New York Art Law Lawyer & Attorney : Fox Rothschild Law Firm : Theft, Intellectual Property, Institutional Negotiation : Manhattan, New York City

Despite the stock market turmoil, both high-grossing art auctions and high-rolling buyers who wish to keep their identity unknown remain a constant. This raises the following question: would a New York court, prior to filing an actual lawsuit, permit a party claiming to be the true owner of a missing artwork learn the identity of the unknowing buyer who purchased it at auction? As you may expect, the answer is: it depends.     

In In re Peters, 34 A.D.3d 29, 821 N.Y.S.2d 61 (1st Dep’t 2006), the Court stated that a party seeking pre-action discovery must establish: (1) a valid basis for seeking pre-action disclosure to aid in bringing the action (i.e., that it needs the information); and (2) that the party has a meritorious claim.   See N.Y. CPLR §§ 3012(c), 7112 for more on pre-action discovery. Notably, the statute does not require that the source of pre-action discovery be the target of the prospective action. In re Goldline Int’l, Inc., No. 2506/07, 2007 WL 3054163 (N.Y. Sup. Ct., N.Y. Co., Mar. 20, 2007).

New York courts have granted pre-action disclosure, such as depositions and document demands, to determine the identity of a potential defendant in a prospective art recovery action. For example, in Alexander v. Spanierman Gallery, LLC, 33 A.D.3d 411, 822 N.Y.S.2d 506 (1st Dep’t 2006), the Court affirmed the lower court’s decision to permit pre-action disclosure to obtain the identity of the individual or entity that purchased a sculpture allegedly stolen from the plaintiff’s home. The Court implied that pre-action disclosure of this nature is proper when the information is sought to file suit and not to determine if one exists.

However, in In re Peters, 34 A.D.3d 29, 821 N.Y.S.2d 61 (1st Dep’t 2006), the Court was not willing to grant the plaintiff pre-action discovery for this same information. There, the plaintiff was the alleged successor-in-interest to the true owner of stolen artwork. She sought pre-action discovery from Sotheby’s to learn the identity of the unknown person who purchased the subject artwork in good-faith at an auction. 

The In re Peters Court agreed that the plaintiff had a valid basis for seeking this information because she needed it in order to sue the proper defendant in a prospective action to recover the artwork. The Court explained that under New York law, one of the elements of a claim for conversion or replevin against a good faith purchaser for value is the demand and refusal rule. Stated otherwise, a plaintiff must be able to show that she made a “demand” for the return of the art from the good faith purchaser, who then “refused” such a demand. Without knowing the identity of the current owner, the plaintiff would not be able to satisfy her burden.

However, the In re Peters Court disagreed with the lower court that plaintiff had a meritorious claim. Interestingly, even though it was very early on in the litigation and the plaintiff may not have ultimately named Sotheby’s as a defendant in the prospective action, the Court was willing to entertain Sotheby’s defenses to the viability of plaintiff’s suit. Specifically, despite the fact-sensitive nature of the inquiry, the Court was persuaded that the plaintiff had unreasonably delayed in filing suit and that the suit was time-barred.  Therefore, the Court reversed the lower court’s decision to permit pre-action discovery of the unknown buyer’s identity, vacated the lower court’s order, and denied the plaintiff’s application and dismissed her petition for pre-action discovery.

The In re Peters case shows that a potential plaintiff seeking to learn the unknown identity of a buyer at auction in aid of bringing an action has to jump through certain hoops in order to have a realistic shot at pre-action discovery.   

For other commentary about discovering the identity of an unknown buyer, see our previous blog “Confidentiality Agreements Between Art Buyers and Art Galleries are Not Bulletproof.”  

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In Art Valuation under New York law – How many millions would a court assign to Warhol’s Mao Zedong?, we discussed a legal dispute surrounding Andy Warhol’s estate and the applicability of the “blockage discount” under New York law. This blog posting is a continuation of that series. 

