Verein – what is it good for?

Background

A ‘verein’ is a legal entity defined in the Swiss civil code (Part one, title two, chapter two). It is similar to the common law voluntary association, or ‘club’. In fact, it is often used in Switzerland by sports and social clubs, and that is the kind of association for which it was originally intended.

Such an association can serve as a non-profit organization or a non-governmental organization and this form is used by several Swiss sections of international NGOs such as Amnesty International, and the World Wildlife Fund. It is also used by international organizations such as FIFA – and by political parties and alliances, such as trade unions.

The only legal requirement is that prior to the establishment, two persons draw up bylaws and appoint the organs of the association (such as the board and the auditors), and – if the entity has commercial objectives – that it registers officially.

The association has also been used as a legal form for a business organisation consisting of a number of independent ‘offices’ or entities, each of which has limited liability vis-à-vis the others. As such, the form is often used by multinational professional firms so they can operate globally under one brand whilst maintaining separate profit pools (and ring-fencing liability) in each country in which they operate. One advantage to the verein structure is that because control of the firm is decentralized, offices are only bound by regulators in their country. For instance, non-US offices of accounting firms in a Verein structure are not bound by Securities and Exchange Commission subpoenas from the United States.

In the legal context, the verein itself is an entity that does not actually practice law in its own right. Rather, the member law firms independently render legal services and severally accept the rewards and liabilities that accompany such work. They do not share a common profit pool.

Accountants

The first use of a verein by a global professional services firm was KPMG which, in the early 1990s, adopted that form as a new structure to operate a global brand, with a broader element of flexibility than that afforded by a full merger. However, in 2003 it decided, for reasons that it did not publicly elaborate, that this structure was no longer appropriate, and changed from a verein to a ‘pure’ Swiss co-operative.

Deloitte followed KPMG initial lead and also became a verein in the 1990s. However, in 2010 it decided to shift its international management and governance to Deloitte Touche Tohmatsu (DTTL), a UK private company, limited by guarantee. Each member firm in its global network remains a separate and independent legal entity, subject to the laws and professional regulations of the particular country or countries in which it operates

A Deloitte spokesman told The Guardian at the time, “After decades of operating as a Swiss Verein, we recently decided to take a fresh look at our legal structure in order to determine whether it was the optimal organisation, now and in the future. We concluded that, although the verein structure had served us well over the years, we had outgrown it.”

PwC, as Deloitte, now operates globally as a network of member firms, each of which is a separate legal entity due to local legislative requirements, with each member firm being financially and legally independent. PwC is co-ordinated by a private company limited by guarantee under English law, called PricewaterhouseCoopers International Limited.

EY is known as “the most globally managed of the Big Four firms”. EY Global sets global standards and oversees global policy and consistency of service, with client work performed by its member firms. Each EY member country is organized as part of one of four areas. This is different from other professional services networks which are more centrally managed.

Law Firms

Ironically, in 2004, just a year after the pioneer of global service verein KPMG gave up this structure the first law firm – Baker & McKenzie – adopted the verein approach.

Other law firms have followed this lead since, the most notable being:

  • DLA Piper June 2008
  • Norton Rose 2009
  • SNR Dentons
  • Squire Sanders
  • Hogan Lovells
  • King & Wood Mallesons

A bit like Brexit, however, there appear to be flavours of verein. On the one hand, we have ‘strong’ relatively centrally managed vereins like Baker & McKenzie – and on the other we have DLA Piper, which, after a lengthy review of its operations in 2007 – 2010 ended up as a referral arrangement between two firms, DLA Piper US and DLA Piper International. It is perhaps worth noting that Baker & McKenzie was already a large global player before they adopted the verein structure, and used it because it suited the international ‘franchise’-style arrangement it had already built. Whereas, the other firms here have adopted vereins as a device for effecting speedy merger strategies.

The Benefits

There are obviously benefits of joining forces with other law firms in other jurisdictions, such as reaping economies of scale, the sharing of knowledge, clients and opportunities and the ability to share a world stage with larger more global competitors.

You get these advantages when you merge – so why not simply merge?

A true merger involves, in practical terms, an almost irrevocable commitment and the process adds a significant amount of complexity and expense, it also encumbers each firm with the regulatory environment of all the other firms as well as shared liability.

So; if a group of law firms want to operate as a ‘unit’ (to use a neutral term) in order to gain economies of scale, wider geographic breadth and the ability to be seen to be seen as a ‘global player’, but do not want to merge – then they often form a verein.

