Rising bankruptcies and deregulation in Japan have promted a wave of mergers and acquisitions of distressed assets by overseas corporations. Law firms are positioning themselves to reap the benefits. Stephen Mulrenan reviews their strategies.

This year has started where 2001 left off for the legal market in Japan: in a frenzy of activity.

Two more of Japan’s leading law firms have announced their intention to merge. The US firm Jones Day has beefed up its local law capability through its merger with Showa Law Office, while US firm Dorsey & Whitney is the latest international firm to secure a joint enterprise with a local firm.

If things carry on at this pace, 2002 may even succeed in eclipsing the frenetic pace of change witnessed last year.

In the year that heralded the introduction of reformist prime minister Junichiro Koizumi on to the world stage, international law firms finally embraced the joint enterprise arrangement that had been in place since January 1995, permitting association with local lawyers, or bengoshi. Ten such associations materialized in 2001 compared with a total of 11 in the preceding six years.

In addition, although a spate of similar domestic consolidations did not follow the groundbreaking merger of Nagashima & Ohno and Tsunematsu Yanase & Sekine in January 2000, May 2001 did see Aoki & Partners’ move to Tokyo Aoyama Law Office.

2001 also heralded the publication of a report by a government advisory body, recommending sweeping changes to Japan’s legal system (but more on that later).

Adapt to changing needs

Christopher O’Brien, managing partner of Dorsey & Whitney’s Tokyo office, believes the recently announced merger between local firms Mori Sogo and Hamada & Matsumoto “illustrates a growing maturity in the Japanese legal market”.

With the bar association’s ‘lawyer’s law’ statute requiring merged firms to share offices, Mori Sogo, one of Japan’s four top-tier firms, will not join forces with finance-focused Hamada until January 1, 2003. However, says Hamada partner Toru Ishiguro, from April 1, 2002 the two firms will “enter into a variety of collaborations, such as working jointly on matters, in preparation for the official merger”.

Ishiguro says Hamada’s clients are “very much welcoming this move”, and cites the firm’s “shortage of lawyers experienced in international and domestic business law”, as the main driver for the merger. “Japanese society is also becoming increasingly litigious”, he says. “Japanese business clients therefore require more lawyers, both in quantity and quality.”

Steve Lewis has witnessed Japan’s recent taste for litigation first hand. Lewis helped set up Herbert Smith’s Tokyo office in early 2000, following many years in Japan with Denton Hall. Lewis’ present firm enjoys an enviable reputation in the area of litigation, but it was only towards the end of 2001 that Herbert Smith established a dispute resolution practice in Tokyo, scooping the other international firms in the process.

The country’s policy of traditionally shying away from disputes is consistent with its mantra of maintaining harmony. But, says Lewis, the sheer shortage of money in Japan’s economy right now has helped to foster an unprecedented willingness to litigate, with clients desperate to collect their debts, often going after people overseas. Lewis expects a spate of dispute resolution practices among the international firms in the near future.

In addition to the rise in litigation, another explanation for the recent consolidation among Japan’s elite firms is the drive to obtain critical mass to be able to service major transactions. And the sheer number and scale of these transactions is on the rise as the market deregulates under the guidance of Prime Minister Koizumi (See box: ‘The bubble bursts’).

Several regulations that had historically hindered restructuring and M&A activity in Japan have recently been amended. For example, on March 10 2001, the government introduced revitalizing tax measures that had a direct impact on M&A. These include the Corporate Restructuring Law (impacting the tax treatment of corporate asset transfers) and the Corporate Division Law (further facilitating company reorganizations).

The impact on the domestic market has been immediate. Already in 2002, the life insurance industry is experiencing consolidation. With insurers struggling against the economic elements – corporate failures leading to cancelled contracts – Meiji Life Insurance and Yasuda Mutual Life Insurance have agreed to merge to form the country’s third largest life insurance group, with assets of US$201bn. Other prospective partners include Asahi and Tokio Marine & Fire Insurance.

In addition to domestic consolidation, critical mass will also be necessary among Japan’s leading law firms as they increasingly follow their preeminent blue-chip clients out into the region. Clients such as mobile telephone company NTT DoCoMo, which has announced plans to list in New York and London from early March 2002 to finance expansion in Asia.

Tokyo-based Lovells partner Tim Lester says that although there have never really been significant impediments to foreign investment in Japan, these regulation amendments, together with, for example, changes to the JREIT (Japanese Real Estate Investment Trust) structure, have produced more liquidity, facilitating foreigners entering Japan (See box: ‘In-house judgment’). There are, of course, also “more distressed assets available for purchase”, he adds.

