Capitalising on capitalism

Despite harsh laws and a lack of local talent, Eastern block countries can be a fruitful area for expansion, writes Chris Fogarty.

When the Berlin wall, dividing communist East and free market West, came down in 1989, lawyers were among the first to climb through the rubble and into the former Soviet satellites.

The last nine years have brought mixed fortunes for firms who risked capitalising on emerging capitalism. Poland and the Czech Republic have provided fertile ground for growing international practices. Hungry and Lithuania have offered more spartan returns, while Ukraine, Bulgaria and Romania have potential but hold no immediate promise. Romania and Ukraine in particular, with large populations and promising economies, are being pinpointed by growth-hungry foreign firms.

Experience has taught international firms in eastern Europe that being the first into a new territory reaps the greatest rewards but also carries the highest risk of failure.

This was clearly illustrated in the former Czechoslovakia, where international firms flocked following the Velvet Revolution. Attracted to the new Czech Republic's adoption of Thatcherite economic policies and the expectation of a large workload, some firms got their fingers burnt. Both Nabarro Nathanson and Norton Rose closed their Prague offices in 1995 and 1996 respectively while others, such as US firm Skadden Arps Slate Meagher & Flom had to cut staff numbers.

One lawyer estimates there has also been a 50 per cent drop in the number of US lawyers in the city following the end of US governmental aid encouraging privatisation.

Those left are operating in a sluggish economy with one lawyer describing the stock market as “about as exciting as road kill”.

Things are worse in neighbouring Slovakia where government policy has hampered free market reform.

However, Christopher Smith, Lovell White Durrant head of central and European practice, says that the more than a dozen international firms that are in Prague are far from struggling. He describes 1997 as “the busiest year for us ever”.

Lovells are enjoying a surge in mergers and acquisitions work as economically troubled firms off-load assets. Allen & Overy reports a boom in financial transaction work.

After a initial rush of alliances between international and local firms, followed by a rush of dissolved relationships, Smith says the internal legal market has settled down in the last 12 months.

But there are frustrations about working alongside the Czechs: “Investors have been lost to Poland and Hungary due to the fact that the Czechs just move too slowly,” said Smith.

So convinced is Smith that the Czechs need to enter a Brussels-style EU system (being great administrators but slow governmentally), that Lovells will consider doing pro bono work to help get the country meet the entry requirements.

Another country desperately seeking EU membership is the tiny state of Lithuania. Although its small population makes it an unattractive target for larger firms to set up a base, it has provided an ideal niche for Scottish firm Bishop and Robertson Chalmers.

Partner Rodger Murray, a director of the firm's local operation UAB, says despite having to use resident lawyers and operate through Lithuanian firms, the small-scale venture is worthwhile.

“It has benefits for us being here and not having huge amounts of competition,” says Murray, who reiterates the market was limited in size.

US firm McDermott Will & Emery is also based in Lithuania and Denton Hall has done extensive work in Estonia but Latvia and Belarus remain largely untapped.

Murray says the less glamourous locations can offer opportunities for smaller firms: “A lot of the prizes in countries like Poland and the Czech Republic have already been claimed. I think the less obvious ones are the best.”

Bishops got into Lithuania through an aid programme helping local lawyers following the fall of communism, while London firm Lawrence Graham launched its Bulgarian operation on the back of contacts with the old communist regime.

Shipping partner Imogen Rumbold said its Bulgarian operation Lawrence Graham Koraboimpex based in the Black Sea city of Varna, was building on the work it carried out for the previous communist regime while forming a “mutual co-operation” agreement with local lawyers.

Bulgaria, a civil law country, provides plenty of shipping work but remains an economic basket case, offering no immediate incentive for law firms.

“You're talking about a country with eight million [people]. Ukraine has had the same problems but has 54 million people,” says Rumbold.

Yet while many lawyers see Ukraine as the next Czech Republic or Poland, Altheimer & Gray Kiev office director Jaroslawa Zelinsky Johnson says optimism may be out-pacing reality. “We've been waiting for the explosion to happen for five years. So far there's only four or five firms on the ground.”