There may also be other reasons why they do not want to merge fully; it is often that – whilst there is some consanguinity of interests – they each fear one of more of the following issues:

  • an imbalance in profitability and partner income in different regions
  • a fear of taking on the professional liabilities of less well managed firms
  • a desire to benefit from the association with the others, whilst retaining their independence
  • for some, a desire to take from the association without effectively giving anything away

The problem is that these issues do not go away, and whilst the verein structure persuades some member firms to shelf their concerns short-term, over the years these differences can return to niggle away and cause simmering and increasing resentment.

It is fair to say that there is one particular set of circumstances where a verein is the only way to get where you want to be, and that is – a ‘merger;’ with a Chinese law firm. Currently a true merger is not allowed under Chinese law – so maybe KWM gets a pass on that one.

There are other key problems with the verein as an operational business structure, and many of these relate to the paradox of trying to be one organisation and many organisations at the same time for different purposes, as it suits you.

These problems manifest themselves in issues relating to shared liability, profit-sharing, cost-sharing, conflict of interest and data sharing.

Liability Sharing

One of the primary advantages of a verein is the ring fencing of liability between the member firms. So far attempts by aggrieved clients to sue a verein (or a member) for acts of other members have failed, as in the Parmalat case. However, if a judge now feels it can decide it is reasonable to pierce the verein veil in relation to conflict of interest (see below), how long will it be before one feels entitled to take the same view when issues of verein-wide agency related vicarious liability arise as a result of the organisation ever more strenuously holding itself out as a single worldwide ‘brand’ and maintaining global processes for establishing control and consistency. This shift can arguably be said to have already begun, as in the US Cromer case in 2002.

Profit-Sharing

Some commentators – such as Edwin Reeser (an ex-partner at the former Sonnenschein) are arguing that the cross-referral fees between verein member firms are just profit-sharing by another means. How long before a judge takes the same view?

There may also be a related problem with the US ABA Model Rule 1.5(e), which governs the divisions of fees among lawyers working at different firms. According to the Model Rule, such divisions need to be fully disclosed to clients and specifically agreed to in writing.

Cost-Sharing

Joining a verein is not free. There is usually a central verein management fund to which each of the member firms need to contribute to cover centralised management overheads. Depending on how this is managed, this may also one day be seen as profit-sharing under another name.

It should also be noted, that software vendors generally should not – according to their own rules – treat vereins as a single organisation for the purposes of software licensing. However, verein CIOs report that some suppliers (or at least their salesmen) – even the largest – are happy to find ways to overcome the issue in order to get approval for a global deal with a much larger number of users.

Data Sharing

The apparently relatively minor issue of data sharing causes really significant problem in practice – further complicated by the varying regulatory environments in different jurisdictions concerning the management of personal data. The major impact is on the sharing of client and contact data – and the practicalities involved can severely diminish the anticipated verein benefits of a centralised CRM function to support the achievement of joint business goals.

These issues led Baker & McKenzie to throw up its hands at the complexities and decide to site their entire new SAP-based global PMS system in the country with the most draconian private data regulations – Germany.

However, even take such a radical step as that that really only solves the problem of storing the data, it shelves the even bigger issue of how you then lawfully share such data between the various member firms. One may be forgive for suspecting that many vereins have not actually solved these problems, but are just ignoring them.

Conflict of Interest

It is in relation to conflicts of interest that verein firms most stretch the proposition that they purport to be one organisation for some purposes and different organisations for others – or in other words ‘to have one’s cake and eat it’.

In 2015 a US International Trade Commission judge granted an order to disqualify Dentons US LLP from representing the US company RevoLaze against Gap in a patent suit.

The case at issue began last August when Dentons filed a complaint with the US International Trade Commission (ITC) accusing The Gap and other companies of importing products using that infringed RevoLaze’s patent. In response to being sued in federal court and investigated by the ITC, Gap filed a motion to disqualify Dentons, arguing that Gap had long been a client of Dentons Canada.

The disqualification motion turned on the structure of Dentons as a global ‘law firm’. In its motion to disqualify, Gap argued that Dentons had an ethical conflict and access to Gap’s confidential information through the shared verein information systems.  Gap alleged that this would allow Dentons US access to information relevant to the ongoing ITC case and prejudice Gap’s ability to defend against RevoLaze’s claims and negotiate a settlement. Additionally, Gap argued that Dentons did not inform Gap of this conflict or seek its waiver as required to continue its representation of RevoLaze – steps it could easily have taken to avoid the ensuing problems – although Gap’s retainer agreement with Dentons Canada did contain a provision waiving future conflicts

Dentons opposed the motions, arguing that the US and Canada offices were independent of one another – because of its verein structure. It contended that the two branches could not access each other’s files, do not share confidential information, and are financially independent of one another.

