Russian Law Firms, 2006

Table
Pokazateli deyatelnosti otdelnyh uridicheskih kompanii Rossii, po itogam 2006 goda¹

Billions for Legal Counseling

As it keeps pushing the shadow business operators into the legal domain, the Government has unintentionally generated an increase in the demand for legal services. From now on it is investors that would be sending their new customers to legal advisers.

V. Khanferian

Most Russian entrepreneurs have used to tackle any and all of their business matters through the use of in-house resources, with no outsiders allowed in unless under extremis. Notably, a large number of business executives continue to do without independent auditors, consultants or appraisers. However, from time to time they are compelled to use the services of legal advisers. Apparently, it would be in order to assume that Russian legal support business constitutes rather a growth-capable segment of the market for corporate services.

However, the aforesaid assumption could not be appropriately corroborated until the present time. Operating in the Russian market for legal services today are numerous offices from foreign law firms, dozens of bigger-foot domestic firms, just as hundreds of small and mid-sized operators scattered across the country. Notwithstanding the circumstance, even approximate knowledge on the size and structure of domestic legal services market is unavailable. The matter is that Russian law firms have traditionally sustained the image of structures reluctant to divulge any proprietary information. As far as Western law firms go, once of Russian soil, they seem to immediately grow oblivious of the need for transparency and assume the vow of silence.

Given the landscape, we sought to fill out the data void as we ran the first research study of local legal services market by way of tapping relevant market players and requesting them for information on their business engagements.

Value of Precedent

Following some exchanges with experts from a range of larger law firms on the kind of data required, we sent out our survey questionnaires to nearly three hundred law firms operating in the corporate sector. Of course, that shortlist included leading Russian and foreign companies, and even less visible regional operators. Following two months of most intensive telephone conversations, urging and cajoling, we eventually received properly filled-out questionnaires from thirty-four law firms. A dozen more respondents (those including a few large Western law corporations and domestic market leaders) submitted the requisite research data on condition of strict confidentiality. Understandably, against a backdrop of total lack of knowledge about the market in question, the secured results amounted to some accomplishment. However, given that nearly 80% of prospective respondents wouldn't cooperate came to be most graphically reflective of the kind of data transparency you can find in the local market for legal services.

Chart 1. The 2006 revenues by 34 law firms stood at RUR 2.2 billion
Revenues from legal services^*

Gross earnings by 34 law firms for 2006 came to stand at RUR2.2 billion (see Chart 1), the figure clearly being no small amount. The latest revenue numbers from our last 140 rating appraisers had merely totaled RUR4.6 billion. To add, most market leaders continue to be reluctant to put their financial performance data (earnings, incidentally, being rather impressive) in the public domain. To point out, the aggregate value of business, pursued by the companies that had provided the requisite knowledge on condition of confidentiality, stands in excess of RUR3.5 billion. Should you add in the legal-counseling earnings (close to RUR5 billion) from the leading audit and consulting group, calculate the weighted average income for the researched forms and extrapolate that un-researched operators would perform in the same fashion, the overall 2006 size of Russian market for legal services could at least be standing in the area of RUR23-25 billion. Put otherwise, Russian business community annually shells out close to $1 billion for legal services.

Looks like this upward spending trend will be sustained. The 2006 revenues by 34 law firms had expanded by a quarter, the indicator nearly being in sync with the big business growth rates, according to Expert-400 ratings. Of course, lawyers are not yet in a position to successfully compete against auditors and consultants in terms of business expansion rates. However, in the years not far ahead the domestic legal services market would be most likely to grow at an accelerated pace. The thing is that currently there are a few rather powerful drivers underpinning the effort pursued by legal counselors.

First of all, the nation's economic expansion serves to push Russian corporate entities towards setting more ambitious goals. Clearly, striking new large deals, making fresh acquisitions, attracting domestic and external financing would only help grow the demand for pertinent legal services. What is more, even possible shifts in the current set of most favorable economic conditions would be playing into the hands of domestic lawyers. "A fresh push for the market could come from a watcher-expected economic crisis that would inevitably break out once the ongoing boom period comes to an end. Obviously, a prospective downshift would increasingly feed the demand for quality management of relationships with market counterparts that might suddenly grow insolvent", says V. Semenikhin, deputy general director, BKR-Interkom-Audit.

