Is the cooperative consensus that has typified a liberalised Japanese legal market finally giving way to greater competition? ALB investigates

From cooperation to competition

As this edition of ALB went to print, the 22nd anniversary of the enactment into law of the Special Measure Law Concerning the Handling of Legal Business by Foreign Lawyers (the law) passed without ceremony or fanfare. Proof that for many in the Japanese legal fraternity, liberalisation is an ongoing process – evidence that there is still plenty more to achieve despite an impressive evolution.

Japan’s present day legal sector is virtually unrecognisable from the one that existed prior to 1987. The presence of foreign law firms (FLFs) has irrevocably reshaped the complexion of the legal sector, lifted standards and changed the way business law is conducted in the country. Not only has their presence proved useful in helping wean Japanese business off government support and onto the welcoming bosom of business lawyers, it has also helped the development of domestic law firms (DLFs), who have gone from strength to strength. 

The Japanese ‘Big Four’ (Anderson Mori & Tomotsune, Mori Hamada & Matsumoto, Nagashima Ohno & Tsunematsu, and Nishimura & Asahi) have gone from modest-sized firms to legal leviathans, casting a shadow over the legal market. After 22 years it is the DLFs who dominate the arena. And while this is not likely to change in the foreseeable future, the cooperative consensus that has so far typified the relationship between DLFs and FLFs in Japan is set to change. In fact, the more observant may have already noticed signs of this occurring: from joint law ventures to the hiring of Japanese graduates by FLFs and gaiben by DLFs – if the past 22 years were about cooperation, it seems the next 22 will be about competition.

Home comforts

Prior to the 16-year-long slump of the Japanese economy that began in 1990, there was little call for the involvement of law firms in the business transactions of Japanese companies. With government bureaucrats heavily involved in economic development and business decision-making, and little in the way of litigation, lawyers were, according to Toru Ishiguro of Mori Hamada & Matsumoto, an “unnecessary evil”.

But things changed as the samurai nation emerged from the despairing depths of the “lost decade”. Suddenly law firms faced a different world, where businesses made their own decisions in an increasingly litigious society, forcing even the most conservative industries to become more aggressive.
As a result, law firms played a much bigger part in the domestic economy, as businesses came to realise the importance of the need for advice. Nagashima Ohno & Tsunematsu chairman Hisashi Hara estimates that in the 1980s, 80% of legal work was garnered from cross-border transactions. Compare that to the current market, where Hara says the breakdown of work handled by the top domestic firms in Japan was articulated as a clear 70:30 division. Seventy per cent was accounted for by domestic work, while 30% was supplemented by cross-border M&A and transactional type work, with FLFs attracting the lion’s share of it owing largely to their international clientele.

But even this is changing. In fact, the changes here have been one of the more noticeable trends in the market over the past 12 months. So, are Japanese lawyers coming full circle and returning to their roots as transactional lawyers?

According to Ishiguro, upping the amount of cross-border work coming into the firm is high on his firm’s agenda. “There has been a general move among all domestic players to invest more attention into cross-border elements of the market and we are now seeing the fruits of this policy pay off,” he says. Ishiguro’s firm has long had an international desk, but has recently seen its market share and that of other DLFs increase substantially in a short period of time.

Nagashima Ohno & Tsunematsu is also making in-roads, but Hara says that any increase in this area will have to preserve the amount of local law work DLFs are doing. “All of the Big Four firms feel that domestic work has become so important and we don’t really want to harm that,” he says. “But cross-border work now is extremely lucrative, so the challenge is how to use what we have resourcefully and how to pick up this work without having to say no to local law work, which has enabled us to grow and thrive.”

One need only look at the table on p49 and see just how much of the M&A market DLFs have to realise that they may have struck this balance already – a balance that will serve them well in an economy that is once again teetering on the precipice of another lost decade. And while there are those that say DLFs returning to their roots, coming full circle and increasing the amount of cross-border work they handle is an added bonus, to others, it is a necessity, as the cooperative status quo between DLFs and FLFs slowly but surely gives way to increased competition.

NEXT: Changing relationships

Changing relationships
Ever since Japan opened its legal market to FLFs in 1987, relations between the domestic and international counterparts have been firmly based on cooperation. Rather than competing for each other’s market share, a clear division has existed between what belonged to each. FLFs advised on international law and their international clients on entering the Japanese market, while DLFs advised domestic clients on their operations both in Japan and overseas. If a matter called for either specialist international or domestic advice, the firm involved would refer the matter to a DLF or FLF of their choosing, thus creating intricate and lucrative networks of referral agreements.  However, regulatory change, law firm consolidation and economic shifts over the past few years have all acted to undermine this once quiet consensus. DLFs and FLFs are now beginning, ever so slightly, to encroach on each others’ turf and this is most apparent in relation to the big ticket items in Japan: transactional work and M&A.

