However, both firms insist that they will be investing in this area of the business, particularly in light of the fact that Clydes currently has no catastrophic injury capability – a central plank of the Manchester office.

One insurance GC argues that developing the Manchester practice is an astute move: "Insurance companies are generally looking at their big areas of spend and one of those is legal services. One of my goals is to get more synergy between the claims area and the corporate end of the business. What this will mean is saying to someone like Clydes: 'If you want to do my corporate work and you do my claims work, I want heavy discounts on the corporate work, and if you don't want to do this I'll pull the whole lot.'"

Indeed, given the sheer scale of the combined firm, the attraction for Clydes to have a sizeable operation in the regions handling volume claims work is arguably much greater than for Barlows alone, which risked being unbalanced by such a large volume presence. With Beachcroft this summer securing a union with fellow insurance specialist Davies Arnold Cooper – creating a £175m law firm – the pressure to attain greater scale and the ability to span the institutional insurance and volume claims markets looks set only to increase.

• For more analysis, see EC3, then the world – Clydes asserts insurance law on global stage