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February 2013
SPENCER’S ART LAW JOURNAL

Can Art Owners, Consigning or Lending Their Art, Protect Themselves in a Bankruptcy Proceeding of the Gallery or Borrower by Specifying Arbitration, and a Choice of Law in Their Consignment or Loan Agreement? Probably Not.

Editor’s Note

This is Volume 3, Issue No. 3 of Spencer’s Art Law Journal. This winter issue contains three essays, which will become available by posting on artnet starting February 2013.

The first essay (Protection from Legal Claims for Opinions...) discusses constitutional First Amendment defenses against legal claims for expert opinion about art—claims which have driven art authentication boards out of existence and seriously chilled public and private scholarly expression.

The second essay (Can Art Owners, Consigning or Lending Protect Themselves in Bankruptcy...) addresses the question of whether an owner can keep himself and his art out of bankruptcy court when the gallery goes into bankruptcy, by imposing his arbitration agreement with the gallery on a bankruptcy court.

The third essay (When Is It Too Late to Recover Artwork You Own...) addresses the question of an owner’s unreasonable delay in claiming art—the very interesting, important, and heavily factual, defense of laches.

Three times a year, issues of this Journal continue to address legal issues of practical significance for institutions, collectors, scholars, dealers, and the general art-minded public.

— RDS

For inquiries or comments, please contact the editor, Ronald D. Spencer, at Carter Ledyard & Milburn LLP, 2 Wall Street, New York, N.Y. 10005, by telephone at (212) 238-8737, or at spencer@clm.com

CAN ART OWNERS, CONSIGNING OR LENDING THEIR ART, PROTECT THEMSELVES IN A BANKRUPTCY PROCEEDING OF THE GALLERY OR BORROWER BY SPECIFYING ARBITRATION AND A CHOICE OF LAW IN THEIR CONSIGNMENT OR LOAN AGREEMENT? PROBABLY NOT.

• • •

Aaron R. Cahn

• • •

This essay is about an art owner who sought to protect himself from the consequences of a bankruptcy by his consignee art gallery. Ordinarily, of course, courts will enforce a contractual choice of law and forum, but apparently not in a bankruptcy proceeding. — RDS

• • •

Aaron R. Cahn, is a member of Carter Ledyard & Milburn LLP’s Insolvency and Creditors’ Rights Group where he often advises on art related matters.

• • •

The art community has been slow to react to the intrusion of modern commercial concepts into a world traditionally ruled by the handshake. But financial difficulties, resulting in such events as gallery bankruptcies and sales by museums of significant portions of their collections, have brought home to all who delight and deal in art the perils inherent in parting with possession of a work. To help protect owners against some of these perils, lawyers who advise clients contemplating consigning or loaning art have built in extra protections in the event of a dispute with the consignee. Such items as arbitration clauses (requiring that disputes be arbitrated rather than the subject of possibly lengthy and expensive court proceedings) and choice of law and forum provisions (requiring that disputes be decided in a the consignor’s home state, province or country, and according to the law of that jurisdiction) can give comfort to a consignor that a legal issue that may arise will not be subject to an unfamiliar body of law in an inconvenient locale.

In many situations, these types of protections work well. But in the context of a bankruptcy proceeding initiated by or against a consignee, enforceability of these protections may not be permitted. The function of a bankruptcy case is to bring together in one forum all the issues relating to the financial condition and future prospects of a debtor, and the US federal policy of ensuring the efficacy of bankruptcy proceedings may sometimes operate to curtail the rights of other parties.

In 2011, this Journal discussed how the failure of a consignor to file a one-page financing statement (form UCC-1) can result in the effective loss of ownership of a work if the consignee files a bankruptcy case.1 In this essay, we review one consignor’s unsuccessful attempt to maneuver around the consequences of this omission.

One of the most notorious art-related bankruptcy cases in recent years was that of Salander-O’Reilly Galleries.2 Salander-O’Reilly Galleries, which was operated in an historic townhouse on New York’s Upper East Side by Lawrence Salander, was a well-known name to collectors and artists alike, regarded as a major force in, among other things, dealing in the works of Old Masters. By 2007, however, the gallery was in bankruptcy proceedings in the midst of accusations of unpaid debts and fraud, including numerous instances of diverting the proceeds of works sold by the gallery, and the facts which came to light eventually resulted in a criminal conviction of Mr. Salander.