The Chief Administrative Law Judge, Charles Bullock, found for the client, Gap, and granted its motion to disqualify Dentons. On his analysis the Dentons’ global verein structure fits within the ABA Model Rule’s 1.0(c) definition of law firm as either an “other association authorized to practice law,” or as an association made up of lawyers “employed in a legal services organization or the legal department of a corporation or other organization.” Because Dentons fitted this definition, the Judge held that the rules regarding conflicts with current clients and imputed conflicts among members of a law firm applied. Thus, Dentons Canada’s conflict with Gap was capable of being a breach of the relevant professional rules.

Judge Bullock then considered whether Dentons’ violation of the rules s prejudiced the investigation to justify its disqualification. Finding Gap to be a current client, Judge Bullock concluded that Dentons owed Gap a fiduciary duty and criticized the firm for “stand[ing] to benefit both in terms of legal fees and a share in certain proceeds by representing other clients who are seeking to bar Gap’s imports into the US.”

The judge said:

“Dentons holds itself out to the public as a unified global law firm in order to attract business, and Dentons’ continued representation in the face of a direct conflict would both contradict this public image and negatively impact the law profession as a whole.”

Do they work financially?

There is little evidence that the legal vereins are performing financially any better than other similarly sized traditional law firms. In two articles in 2013 and 2014 The Economist analysed this and pointed out that they significantly underperform their peers, concluding that “there is little sign that the vereins’ size is helping them much in terms of economies of scale”.

Several of the vereins complained that the comparison was unfair in that they were the result of recent combinations between US and UK law firms with different levels of profitability. This is a fair point, as far as it goes; after all, the New York and London ‘magic circle’ firms have had decades of organic growth – yes, and some well-judged ‘proper’ mergers – which has meant that they have been able to maintain better overall management and performance as they grew. But that very point rather begs the question about which is the best way to go about building a well-managed and profitable global mega-law firm.

The KWM Lesson

There is another danger, and that is joining an established verein that is much larger than you are. The risk is that the smaller firm feels that it will gain much from the association, but without having to change its own behaviour too much – maybe to deal with capitalisation issues. This expectation is simply unrealistic. As I used to hear at KPMG many years ago; with any merger of unequals there is always a hedgehog and car tyre. In this case SJ Berwin was always destined to be the hedgehog. As one former KWM London partner was quoted as saying in a recent Legal Week article, “we were always reminded that we were the lesser link in the chain of three. Asia was running the show.” It is also apparent that the local and global incentivisation and reward metrics and policies were not aligned, which meant that very different messages were being sent to the partners as to how they should behave.

Vereins tend to be run with a ‘global’ senior and managing partner / board. The verein members may feel that they are not suitable represented at that level and therefore have decisions being imposed on them by a verein board even though they may not be beneficial at their local area.

As a recent story in The Times this December stated:

“Some analysts point to the vagaries of the complex Swiss verein association model that was forced on the SJ Berwin partners when they did the deal four years ago. One commentator told The Times that the Chinese and Australian partners lacked a collegiate approach to the point where they would undercut their London counterparts to win work.”

Furthermore, such a verien combination does not generally solve any capitalisation issues, as the large-scale partner departures and subsequent EUME call for partner cash injection demonstrates.

The main lessons? Firstly, if you are the much smaller party, you will have little power or influence; secondly, do not join a verein to solve major problems – solve them first, then join – especially if it involves funding.

Again, from the same Times article: ’ “The problems with the firm’s management were profound and could not be cured by merger,” one source said’.

Ironically, there are probably Asian and Australian KWM partners who are thinking that being isolated financially from the ex-SJB implosion is exactly why a verein association is such a good thing. However, this also begs the question of whether a full-hearted merger might have been able to weather and absorb these problems. In any event, as previously noted, merger was not an option with the Chinese firm in any event – so this point is moot.

Just Merge Dammit

We have dealt mentioned the issue of the lower billing rates and profitability of UK firm versus US firms; even more asymmetrical is the performance of Australian firms relative to those in the US and UK. This makes full mergers unattractive, and was undoubtedly a major factor for such as Norton Rose Fulbright and SNR Dentons.

However, despite the financial pain that it must have caused Herbert Smith decided on a full financial merger with Australian firm Freehills, in 2012.

“The reason we thought it was so important to have one profit pool is it leads to the sort of behavior we want to encourage, which is cooperation, collaboration—no silos,” said Sonya Leydecker, CEO of Herbert Smith Freehills. “There’s also the quality issue—the reason people will refer work to their partners is they know they’re of a certain standard and they will treat their clients well. If you’ve got a shared economic interest and you spend time getting to know your partners in different places and working with them, you’ve got a better chance of making it work.”