The blockage discount is a legal principle for adjusting the fair market value of art when there is a significant volume of art by the same artist at issue. In re Warhol, No. 824/87, 1994 WL 245246 * 1 (Surr. Ct., N.Y. Co. 1994). The In re Warhol court summarized a blockage discount as follows: If an immediate sale of a block of art would depress the market, the value of the block cannot be determined by totaling the fair market value of its individual components as of a specific date. Instead, a percentage discount must be applied, based upon: (i) the nature and number of artworks, (ii) the artist’s marketability, (iii) the stability or permanence of the artist’s reputation, (iv) the likelihood of appreciation or risk of depreciation in the art market and the artist’s work, and (v) how long it would take for the various markets to absorb all of the works comprising the block.   

The In re Warhol court applied the blockage discount to the 4,118 paintings; 5,103 drawings; 19,086 prints; and 66,512 photographs at issue. Other courts applying New York law have used the blockage discount for as few as 400 works. See Grosz v. Serge Sabarsky, Inc., 24 A.D.3d 264, 806 N.Y.S.2d 498, 500 (1st Dep’t 2005). 

In Grosz v. Serge Sabarsky, Inc., 24 A.D.3d 264, 806 N.Y.S.2d 498 (1st Dep’t 2005), the Appellate Division, First Department confirmed the consistent use of the blockage discount principle under New York law. However, the Grosz court questioned whether it was appropriate to apply the discount when only 90 artworks were at issue. The court therefore remanded the case to the trial court for a hearing on this issue. 

Thus, it remains to be seen how low the courts will go in applying the blockage discount, and whether a hard and fast rule is in the near future. 

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The famous portrait of Mao Zedong by Andy Warhol will be put up for private sale in Hong Kong at the end of May 2008 and may go for $120 million.  See, for example, this article. Would a court applying New York law also value it at $120 million? The answer is, as usual, it depends. One factor is whether it is being valued on its own or as part of a large block of Warhols.

As emphasized by the court in a legal dispute regarding Warhol’s own estate, the value of art is “‘inherently imprecise and capable of resolution only by a Solomon-like pronouncement.’” In re Warhol, No. 824/87, 1994 WL 245246 * 1 (Surr. Ct., N.Y. Co. 1994), quoting Morris v. Messing, 48 T.C. 502, 512. For this reason, to ascribe a value to Warhol’s voluminous art assets, the In re Warhol court applied a legal principle referred to as the “blockage discount.” 

At issue in In re Warhol was the amount of legal fees owed to the lawyer for the executor of Warhol’s estate. The lawyer’s contract provided that his fees were a percentage of the value of the estate. The estate included Warhol’s art assets - 4,118 paintings; 5,103 drawings; 19,086 prints; and 66,512 photographs. Not surprisingly, the lawyer’s appraisers valued Warhol’s art assets much higher than the appraiser of the sole beneficiary of the estate – the Andy Warhol Foundation for the Visual Arts. How much higher? The spread was $600 million. 

The Foundation applied a significant blockage discount to the fair market value[1] of the art assets, whereas the lawyer applied none. The court summarized a blockage discount as follows: If an immediate sale of a block of art would depress the market, the value of the block cannot be determined by totaling the fair market value of its individual components as of a specific date. Instead, a percentage discount must be applied, based upon: (i) the nature and number of artworks, (ii) the artist’s marketability, (iii) the stability or permanence of the artist’s reputation, (iv) the likelihood of appreciation or risk of depreciation in the art market and the artist’s work, and (v) how long it would take for the various markets to absorb all of the works comprising the block.   

After finding the analysis of both experts unreliable, the court made its own evaluation based upon the wealth of data provided to it. After arriving at its own fair market value, the court elected to apply a blockage discount that it fashioned (and even applied different discounts to each subcategory). Ultimately, In re Warhol reveals that although there are precise legal principles for art valuation, the ultimate value ascribed by a court may be just as unpredictable as the art market itself.

This posting is part of an ongoing series concerning art valuation under New York law.

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In recent months, the Wall Street Journal (“WSJ”) has reported that art loans are subject to the credit crunch that is affecting the economy-at-large. For example, an article in the April 27, 2008 edition of the WSJ noted that many art lenders, including banks, who typically loan funds backed by fine art, are “reining” in these loans. The WSJ noted that significant question remains about what will happen if these loans go “sour” due to the possibility of the diminishing value of the fine art that is being used as collateral for the loans. 