“Domestic law firms have started to move directly into competition with foreign firms in these areas of late,” says Ken Siegel, managing partner of Morrison & Foerster’s Tokyo office. “When foreign firms entered Japan back in the late 80s these areas were almost their exclusive domain, but what we are seeing now, either through the establishment of international desks, international law departments or the hiring of gaiben [foreign attorneys] is that domestic firms are making a real end-run in this area.”
Bonnie Dixon and Daniel Hounslow of local firm Atsumi & Partners are two such gaiben – the first foreign lawyers to be elevated to partnership at a DLF in Japan. For Dixon the bubbling competition between domestic and foreign law firms has been dented somewhat by the onset of the global economic crisis. “Prior to the recent financial crisis I would have said that foreign firms are strong competitors for securitisation work, but that is not relevant now [the market for securitisation in Japan is at its lowest point in 15 years, according to the latest Thomson Reuters statistics]. Foreign firms may still maintain a competitive edge over domestic firms for private equity and fund formation work.”

But according to Darrel Holstein, Tokyo managing partner at US firm Milbank, it’s not so much a case of DLFs competing with international law firms, nor all FLFs making a charge for a greater share of the domestic market. It’s a specific type of FLF that is shaking up the status quo.“The international firms with large numbers of bengoshi of those in joint ventures or alliances with substantial local firms present the biggest threat to large independent domestic firms because they compete directly with them for domestic law transactional work ,” he says.

However, as Holstein’s colleague and fellow partner Gary Wigmore is quick to point out, the service offered by integrated or JV firms is not always equal to that offered by independents like the Big Four. “The large independent domestic firms offer depth and quality of service on Japanese law matters. Some of the JV firms have had success in developing domestic law practices, but most are not at the same level of the big four. I think the joint venture strategy can only work long term if you are offering something special and unique,” he says.

Holstein and Wigmore go on to note that when they need to bring a local firm on board they rarely look outside the top four or five firms in the market and even more rarely to a joint venture firm. MoFo’s Siegel, however, disagrees with those who question the long term viability of the joint law venture model or those foreign firms who have chosen to establish a critical mass of bengoshi within their ranks.  “Our Tokyo operations have been extremely successful and if there is any sign that this model, that is, the development of Japanese law capability, is not feasible in the long run I have not seen any indication of it. We have some 110 lawyers here and all are extremely busy. We not only act for international clients but some of the largest companies in Japan are also regular clients,” he says.

And it is not only Siegel singing the praises of his firm’s model, domestic  lawyers firms also single out MoFo’s Tokyo office as one of its most profitable worldwide.

Leaders of the pack
Notwithstanding debates regarding the business models of international firms, referral agreements and increased competition, the consensus is that DLFs still dominate the legal sector in Japan. A glance at the empirical evidence seems to support such a view. After 22 years it is DLFs who are the largest, who have the greatest pulling power for domestic clients and local graduates and, arguably, are the most profitable.

Dixon says this is due to size and age-old issues like fees and legal costs. “The bulk of international work for the last several years in Japan has been inbound; hence domestic lawyers are key to serving clients. Many transactions require large numbers of attorneys – merger due diligence, large scale securitisations; few foreign firms have sufficient numbers of Japanese attorneys in a sufficient variety of fields to provide full service for these large transactions,” she says.

A theme running through this decade has been large-scale consolidation among DLFs most of which have sought critical mass to maintain their competitive advantage over each other and the threat of foreign firms. It started with Nagashima Ohno’s merger with Tsunematsu Yanase & Sekine back in 2000, and was followed by others involving the present big four, such as Anderson Mori’s combination with Tomotsune & Kimura, and Mori Sogo’s merger with Hamada & Matsumoto. The result, when including the latest merger of Asahi Koma & Nishimura & Partners, is that each of the Big Four now boast in excess of 300 lawyers.

Fees are another area where DLFs still hold sway. “Foreign firms are rather expensive,” Dixon says, “with hourly rates for junior associates matching the hourly rates of very senior attorneys in Japanese law firms. Although some foreign firms charge a lower rate for their Japanese lawyers compared to their non-Japanese lawyers in order to remain somewhat competitive with local firms, they rarely match the market completely.”