The pain is temporary, but the benefits of truly being one firm are permanent.

What do global clients want?

Clients operating on a worldwide basis want a similarly global law firm that is capable of responding to its needs and which can provide a totally seamless suite of services delivered in any country to a consistent form and content and delivered to a consistent quality, cost and standard.

They want transparency in fees and in the process of service delivery, accurate matter budgets and an organisation that it believes really understand their business. This translates into feeling able to educate ‘the firm’ about their business, their needs and their priorities in any office and have that knowledge available and acted upon in any other office worldwide without them having to repeat it.

Some of this is very difficult to deliver without forming one centrally controlled business, and full client, knowledge and data sharing, just like they are – and they will not understand or appreciate it when it is not forthcoming. I do not suppose that Gap cared about to ins and outs of the verein structure – all they know is that they felt badly served by their supposed global legal adviser.

Finally, they probably expect that adviser – which holds itself out as a single global entity – to be operated, managed and behave as a single global entity on a normal commercial basis – also, like they are.

But, as we have seen, in a verein there are strong cultural, organisational, technological, regulatory issues and fundamental economic self-interest are all factors pulling in the opposite direction. Even in this day and age, it is still extremely difficult to get lawyers in one firm to institute an enterprise-wide sharing culture for knowledge, business opportunities and referrals – without seeking to do so at arms’ length with associate verein member firms.

Conclusion

It would appear that a verein may be used effectively to bind an organisation that already has a sufficient pre-existing historical, cultural and commercial ‘glue’ to hold itself together: but there has to be a degree of unselfishness, co-operation and mutual self-interest leading to a feeling of unity, such as perhaps with Baker & McKenzie.

However, it is also becoming apparent that the verein structure is not – of itself – sufficient to ‘cement’ firms with different cultures and motivations – especially if it is used as a compromise to encourage discrete law firms to ‘semi-merge’ i.e. to join together on the basis that they will get all the benefits of a merger, whilst retaining their own profit and liabilities and working practices.

Many years ago, a now-defunct law firm ‘association’ undertook a study in order to identify why the member firms were not obtaining the level of benefits that they expected from the association. These expected benefits largely related to economies of scale relating to training and knowledge management, referrals and ‘branding’. What was found was that – apart from the London firm – some of the other member firms had joined in ordered to gain benefits in these areas without actively seeking to contribute to any of them. In particular, one member firm had no knowledge repository of their own at all, did not use the association co-branding livery in reception (as they were supposed to) and had enough problems with internal referrals, never mind the issue of actively referring work out of the firm. Soon afterwards, mainly as a result of these issues, the association folded.

The lesson here is that in any close association of law firms is doomed to fail unless each member firm is a truly enthusiastic participant which understands that it has to change the way it operates, and give as much as it expects to receive.

Otherwise, it is my contention that vereins are eventually doomed to failure, unless a Damascene conversion takes place in the membership and persuades them to undertake a ‘proper’ merger. Otherwise, the cultural, organisational, technological and regulatory issues and underlying fundamental economic self-interest already referred to will eventually cause such a verein to break up into its constituent parts, or some combinations thereof.

That is if the judges don’t get there first and do away with the basic perceived advantages of the verein by piercing through the ‘corporate’ veil: then the emperor will truly have no clothes.

I shall leave the last words to Aster Crawshaw, an expert in corporate law at Addleshaw Goddard from a Guardian article in 2010:

“There is a very faint legal question mark over the use of vereins by commercial organisations. There are some scholars in Switzerland who have concerns about vereins having an economic purpose … some feel vereins should only be used for voluntary organisations, such as the local church choir, which was their original purpose”

 

 

Sources

Swiss verein, Wikipedia

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http://www.abajournal.com/magazine/article/the_rise_of_the_megafirm

“Exploring a move to a Swiss Verein structure?”, Haley O’Brien, LexisNexis Blog, 2015

http://www.lexisnexis-es.co.uk/blog/2015/02/02/Exploring-a-move-to-a-Swiss-Verein-structure/

“The Advance of Global Verein Firms – Threats and Opportunities”, Tony Williams, WSG Annual Meeting 2014

http://www.worldservicesgroup.com/presentations/928/928_2.pdf

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http://scholarship.law.stjohns.edu/cgi/viewcontent.cgi?article=6694&context=lawreview

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https://www.theguardian.com/business/2010/sep/20/deloitte-touche-tohmatsu-legal-registration-london

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http://www.law360.com/articles/675268/dentons-dq-d-over-verein-conflict-in-gap-patent-case

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http://www.abajournal.com/news/article/dentons_challenges_conflict_of_interest_ruling_claims_its_verein_structure/

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