Secondly, given the local experiences of recent years, Russian business community has been compelled to yield to the government inevitably beefing up its controls in the economic arena. "Over the last two years, expansion of the local legal services market has been primarily driven by the growing demand for said services, the trend being reflective of the government seeking to put things in order in the area of business pursuits. Just to remind, the YUKOS and Russneft affairs had made many entrepreneurs grow pensive. For heated arguments with the authorities to be terminated, an effort had to be made to improve the quality of business management, the legal dimension having to be particularly focused", observes V. Semenikhin.

Then, government policies and equally important pragmatic aspirations serve to help push business operators from the shadow and into the reported economic arena. Today, no one comes to be surprised to see several dozen stand-alone companies (owned by a single beneficiary in the best case) being transformed into a well-structured holding conglomerate. Understandably, that kind of conversion can hardly pass without legal advisers being tapped. "Nowadays, a concerted drive is under way to get private-owned businesses legalized, with transparency goals being especially emphasized to attract fresh investments. Surely, to get a business rightly streamlined, you absolutely need some sound legal advice. By and large, emergence of new holdings and expansion of their business pursuits ought to go hand in hand with deployment of the right legal arrangements defined to help keep the registered assets and grow them further", concludes N . Orlova, partner for tax and legal matters, FBK.

Tax Returns Revisited

Chart 2. Lawyers earn the most when providing tax-related services
The 2006 structure of legal services market, %

Lawyers earn the most when providing tax-related services . For 2006 this segment accounted for 40% of total earnings by the listed law firms (see Chart 2). Exporters-geared legal counseling had been particularly in high demand. Persistent export drawback delays on the VAT payable for export deals have compelled Russian companies to turn to legal counselors to sort out the matters. Just to remind, starting from January 1, 2007, Russia has been maintaining a notification-based VAT-refund procedure that was supposed to facilitate the tax-related tasks supported by exporters. As a consequence, the volumes of VAT-refunds have indeed been rapidly on the rise. Over the first five months of the current year the amount of VAT-refunds had been up 1.8 times on the comparable period for previous year. This improvement is likely to cause some contraction of this line of business practiced by law firms. "Under the notification-based rules for VAT-refunding, once a batch of goods with a zero-tax rate has been sold, no tax return needs to be submitted to the federal tax authorities", says V. Semenikhin.

Demand for tax-related legal services has for the most part been driven by the government seeking to improve the budget revenue performance, the circumstance serving to radically shift the relevant customer demand. "While in the past a good measure of legal counseling was needed to assure the right avoidance of taxes, now we have been increasingly signed up to help do away with the old avoidance schemes in order to bring the statutory tax returns in line with the applicable Russian legislation," explains V. Semenikhin.

Mediation in litigation engagements now accounts for 18% of revenues generated by law firms. Lawyers have been reporting a sustained and rather meaningful rise in the numbers of cases tackled by courts of law. Diminishing corruption in the domestic arbitration system on account of the government updating relevant judicial procedures and augmenting transparency requirements, just as the right legal culture incrementally embraced by the business community and a sequence of judicial precedents with the government ending up the loser have come to be some of the drivers making companies stand up for their interests through litigation, according to the experts surveyed. "The ongoing trend can only be welcome: businessmen now readily go to a court of law and meet pertinent legal expenses in order to defend their equity legally rather than through the "old-boy network." Clearly, this is one of the consequences of the arbitration system being made less corrupted", explains A. Trifonov, principals manager, MEGAPOLIS Legal. Coming to reinforce the judgment has been E. Pigaleva, general director, Territoriya Prava, who made the following comment: "Extra-legal or rule-of-thumb settlements have become increasingly rare and far-between, with all major conflicts being resolved through proper litigation. In addition, businesses are now less reluctant to appeal against that or other wrongful act issued by the government. Apart from conventional litigation engagements (receivables claims, enforcement of contracts, etc.), lawyers have been incrementally attracted to work the cases having to do with protection of shareholder rights and company goodwill. "The more compelling recent cases include: protection of the good names of ROEL Group’s owners bringing an action against Tverskaya 13 daily publishers, and presentation of OAO PZR shareholder interests (challenging the company management on the property divestment issue)", explains E. Pigaleva.