No British firms have yet set up in the potentially rich region and those who tried to direct their operations from their Moscow offices found this was “politically incorrect” in the newly independent Ukraine.

After nine years working in the Ukraine it is perhaps not surprising that Johnson is not expecting the economic downturn to end any time soon. “The Ukrainians defy my predictions,” she says.

So far privatisation, mergers and acquisitions and investment bank work has kept firms going in a small but very competitive market. But if the economy does turn, prospects for foreign firms look promising. “Local law firms are out of the league for the most part.” says Johnson, who has employed 12 young Ukraine lawyers.

Romania is another country that promises much for international firms but that has so far only delivered for a few.

“One of the real problems that Romania faces is that the government is always arguing,” says Taylor Joynson Garrett partner Philip Newhouse, who manages the 13-fee earner Bucharest office. “The laws are not particularly well drafted and tend to contradict each other.”

Add to that a Bucharest Bar hostile towards Western firms and things hardly look promising. But Newhouse says the population is well educated and there are investment opportunities while Romania's superb agricultural land is attracting UK farming interest.

Taylor Joynson which, along with Sinclair Roche & Temperley, is one of only a handful foreign firms there, sees the office as a long-term investment rather than a swift earner.

Like Romania, Hungarian lawyers have also shown their disapproval of foreign firms by lobbying for a new law, passed two weeks ago, banning foreign lawyers from practising Hungarian law and forcing them to link-up with a local firm.

But as the implications of the law are studied in the EU, most lawyers on the ground seem relaxed, especially now that foreign firms have been permitted to keep their own name.

Stephen Forster, resident partner at Cameron McKenna's office in Budapest, appears to sum up local lawyers' viewpoint when he says that the new law is not perfect, “but we didn't want to complain and jeopardise what is an acceptable compromise”.

Certainly laws passed last September in Poland allowing only Polish lawyers to hold shares in foreign firms operating there appear to have had little impact, despite strong initial concerns from ex-pat lawyers.

The rule change will come in for existing foreign firms in three years time while firms coming into Poland face the restriction straight away.

Some firms say they will effectively use shadow partners Polish lawyers who have a share in a foreign firm, do not actually work there but enter into exclusive co-operation agreements to get around the law.

That is likely to mean that the hunt for suitable local lawyers will intensify. “Until recently there was no poaching,” says White & Case Warsaw executive partner Witold Danilowicz. “It looks like it's starting.”

Ironically, far from capitalising on the big spending foreign firms, hostile Polish lawyers claim they are robbing them of business.

Danilowicz says only three local firms have the experience and quality to compete with foreign firms. According to Salans Hertzfeld & Heilbronn Warsaw managing partner Dariusz Olbszczuk, that will change with Polish lawyers and firms providing increasing competition.

Olbszczuk believes Poland's expected entry into the EU in the next four to five years will see the shareholder rule scuttled but says many foreign firms will be totally staffed by Poles.

“I think although our name is Salans Hertzfeld & Heilbronn, we will be a purely Polish law firm,” says Olbszczuk.

Despite growing competition between law firms, Poland's reasonably stable government, a well educated population, lack of corruption, “reasonably good laws” and a low wage manufacturing economy provide the ideal ingredients for incoming foreign firms.

But Allen & Overy's managing partner for central Europe Stephen Denyer says new firms may find the going tough because of the resources needed and growing wage bills.

“I think the people who succeeded in Poland by and large were the people who were in early,” he said.

The importance of the region for firms like Allen & Overy is such that their 37-fee-earner office is their third largest, behind Hong Kong and London.

Poland and Eastern Europe are rewarding many of the early risk-takers. Despite perhaps predictably cautious words from firms operating in the area, there is still room for growth and new firms.

For foreign firms have proven that no amount of red tape or hostility can hold back their ambitions of Eastern expansion.