They are also unable to match the local firms in terms of their ability to attract the nation’s best and brightest lawyers. “Japanese lawyers remain very independent,” Ishiguro says. “When they finish university, they look to come and work at one the Big Four firms – this has been a trend of the last decade and it will continue in the future, not least of all because of some of the difficulties that international firms are facing in their US and UK headquarters. Domestic firms are the preferred choice because of this and the high quality work we can offer.”

Hara also notes that despite the international appeal some FLFs operating in Tokyo may have, DLFs continue to attract young Japanese lawyers because of their ability to offer the same high calibre international work as their foreign counterparts. “Although many Japanese law firms have been handling a lot of domestic work lately, we still offer our lawyers the ability to work on complex cross-border transactions and allow them to get the international exposure that is considered important that way,” he says. “In choosing to come to a domestic firm they can see a clear path to partnership and progression – this is not always clear in international firms.”

However, lawyers at FLFs said that even if young lawyers wanted to come on board, there would be no guarantee that international firms would employ them with one partner stating that the technical ability and English language proficiency of some Japanese graduates is not comparable to that of US or UK law school graduates.

A drag on foreign firms: the three-year requirement

The need for foreign lawyers employed by international law firms operating in Japan to have three years international experience under their belts prior to being registered to practice in the country is simply a “drag on foreign law firms” according to lawyers ALB spoke to.

When foreign law offices were first allowed to set up shop in Japan some 22 years ago the requirement was set at five years’ international experience and in 2005 this was reduced to three – but this is still not good enough, say international lawyers in Japan.

“The Bar Association has insisted on making the conditions here for foreign lawyers very difficult. It has got to a stage where it impacts our ability to work, expand and essentially bring clients to the Japanese market,” says the Tokyo managing partner at one US-based firm.
For others it’s a move that screams protectionism, a move designed to push foreign law firms operating in the country to employ graduates of Japanese law schools instead of looking to their international offices to fill vacancies.

“This is part of broader moves to make conditions inhospitable and could well be viewed as protectionist. In some instances it’s hard to place lawyers to come to Japan and this is yet another difficulty,” says another managing partner at a US firm operating in Tokyo. “If the intention of such restrictions is to encourage us to employ Japanese graduates this is not the correct way to go about it. While graduates of Japanese law schools are of an increasingly high calibre, they often lack the technical and language skills of international lawyers.”

Indeed, the situation has got so bad that even domestic law firms are calling for an overhaul of the system. “The domestic law firms in Japan need foreign law firms to be operating optimally. It will get to a stage when domestic law firms, foreign law firms and even the economy start to suffer,” says the managing partner of one domestic firm.

Add to this other restrictions imposed on foreign law firms, for example prohibition on them opening additional branch offices in Japan, and many are crying foul. And while ALB understands that foreign law firms in the country are currently in negotiation with the authorities to relax such restrictions, the consensus is that foreign law firms shouldn’t hold their breath: the lifting of such restrictions, especially in the current economic climate, may take some time.

An unsuccessful venture?
The observation that foreign firms appear to have not been as successful in Japan as they have in other liberalised legal markets across the region appears to be borne out by the unusually high number of FLFs that have abandoned their offices in Tokyo, either due to economic hardship or to take up the opportunities on offer in the boom Chinese market. However, according to many lawyers at FLFs, such an assertion would be erroneous.

“There may be a perception that foreign firms have not been successful in penetrating the legal market in Japan but that is misconceived,” says Wigmore adding that those who hold such a view use size as a measure of success and operate on the assumption that FLFs and DLFs operate in the same sphere.
“Comparing international and domestic firms on the basis of the size and strength of their Japanese law practices is meaningful only if the goal if the goal is to compete head to head with Japanese domestic firms. Holstein concurs adding that this is not the strategy employed by many international firms in Japan including his own. “Many foreign law firms have made the strategic decision not to compete in the domestic law market. We and most of our peer US firms have chosen instead to focus on international law practices and play to our strengths: outbound investments, financing and high-end cross border deals where we work collaborartively with the big four domestic firms. This model has been successful for us.”

And it is not only Milbank that has a successful practice. The likes of Skadden, MoFo, Paul Hastings and Linklaters are known as firms who are making solid, profitable inroads in the market. Even so, the general market perception is that some other firms are struggling, especially the second or third tier international firms, and some lawyers believe there may be significant movement at the lower end of the market.

Siegel says that any such activity is likely to occur quietly and it is likely that even those with their ears to the ground in Tokyo won’t hear much about it. “I don’t think there will be many new foreign firms opening offices in Japan this year, but there will almost certainly be some closures,” he says. “But we are unlikely to hear about this, these will most likely take the form of global firms ‘merging’ with small local practices – looking to pull out their ex-pat attorneys in this way to reduce costs and save face.” ALB