The growing demand for corporate-law-related legal services (the effort accounting for 15% of the revenues by law firms and 50% of incremental earnings for the year) primarily comes from: a surge in increasingly more civilized M&A deals, focused effort to assure legal credibility of business transactions and minimize outstanding risks, public offerings of securities, and (Sic!) business conversions into larger holdings in the form of shifting to a "single-share" arrangement. "For the most part, the trend had been set off by the following changes made to the company legislation: improving the procedures to transform joint stock companies, updating the IPO rules, perfecting the regulatory requirements for offering securities", according to R. Kozlov, general director, Tekhnologiya Korporativnogo Upravleniya. Some of the most graphic examples to that effect had been our taking part in: building Dalenergo Company by way of bringing together the assets originally held by Dalenergo, Amurenergo, Khabarovskenergo, Yuzhnoe Yakutsenergo and LuTEK; helping Volga Inter-Regional Distribution Company switch over to the "single share arrangement"; creating TGK-4 and TGK-5 through reshaping relevant regional energy providers under the TGK-power-generation-capability approach; tracking private GidroOGK share placements.

From TEK to Finances

The trite verity runs as follows: any Russian industry or service provision sector either directly or indirectly hinges on the availability of cash flows generated by TEK fuel and energy companies. Lawyers happen to be no exception to this rule. Much of their earnings come from their working together with oil/gas and energy giants. However, numerous law firms have been increasing shedding that "resource dependency" of late. The 2006 earnings from services used by TEK and extractive industries had shrunk by more than 20% (see Chart 3). This appears to be the only one legal practice segment featuring downward dynamics. In part, this trend had been generated by the oil and gas sector being increasingly appropriated by the government and the new-energy-company-building effort coming to a close. With the crucial phases of TEK transformation effort now nearly completed, most of the corporate-related legal engagements would shortly be wrapped up, the circumstance clearly signaling emergence of stability in the sector, according to A. Lavrentyev, deputy general director, Yurenergo Group.

Chart 3. Earnings from legal services used by TEK and extractive industries had shrunk
Legal services market growth rates for 2006

Conversely, indigenously new business areas have been expanding exponentially. By way of example, the value of IP legal services for 2006 had doubled, the credit largely being due not only to Bill Gates jealously safeguarding his licensed rights to the latest Windows version but also to Russian holders of rights gradually embracing legal tools needed to stand up for their lawful interests. "The more marketable legal services should include: protection of trade marks against their being unlawfully used by unscrupulous competitors, research of rightful trade-mark-application practices and development of relevant security measures needed for the products to expand regionally and internationally. In particular, mention ought to be made of successful outcomes for the Bosco di Ciliegi brand-related conflict and effective completion of the projects related to registration and utilization of RTS and GUM brands. To underscore, those had been some of the more visible and exciting intellectual-property-related cases worked and fruitfully closed by our lawyers in the previous year.

Labor-law-related engagements account for more than 60% of revenues from legal services made available. Admittedly, the given segment's expansion has been directly influenced by major hikes in wages and compensation packages. "Heightened demand for legal services has come from the overheated labor market and growing numbers of industrial actions that served to force employers to be more focused on how to get the prevailing labor management practices appropriately brought in line with applicable regulatory requirements, the circumstance clearly helping boost marketability of the legal services related to tracking labor conflicts", says V. Semenikhin. Incidentally, the weight of this line of business in the overall legal services market landscape continued to be nearly negligible in the course of 2006, while merely accounting for 3% of the entire effort in terms of earnings secured.

Conversely, the segment of financial sector-related legal services has already expanded by two times and keeps growing at rather a fast clip. While cooperating with banks and other financial institutions in the course of 2006, law firms had improved their wealth by 82%. Looks like the rend will continue to be sustained over a long haul. Just to clarify, investment engagements of domestic companies have been increasingly dependent of attracting debt capital, launching public offerings and IPOs. Importantly, one of the key criteria for either domestic of foreign investors happens to be made by legal credibility of a prospective partner's business and meticulous application of any and all procedures underpinning a placement of securities. According to V. Semenikhin, the due diligence-related legal services have come to be increasingly in demand, the overriding goal being to achieve unbiased understanding of the projected investment recipient. Of course, that comprehensive appraisal effort includes a range of efforts to measure relevant legal, tax and financial performance risks, possible government funding problems having to be accounted for. As a consequence, legal practices sustained by domestic and foreign companies will be incrementally generated by the customers that happen to be on the hunt for more financing.