Lester believes Mori Sogo and Hamada & Matsumoto “complement each other” perfectly. He says: “Japanese firms have not really had sufficient critical mass to service, in particular, the due diligence requirements of major transactions.”

Rob Burley, managing partner of Clifford Chance’s Tokyo office, adds: “The bengoshi market is moving quite fast. There is definitely a lot of fluidity.” He believes the local firms are also seeking to develop full service law firms, having not been that specialized in the past. “Nagashima & Ohno was short on capital markets/securities capability”, he says. “Therefore, a tie-up with Tsunematsu Yanase & Sekine made sense.”

Mori Sogo, meanwhile, had a traditional Japanese practice focusing on litigation before evolving into more international business law matters such as mergers and acquisitions. It always intended to become full service and added the word ‘Sogo’ to its name in 1970 (‘Sogo’ means ‘general’ in Japanese). In contrast, the younger firm of Hamada & Matsumoto, from its inception, engaged mainly in international financial matters, establishing Japan’s first overseas branch office in London in 1987.

Commentators suggest that market conditions, following the Mori Hamada & Matsumoto merger, may now nurture a spate of similar tie-ups in a way that was not possible after the Nagashima Ohno & Tsunematsu merger.

Hamada partner Toru Ishiguro agrees that the merger of the firms is partly driven by the need to develop a full service, as well as helping the merged entity “recruit the most able, motivated and energetic lawyers”. “And our expectation is that it will push other large firms not seeking international cooperation at the moment towards similar mergers,” he says. “I would be surprised if they have not at least discussed it.”

If they haven’t yet they should be, as the prospects for the remaining mid-sized firms in Japan will likely follow the example set in the more sophisticated legal markets of the US and the UK. Mid-sized firms in these jurisdictions have had to either expand (organically or through merger/acquisition) and take the big boys on at their own game, or tread the boutique path.

“That may well be what happens, there is room for the boutique approach with IP, in particular” says Ishiguro.

“If these mergers continue, their [the mid-tier firms’] relative standing in the larger corporate areas of law will be weaker and these areas would then naturally be handled by the larger firms. But most Japanese firms have not been that specialized in the past, and in reality, they were not in the position to handle larger matters to begin with.”

Joint enterprises

It has also been murmured in the corridors of power that these domestic tie-ups could be a pre-cursor to a link with an international firm, but on more of an even keel. Although the express view of the local firms is that they will remain independent for now, “that is not far away”, says Ishiguro, “and is within the sights of many of the larger Japanese firms”. He admits that “conceptually speaking” it is also what his clients want.“Foreign firms, in particular the UK firms, would prefer to secure a link with a major Japanese firm rather than pick up small groups of lawyers” says Ishiguro.

In October 2001, Simmons & Simmons perhaps went closest to achieving this when it announced its joint venture with TMI Associates. Created in 1990 as a breakaway from Nishimura & Partners’ IP practice, TMI is a “good-sized firm”, says Dorsey & Whitney’s Christopher O’Brien, and its link with Simmons must be viewed as “pretty significant”.

With some 44 lawyers and 80 legal staff in Tokyo, TMI is only just behind Baker & McKenzie’s joint venture partner Tokyo Aoyama Aoki Law Office in terms of size, but it houses more bengoshi than the next two largest joint enterprises of international firms (Freshfields and White & Case) put together.

Another firm to have finally made the leap in 2001 was Clif-ford Chance. Although a tenant in Tokyo for many years, Clifford Chance patiently sought its prey while some of its City peers jumped in headfirst. On May 1 2001, the firm secured a deal with 10-lawyer Tanaka & Akita. It has since added a couple more bengoshi, making it one of the larger ventures.

“The joint enterprises were very slow to start with, but more people are doing them now”, says CC’s Rob Burley. “And the pressure has increased as more people have done it.”

Increasing the pressure also are the demands of multinational clients. Although there has been a slowdown with straight banking and finance work on the US investment bank side (at the end of 2001, the securities industry closed its books on its roughest year since the 1987 stock market crash) 2001 proved to be very successful for debt and structured equity financing.

US firm Morgan Lewis recently boosted its finance capability in Tokyo, adding Bonnie Dixon from Schulte Roth & Zabel in New York. Dixon, who worked in Tokyo from 1981 to 1984, will act, says the firm, for both Asian and non-Asian clients on transactions such as distressed debt, asset securitization, private equity and venture capital deals.

Clifford Chance, meanwhile, has profited from Japan’s economic woes, advising on a number of securitizations connected to distressed assets. The highlight was the ICRJ3 (International Credit Recovery Japan) non-performing loan securitization: the largest securitization of this asset type to date in Japan.