In a December 30, 2007 article in the Washington Post, Ian Peck, chief executive of the art-finance firm Art Capital Group, was quoted as saying that the art market trails the Dow Jones industrial average and other market indexes by about six to eight months. Since October 9, 2007, when the Dow hit an all-time high of 14164, the average has since dropped to around 13,000 and has remained volatile since that time.

If the art market does go in the direction of the stock market, many banks and lenders may be looking to recover on their loans and the borrowers may be looking to protect themselves from the onslaught of potential litigation.

The 2002 case of Christie's Inc. v. Davis, 247 F.Supp.2d 414 (S.D.N.Y. 2002) may be an indication of what’s to come. There, the court granted summary judgment to Christie’s when it sought to collect on multiple loans made to defendants. The loans were secured by hundreds of pieces of fine and decorative art and antique furniture (the “art”), most of which the defendants kept in their house in Greenwich. After the defendants defaulted on the loans, Christie's filed the action, seeking repossession of the collateral, pursuant to the New York recovery of chattels statute, C.P.L.R. Article 71. The court found that the language of the loan documents permitted Christie’s to foreclose on the art, notwithstanding the fact that the art was worth twice the value of the loan.

Art lenders and borrowers are strongly encouraged to review their rights with an attorney. This is especially true in the current credit crunch.

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One way that the New York legislature has attempted to protect unwary artists is through the enactment of the New York’s Arts and Cultural Affairs Law Section 12.01.[1] This statute is particularly relevant in today’s uncertain economy because it prohibits an art merchant from taking a security interest in an artwork that is loaned to the merchant by the artist, thereby prohibiting the artworks from being subject to the claims of the merchant’s creditors, in the event that the merchant goes out of business and/or files for bankruptcy protection.

The statute provides, in part:

1. Notwithstanding any custom, practice or usage of the trade, any provision of the uniform commercial code or any other law, statute, requirement or rule, or any agreement, note, memorandum or writing to the contrary:
(a) Whenever an artist or craftsperson, his heirs or personal representatives, delivers or causes to be delivered a work of fine art, craft or a print of his own creation to an art merchant for the purpose of exhibition and/or sale on a commission, fee or other basis of compensation, the delivery to and acceptance thereof by the art merchant establishes a consignor/consignee relationship as between such artist or craftsperson and such art merchant with respect to the said work, and:
(i) such consignee shall thereafter be deemed to be the agent of such consignor with respect to the said work;
(ii) such work is trust property in the hands of the consignee for the benefit of the consignor;
(iii) any proceeds from the sale of such work are trust funds in the hands of the consignee for the benefit of the consignor.

For example, in Zucker v. Hirschl & Adler Galleries, Inc., 170 Misc.2d 426, 648 N.Y.S.2d 521 (Sup. Ct., N.Y. Co. 1996), the Court granted partial summary judgment for the plaintiff-artist Joseph Zucker on the basis that the statute expressly precluded the claim by the defendant art gallery that Zucker’s works were subject to the gallery’s security interest.

In plain terms then, in the event of the merchant’s bankruptcy, under New York’s law, an artist’s work should not be subject to the claims of the merchant, the merchant’s estate, or its creditors. Not all states, however, may protect artists the way New York does. If you are an artist, you should find out what state’s law applies to you before consigning your work, and whether or not your works will be protected.

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Many art buyers operate under the belief that a confidentiality agreement with an art gallery is a bulletproof mechanism to preserve the secrecy of their identities. A recent case by a New York Surrogate Court shows that this is a misperception because the law is above these private agreements.     

In Lumerman v. Tunick et. al., No. 0489/05, 2008 WL 920666 (Surr. Co., Westchester Co. Mar. 14, 2008), a New York Surrogate Court ruled that Sotheby’s, Inc. (“Sotheby’s”) and Christie’s, Inc. (“Christie’s”) had to turn over information concerning the identities of buyers, despite confidentiality agreements with the buyers. 

