Skip to 0 minutes and 51 seconds SPEAKER 1: On the vast majority of banking deals that I work on, the borrower pays the bank’s legal fees. And it’s been like that since time immemorial, really. But what the powerful sponsors now do, or even the big borrowers, corporate borrowers, they say, if we are paying the bank’s lawyers’ fees, we want to choose who the bank’s lawyers are. And of course that creates some very odd dynamics, because they’re never going to choose a law firm that’s going to give them a bloody nose. So who really is your client?
Skip to 1 minute and 26 seconds And anecdotally, there are lots of stories where the banks feel pretty hacked off that the people that are meant to be batting for them seem to be conceding much more to the sponsor than you would expect.
Skip to 1 minute and 40 seconds SPEAKER 2: I think there is a genuine potential, I only say potential, for ethical conflict if your fees are being paid by a third party.
Skip to 1 minute and 47 seconds SPEAKER 3: I think that the point about the fees being paid by the other side and us being appointed by the other side is probably the main professional area of interest at the moment. It doesn’t necessarily work to our disadvantage, but there is that concern, especially with very powerful borrowers who have maybe got themselves too much leverage with the banks. Some might go a bit too far in terms of accommodating them.
Skip to 2 minutes and 10 seconds SPEAKER 4: We have one very significant client. Well, they’re actually not a client. We have one institution in our capital markets practice which always requires us to act for the underwriters. So they’re never our client, but our relationship is they always refer, they always say to the underwriters, you’ve got to use this particular law firm.
Skip to 2 minutes and 32 seconds SPEAKER 5: Does that present any professional issues or how can you make sure it doesn’t?
Skip to 2 minutes and 37 seconds SPEAKER 4: I’m not sure it presents any professional issues.
Skip to 2 minutes and 40 seconds SPEAKER 5: Independence issues?
Skip to 2 minutes and 42 seconds SPEAKER 4: I think it can get a bit awkward sometimes, if you’ve got a really difficult issue on a deal. And particularly if the borrower or originator, issuer doesn’t see it as a difficult issue and just thinks you’re being difficult. Or one of the underwriters or one of the lenders raises a particular issue, which may be totally unreasonable, but because you’re their counsel you’ve got to represent it and fight for it. Yeah, that can be awkward. I suppose it might cross your mind that unless you handle it properly, you’re not going to get a referral in the future. But I don’t think it changes the way we do it.
Skip to 3 minutes and 20 seconds SPEAKER 6: It genuinely doesn’t change our legal advice. I can say that hand on heart. I know that’s the right answer, but it’s genuinely the right answer as well.
The Case of ‘Shadow Clients’
Read the below information on ‘shadow clients’ from Steven’s research and then watch this video in which members of Birmingham Law School read out from the transcripts of interviews Steven has conducted with corporate finance lawyers over the last three years.
One particular example from Steven’s research illustrates how market practice may develop within particular practice areas and which has the potential to compromise lawyer independence. This example is the situation in which a borrower appoints the lawyers to act for the bank from which it wants to borrow money, often some time before the lender bank is itself chosen. This is not a problem confined to the UK. At the start of 2016, Andrew Ross Sorkin, author of Too Big to Fail, wrote in the New York Times about concerns over the appointment of “designated lender counsel” in the US. He said:
“Think about it this way: It is, in effect, the equivalent of your employer giving you an employment agreement and telling you that the only lawyer who can look it over is the one the company has retained.”
In his work, Steven (and his co-author, Claire Coe) call this the “shadow client” problem. This situation arises because borrowers typically pay the banks’ legal fees and so feel justified influencing who they instruct to act as lawyers for the bank. In this situation, the borrower becomes, in effect, a law firm’s ‘shadow client’ with significant influence over the law firm’s appointment, remuneration, and potentially the scope and substance of its work, but without (in theory) direct instruction. The borrow is not the client of that law firm (the bank is the client), but the borrow pays that law firm’s legal fees and chooses which law firm which act for the bank. This relationship is represented by the diagram below:
This ‘shadow client’ situation raises several issues relating to independence. Critically, the interviewees said that while this practice has been in existence for decades, it is becoming increasingly common for borrowers to appoint the law firm that will advise the bank well before that lender bank has been chosen. This means that the scope of that law firm’s role and the terms of its engagement are agreed with the borrower, instead of with the bank that will ultimately be the law firm’s client.
This point does not require belabouring, but the law firm acting for the bank is potentially motivated more by satisfying the borrower on the other side of the table – because that is where the next deal will come from – than by satisfying his or her client. Firms may also potentially take instructions on which pieces of advice to give, and which points of law to take, from the other side.
In the video you will hear what the lawyers Steven interviewed had to say about this practice. Reflect on any new information or ideas that you have come across, then share your thoughts in the discussion area.
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