The ICRJ3 deal involved Classes A, B, C and D FRNs (floating rate notes) due 2006. Clifford Chance delivered a 10b-5 opinion for the 144A tranche to Morgan Stanley and Burley says it is an example of what the Tanaka & Akita relationship has given them. “We can now do the asset side as well as the bond side”, he says.

The firm also advised Morgan Stanley on Japan’s largest securitization in any asset class for the Aiful Corporation, as well as completing a number of good deals for Chase, Sony and Citibank. “It is, primarily, international clients that are expecting the one-stop-shop service,” says Burley.

Who you gonna call?

Meeting these growing expectations is the name of the game and is, perhaps, the best explanation for the spate of joint enterprises that emerged in 2001. But there are many in Tokyo who have yet to commit and the Allen & Overy debacle only served to strengthen their resolve (A&O’s goals were not realized with its venture with Akatsuki Kokusai Horitsu Jimusho which ceased in 2001 – Akatsuki has since teamed up with Orrick Herrington & Sutcliffe).

The partner at one such firm says: “We think the Japanese lawyers that have joined the international firms have, generally, not been of sufficient quality.”

Even Clifford Chance’s Burley admits: “We looked for quite a while for the right people.”

The difficulty in attracting what one foreign lawyer described as “the cream of the local legal profession”, is primarily due to the limitations still in place with the joint enterprise arrangements. “Senior bengoshi do not want to work for international firms,” the lawyer says. “They want to continue to run their own partnerships.”

Adds Lovells’ Tim Lester: “Not being able to share equity and have access to certain types of work is not as attractive to a leading local lawyer.”

Lovells has been openly searching for a suitable venture partner for some time. “We’ve been exploring options,” says Lester, “but we’re not ready to jump into a joint venture arrangement unless we find the right person.”

Its strategy does not seem to have harmed the firm too greatly either. In late 2001, following his return to Tokyo to set up the firm’s capital markets group in Japan, Lester led a Lovells team from Tokyo, London and Paris on the largest collateralized debt obligation (CDO) issued in Japan. He advised Shun Cajot Yoshida and Go Yajima in BNP Paribas’ credit derivatives department in Tokyo. And, he says, “this year is so far proving busier than the last” on the credit derivatives side in particular.

The firm continues to work on a transaction-by-transaction basis with the leading local firms. But Lester admits: “It is difficult to provide a comprehensive service for our international clients.”

While there remain serious reservations on joint enterprises among senior bengoshi, the same may not be said for the younger generation entering the profession. Eric Sedlak of Squire Sanders & Dempsey says: “The younger lawyers would seem to be more open to the idea.”

Another firm yet to commit is Herbert Smith. Steve Lewis says he also prefers not to restrict himself from working with the top Japanese lawyers at the top firms. “I haven’t suffered – touch wood. When I’m in competitive tenders, a lot of clients understand the argument.”

On M&A transactions, Lewis has been working with the same bengoshi for six or seven years. “I am his best client,” he says. “He is ex Nagashima & Ohno, set up his own firm, and is very good.”

Given the difficulty in securing a venture with leading bengoshi, and until the catchphrase of the day (“unrestricted freedom of association”) is realized, it is almost certainly preferable to remain independent than tied to an unsuitable partner, in spite of the pressure.

“You must have a clear understanding of the expectations one has of the other,” says Christopher O’Brien of Dorsey & Whitney. The US firm opened in Japan in November 1999 but has only just sealed its venture with local firm Kyo Sogo Law Offices. “Our strategy from the start was that it was necessary to bring in Japanese lawyers,” he says, citing the success of the firm’s London and Brussels offices where it has employed a similar strategy. “But in Japan, we are finding it is necessary to have worked with them before.”

Despite the judicial reform initiative that commenced in 2001, lawyers believe it will still be some time before the barriers between local and foreign lawyers are fully dismantled. Although welcoming statements made by the government on the need for further liberalization of the legal market, they remain cautious.

Squire Sanders’ Sedlak established and managed Graham & James’ joint venture offices in Ho Chi Minh City and Singapore before the two US firms merged in July 2000. Experienced with this debate in other jurisdictions, he says: “The hope is that Japan will liberalize sooner rather than later. But I was here in Tokyo from 1988 to 1994 and I had high hopes that they would reform by the time I returned.”

Meanwhile, Clifford Chance’s Rob Burley says: “Any statement about further liberalization is a good thing. But we’re all waiting to see whether the proof is in the eating of the pudding.”

Says Tim Lester of Lovells: “Nobody is expecting things to change overnight. It is a frustrating process.” But Lester adds: “Tokyo is in the doldrums at the moment and is going to continue to be for a while, but, increasingly, there are opportunities there.”