At issue in the case were over 200 of the decedent’s artworks by the famous artist Willem de Kooning. In May 2007, the decedent’s first wife and three daughters (over the objection of the second wife) sued to recover certain of these artworks that had been consigned to Christie’s and Sotheby’s prior to and shortly after the decedent’s death. Among others, the lawsuit named Christie’s, Sotheby’s, and “John Does” as defendants. The John Does referred to persons and/or entities who purchased the subject items from Christie’s and Sotheby’s (the “buyers”). After Christie’s and Sotheby’s refused to identify during discovery the names of these buyers, the plaintiffs filed a motion to compel. Both Christie’s and Sotheby’s opposed plaintiffs’ motion on the basis that confidentiality agreements were in place with the buyers which prevented them from disclosing the buyers’ identities. Christie’s and Sotheby’s also claimed that having to disclose this information would damage their trust-based relationships, threaten the privacy and safety of the buyers, and harm their reputation and business advantage. Christie’s and Sotheby’s also argued that the plaintiffs should first be required to prove that they are entitled to the return of the artworks.

The court rejected all of these arguments, and compelled Christie’s and Sotheby’s to turn over the information requested about the buyer’s identities. The court found that: (i) New York’s C.P.L.R. § 3101, which requires “full disclosure of all evidence material and necessary to the prosecution or defenses of action,” was met because without this information, the plaintiffs would not be able to maintain an action against the buyers - i.e., satisfy New York’s demand and refusal rule; (ii) denying the requested disclosure would increase the chance that the art would be re-sold or moved beyond the jurisdiction of the court; and (iii) proving ownership first would be a waste of judicial resources, because the plaintiffs would still need to know who was in possession of the artworks to satisfy New York’s demand and refusal rule.     

This case presents an important reason why clients should understand that a confidentiality agreement is not impregnable and its enforceability may one day be subject to the discretion of a court.

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The recent chapter 11 bankruptcy of the Salander-O’Reilly art galleries (located on New York City’s Upper East Side) shows that the financial distress of a consignee of art is not always readily apparent.   In today’s credit crunch, sadly, consignors may not recognize how their failure to take adequate steps to protect their interests in art prior to entering into a consignment arrangement may result in tragic consequences should the consignee end up in bankruptcy.

In both In re G.S. Distribution, Inc., No. 331 B.R. 552 (Bankr. S.D.N.Y. 2005) and In re Morgansen’s Ltd., 302 B.R. 784 (Bankr. E.D.N.Y. 2003), aff’d in part, No. 04-CV-0268, 2005 WL 2370856 (E.D.N.Y. Sept. 27, 2005), parties who consigned their goods did not file financing statements to protect their interest in these items. After the consignee ended up in bankruptcy, the consignors fought vigorously to prevent their consigned goods, in the consignee’s possession, from being subject to the claims of the consignee’s general creditors. This is because, as explained by the court in In re G.S. Distribution, Inc., “property acquired under a consignment arrangement, even if it is not paid for, may be subject to the claims of the consignee’s creditors,” and a debtor in possession or a bankruptcy trustee “may be entitled to exercise these rights under the Uniform Commercial Code (“U.C.C.”) for the benefit of the estate and its creditors.” 331 B.R. at 561. 

Specifically, the In re G.S. Distribution, Inc. court explained that if the transaction is a consignment as contemplated by New York’s U.C.C. - Secured Transactions (“New York’s Article 9”), the consignor must ordinarily file a financing statement to protect its interest in the property from the claims of a bankruptcy trustee or a debtor in possession acting on behalf of the estate. Id. at 361. However, if the consignment relationship does not satisfy the definition in New York’s Article 9, the consignor is not automatically free from the claims of the consignee’s creditors. Instead, In re G.S. Distribution and In re Morgansen’s Ltd. explain that the parties’ relationship will be evaluated under New York’s U.C.C. – Sales (New York’s Article 2) and common law principles of bailment to determine whether, in the absence of a financing statement, the consigned goods are subject to the claims of the consignee’s creditors.  

In today’s distressed market, these two decisions are important. These cases show that, in the absence of an enforceable financing statement at the outset of a relationship, a party may later be at the mercy of a court’s ad hoc determination because although the parties may describe the relationship as a “consignment,” the law may treat it differently. This could result in a court order that consigned art is subject to the claims of the consignee’s creditors, and thus, the loss of extremely valuable property.  

If you are considering consigning art, it is important to consider whether a financing statement makes sense for you, and if so, where and how it should be filed, and how often it must be updated. For general information on financing statements in New York, see N.Y. Department of State: Uniform Commercial Code, http://www.dos.state.ny.us/corp/ucc.html. 

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