Lawful Competition

Generally, law firms operating in the domestic market for legal services can be easily broken down into the following three major categories: international and Russian auditing and consulting groups (ACGs) with legal counseling business units, major international and Russian specialized law firms, and a broad range of small and mid-sized legal service providers. Understandably, each operator would feature its own specifics and capabilities to effectively compete in the marketplace.

One of the more explicit strengths of ACGs is their being comprehensively equipped to offer a broad range of services. "ACG-held law firms are normally engaged to support extensive and multidimensional projects when a legal consultant is required to command the requisite knowledge and skills relating to a number of disciplines: tax and corporate law, expertise needed to stand up for customer interests in litigated cases, ability to tackle financial and management consulting-related tasks", according to N. Orlova. Another ACG strength is made by the established and well-oiled links with a broad array of Russian customers. What is more, the recently acquired ACG experiences of assisting domestic companies in their effort to switch over to IFRS practices would enable the integrated law firms to readily perform assorted due diligence and consulting jobs. And then, the very fact of an ACG commanding a world-class network of operations poses as a most critical factor whenever it comes to a prospective foreign customer seeking to pick out the right partner in Russia.

Foreign-based law firms are known to maintain specialized business units primarily designed to originate and complete disparate cross-border transactions, provide services for Russian companies breaking into international markets or represent their foreign customers in Russia. "Our company is filling out a very special niche in the Russian legal services market. As a matter of fact, it poses as a leading high-visibility law firm operating within the confines of Northern Europe. What is more, our committed customers have for the most part been made by European-based companies pursuing investment and other commercial operations within Russia", according to A. Gusev, partner of Mannheimer Swartling and head of the Company's Saint Petersburg office. To point out, the key strengths of foreign law firms are primarily made by their global recognition, availability of smoothly running providers of legal services and superior quality of management.

Admittedly, now and again domestic companies pose as subcontractors of foreign law firms. "By now we have the following major Russian law firms that have established themselves as leaders in the local market for legal services: Pepeliayev, Goeltsblat & Partners; Egorov, Puginsky, Afanasyev & Partners; and Vegas-Lex. In fact, these firms appear as "legal services factories" with celebrity lawyers working in support of larger companies for large fees. To clarify, their competitive advantages amount to the capability to offer comprehensive legal services for any given principal. They no longer see any point in remaining too specialized or sticking to a single professional competency", according to market watcher A. Trifonov. Apparently, not far away is the day when those domestic majors would be sufficiently equipped as they have their impressive business expertise multiplied by aggressive marketing strategies in order to meaningfully squeeze their foreign peers out of the Russian marketplace.

Further on, the competition amongst law firms will only intensify, domestic and foreign players operating at par within a single arena. Firstly, competitive battles will be on the rise, especially given that Russian law firms would command the right knowledge of domestic legislation, hold the expertise needed to provide legal services for their foreign customers and maintain affordable service provision costs that might be more often than not lower than those posted by their foreign-based counterparts. "Their stature and goodwill notwithstanding, foreign law firms often are less knowledgeable about the specifics and intricacies of applicable Russian legislation than their Russian peers. Of course, the costs of foreign legal services also come to be of some relevance. The matter is that they sometimes are higher than the costs of comparable domestic services by several orders of magnitude", according to M. Steshev, general director, Mikhailov & Partners consulting group. Foreign experts likewise have been observing that rivalry between Russian and foreign legal counselors has been evolving upwards. "Inasmuch as Russian law firms offer more affordable services, they successfully compete against their foreign counterparts. To be more specific, this has to do with provision of consulting services and tracking mid-sized corporate projects", explains I. Rybalkin, partner of Hogan & Hartson LLP.

Secondly, the growing demand for legal services would inevitably result in the larger numbers of market players: Russian law firms for the most part. After all, one can hardly speak of any major constraints barring new service providers from entering the market. In the end, the trend would lead to domestic law firms competing more aggressively for new business.

Discuss in the forum

Rightful rivalries

Business info