The collapse of Salander-O’Reilly was an unwelcome development for Dr. Ronald Fuhrer, an Israeli art dealer who owned Kraken Investments Ltd., a British Virgin Islands corporation with its principal place of business in Jersey, Channel Islands. In 2006, Kraken and Salander entered into a consignment agreement for Salander to sell a piece of artwork owned by Kraken—Sandro Botticelli’s “Madonna and Child.” Kraken was to receive no less than US$8.5 million from the sale of the painting.

The consignment agreement mandated that all disputes between the parties be decided by arbitration in Jersey, and also provided that Jersey law would control any such proceedings. Kraken did not file a UCC-1 financing statement protecting its interest in the artwork. Kraken, as was its contractual right, requested the return of the work at the expiration of the consignment period, but Salander did not comply. Kraken wished to commence an arbitration proceeding in Jersey to enforce the terms of the consignment agreement and declare that it remained the owner of the work, but since the bankruptcy case had been commenced, Kraken was required by bankruptcy law to request bankruptcy court permission to proceed to arbitration.

The stakes for both sides were high. Kraken’s US counsel were, presumably, well aware of the rule, noted earlier, that a consignor who does not file a financing statement runs a significant risk of losing control of the consigned works to the bankruptcy trustee and the estate’s creditors. Accordingly, they sought to enforce the agreement to arbitrate in Jersey, Channel Islands, hoping perhaps for more favorable treatment under Jersey law. The risk to the bankruptcy trustee and the Salander Gallery estate was just as significant; namely, if forced to litigate in a distant forum before a tribunal unfamiliar with American bankruptcy law, they might not only lose rights to a valuable work but also see a flood of similar requests made by other consignors to Salander-O’Reilly Galleries.

The bankruptcy court denied Kraken’s motion, finding that the trustee was not obligated to abide by the provisions of the consignment agreement because the questions presented were central to the operation of the bankruptcy system.3 Kraken then appealed to the district court.

Judge Cathy Seibel of the Southern District of New York affirmed the judgment of the bankruptcy court.4 She noted that while a bankruptcy trustee is in many cases bound by the contracts made by the debtor before bankruptcy, it is not so bound when enforcement of a contract would impede the operation of the bankruptcy scheme.5 Since the ultimate issue between the parties was whether the bankrupt estate or Kraken had superior rights to the Botticelli, and thus whether the work could be sold to satisfy claims of creditors rather than being returned to Kraken, the court held that that determining what is and is not property of the estate is a principal function of the bankruptcy court, and thus should be decided there.

The District Court also determined that its finding that the consignment agreement as a whole was not binding on the trustee negated the choice of Jersey law as governing the rights of the parties. In addition, Seibel found that the bankruptcy court did not abuse its discretion in choosing New York law, as New York was the location of the artwork, the debtor, and the bankruptcy proceedings, among other factors.

Clearly, this was not a happy result for Kraken, and Judge Seibel went out of her way, at the end of the opinion, to offer some measure of verbal comfort (not being able to provide more tangible support) to Kraken. “The Court well understands why Kraken is perturbed, even outraged, by the idea that [Salander’s] creditors may well enjoy the proceeds of a valuable painting concededly owned by Kraken. The law of the state in which Kraken consigned the painting, however, allows for such an outcome where the consignor does not protect itself by filing a financing statement giving notice of the consignment to the consignee’s creditors.”6

The lesson to art owners is clear: the risks of not filing a UCC-1 financing statement for consigned art far outweigh any inconvenience involved in filing one. And while the odds against a dealer going bankrupt may be small, the possibility does exist, and should be guarded against.

New York, NY
January, 2013

Aaron R. Cahn
Carter Ledyard & Milburn LLP
Two Wall Street
New York, NY 10005
Email: cahn@clm.com
Website: www.clm.com

Notes

1 Aaron R. Cahn, A Funny Thing Happened on the Way to the Gallery: A Bankruptcy Fable (or Not), Spencer’s Art Law Journal, Vol. 2, No. 1 (Spring 2011).
2 In re Salander-O’Reilly, 475 B.R. 9, 28-29 (S.D.N.Y. 2012).
3 In re Salander O’Reilly Galleries, 453 B.R. 106 (Bankr. S.D.N.Y. 2011).
4 In re Salander-O’Reilly, 475 B.R. 9, 28-29 (S.D.N.Y. 2012)...
5 See Hays and Co. v. Merrill Lynch, Peirce, Fenner & Smith, Inc., 885 F.2d 1149, 1153 (3rd Cir. 1989).
6 In re Salander-O’Reilly, 475 B.R. 9, 33.

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