The ‘Chinese walls’ technique is still widely used at top firms, especially on private equity deals. Did the great M&S conflict debacle of 2004 really change anything?
It was on 2 June 2004 that Freshfields Bruckhaus Deringer fully realised the importance of serious and comprehensive conflict checks. Instructed by Philip Green to advise on his £9bn takeover bid for Marks & Spencer (M&S), Freshfields had been challenged by M&S adviser Slaughter and May over an alleged conflict of interest by dint of the Fleet Street firm having advised the department store chain on a commercial contract with Per Una creator George Davies.
That Wednesday, High Court judge and former Herbert Smith partner Mr Justice Collins granted Slaughters the injunction it had sought, ultimately knocking its magic circle rival off the bid in favour of Ashurst, despite lead partner Barry O’Brien’s unsuccessful Court of Appeal plea the following day. O’Brien was eventually fined three years later, with the firm footing the bill.
Freshfields claimed the conflict was purely theoretical, and the episode is widely seen in the market as a mountain crafted out of a molehill, given the supposedly minor nature of Freshfields’ previous involvement with M&S. But it is still remembered by big-ticket corporate partners who fear similar reprisals should conflict procedures go wrong.
“That was Freshfields failing to have conflict prevention in place,” says a City M&A lawyer. “The outcome was the very public embarrassment of getting knocked off. They were prevented from acting. Everybody’s a bit more suspicious about these things now.”
Freshfields upgraded its conflict-checking systems later in 2004, but insisted the changes were not related to the M&S experience.
And there has been a wider flight towards more complex conflict checks across the market, especially at international firms where conflicts can go unnoticed without the right processes in place. This is one of the many operational changes that take place when global firms merge.
Yet the incident appears to have done little to ward off firms from using Chinese walls as a prevention for conflicts or confidentiality breaches. Indeed, these seem even to have grown in popularity as firms eye revenues from bidding processes in which a number of companies are tendering. This is perhaps most common for firms majoring in the prime domain of competitive bidding: private equity. Indeed, the concept of the Chinese wall harks back to the late 1980s when banks lent to multiple M&A clients, including private equity houses, bidding against each other to take companies over.
According to Weil Gotshal & Manges London private equity partner Marco Compagnoni, the nature of deals in his sector is such that the practice area’s leading firms would be foolish to minimise their role when one of a number of bidders could end up buying the company or asset.
“Where there is a competitive auction lots of companies will start out needing lawyers,” Compagnoni explains. “As the field narrows, [if you put up an information barrier] you’re not shut out and the clients aren’t shut out either.”
“It happens all the time. We only do it if the client in the engagement letter has accepted you can do it.”
Another brick in the wall
Back at Freshfields, City corporate chief Julian Long does not foresee any reduction in the use of Chinese walls. “We operate M&A parallel mandates, always with the agreement of the client and using Chinese walls,” says Long. “Are we seeing more or less of them? About the same – I certainly haven’t seen any decline in their use.
“The main time we use Chinese walls is on M&A. Parallel mandates were encouraged by clients that wanted their favourite house to look after them. We don’t see any let-up in the market accepting that.”
Perhaps bizarrely, there is little formal guidance. The most recent significant reference to Chinese walls in the legal profession’s regulations seems to be as far back as 1999, when the Law Society Code of Conduct addressed the issue of commercial conflicts and confidentiality in the context of firm mergers. The Law Society began the long task of rewriting solicitors’ conflict of interest rules in 2000, following the key House of Lords judgment in Prince Jefri Bolkiah v KPMG. Although the case centred around conflicts of interest for accountants, the House of Lords decided the same rules applied and, for the first time, gave a judgment which suggested a Chinese wall needed to be “an established part of the organisational structure of the firm” rather than something created ad hoc for a specific situation.
The Lords rejected previous case law, overturning the Court of Appeal judgment in Prince Jefri and finding that KPMG had failed to protect its former client’s confidential information in agreeing to act for another client with an adverse interest.
The decision prompted law firms across the City to examine their conflicts procedures and in 2000 a consultation was launched by the Law Society with the aim of drafting new conflicts of interest rules, which were finally implemented in 2006.
The SRA’s required outcomes in its Code of Conduct demand both confidentiality of client affairs and making a client aware of material information of which the lawyer is aware. Crucially, duty of confidentiality takes precedence over the duty of disclosure and a mandate cannot be taken on without an adequate Chinese wall in place.
Even with this, there is the question of whether clients really know what they are letting themselves in for. One source close to the regulatory framework points out that clients “may be vulnerable” despite Chinese walls, as they may feel pressurised by the firm to agree to their use.
Weil’s Compagnoni puts it in a different way.
“What it points to is the need for an effective and well-run conflict facility in the firm,” he says.
International firms, while more likely to use Chinese walls, face probably the biggest challenge.
“For us, because it’s such a sensitive issue you apply best practice – you don’t just do what the rules say – and you apply that best practice wherever you are,” says Bardell, who recently experienced informational separation on Ithaca Energy’s £203m acquisition of Valiant Petroleum, announced earlier this year.
The corporate partner acted for Valiant but worked on the other side of a Chinese wall from finance partner Jason Fox and senior associate Olivia Caddy, who advised Ithaca’s lenders, Banc of America Securities, BNP Paribas and Bank of Nova Scotia. The situation was made more unusual by the fact that Fox resigned to join Bracewell & Giuliani halfway through the deal.
Pinsent Masons also put up a Chinese wall on the Ithaca deal for its financing role through Edinburgh partner Iain Macaulay and a separate role advising Valiant on due diligence led by Glasgow partner Rosalie Chadwick. Pinsents’ Chinese wall – or information barrier, as lawyers prefer to call it – was one of many examples of fences firms put up as an extra precaution even where not strictly necessary.
Chadwick’s role was not the dominant one on the transaction, which was led for Ithaca by CMS Cameron McKenna corporate partners Gary Green and James Parkes.
Bardell adds: “Sometimes they’re put in place out of an abundance of caution. As a hypothetical example, if you were acting on a sell-side mandate and a bidder came into the data room unexpectedly who you had previously advised in detail, for example on an aborted IPO, you might have a significant amount of information about the bidder that may be relevant to the sell-side client as diligence.
“In those circumstances I’d set up an information barrier so there could be no doubt anyone working on the sell-side didn’t pass on the benefit of anything previously learned about the bidder in the context of the previous instruction.”
Even HSF’s double role on the Ithaca sale is said to be one not every firm would take on.
Some magic circle firms are talked of as being especially open to using barriers. One partner notes a particular magic circle beast’s tendency to “pop up in all sorts of places on a deal” in private equity bidding, but this can cause internal political wrangling. Firms such as Allen & Overy, Clifford Chance and Linklaters, with strong and established banking practices, sometimes need to choose between banking clients and corporate clients, leading to potential tension. Clifford Chance in particular seems to deal with this well.
Two sides to the story
Despite the widespread use of Chinese walls, the logical conclusion – that firms will one day take lead roles on both sides of an M&A deal with a secure barrier in between – seems close to impossible, mostly because of the adversarial nature of opposing corporate roles.
As one senior City partner says, “Chinese walls work effectively when the wall is between two teams attempting to buy the same asset, not when they’re on the buy-side and the sell-side. We’d all love to act on both sides.”
And fierce rivals are also unlikely to play ball, even within the current framework. “I don’t think it would surprise us if Coca-Cola wouldn’t have a Chinese wall with Pepsi,” adds the partner.
Freshfields negotiating a commercial contract for an M&S supplier seems pretty mild in comparison.
Additional reporting by Joanne Harris
Secrets and advisers
The central issue with regard to information barriers is client confidentiality, and the dual obligation of protecting client data and providing them will all available information. Hence the Marks & Spencer debacle.
Freshfields Bruckhaus Deringer is also understood to have erected a Chinese wall for two major M&A deals it has recently been carrying out for a duo of London clients, while Clifford Chance equity capital markets partner Adrian Cartwright declined to comment on whether any such separation was in place for the firm’s lead role advising the underwriters on established client Cinven’s IPO of insurance business Partnership Assurance, which launched this month. Freshfields partners Mark Austin and Adrian Maguire advised Cinven.
Herbert Smith Freehills and Pinsent Masons put up Chinese walls for the takeover of Ithaca as both had roles for distinct parties, but this was merely a particularly careful precaution as the chance of any confidentiality breach was low.