Trouble Valuing Donated Art for Tax Purposes December 2010
Ronald D. Spencer
Buyers’ Rescission Rights for High Value Art Purchases - Spreading the Risk December 2010
Editor’s Note
This is Volume 1, Issue No. 3 of Spencer’s Art Law Journal. This issue contains three essays, which will become available by posting on Artnet, starting December 2010.
As noted in Issue numbers 1 and 2 of this Journal, the legal structure we call art law (an amalgam of personal property law, contract, estate, tax and intellectual property law) supporting the acquisition, retention and disposition of fine art, often fits uneasily with art market custom and practice. The result is that 21st century art market participants are frequently unsure of their legal rights and obligations.
The goal of this Journal is to promote discussion of art law legal issues for lawyers and nonlawyers alike, so as to provide greater transparency, stability and predictability.
The two essays in this Winter Issue continue to deal with two core issues for the ownership of visual art -- authenticity and title (who created it and who owns it?). The first essay looks at the ownership risk involved in entrusting your art to a third party for sale, conservation, framing, etc., and the coverage of your fine arts insurance policy for an "entrustment" loss of title. The second essay deals with the difficult process of valuing art for tax purposes. The last essay addresses protection for the art buyer against post-sale changes in expert consensus on attribution.
Three times a year issues of this Journal will address legal issues of practical significance to collectors, dealers, scholars and the general art-minded public.
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
ENTRUSTMENT, THE HIDDEN TITLE RISK OF LEAVING YOUR ARTWORK IN THE CARE OR POSSESSION OF OTHERS -- WILL YOUR FINE ART INSURANCE COVER YOUR LOSS? PROBABLY NOT.
Elizabeth C. Black
This essay is about the risk of losing your artwork after entrusting it to an art merchant (dealer, restorer, framer, etc.) who then sells the artwork, without your permission, to an unsuspecting buyer. You will likely not be able to recover the artwork from the buyer and your fine arts insurance policy will probably not cover your loss.
-- RDS
Elizabeth C. Black is an associate in the litigation department at Carter Ledyard & Milburn LLP and has assisted individuals, galleries, and foundations in a variety of art-related matters.
Imagine a young woman walking down Madison Avenue in New York City, casually window shopping the neighborhood’s galleries. A painting catches her eye and she steps into the gallery to inquire. She might ask some questions about the artist, the style, and the price. But is she going to ask whether the painting is actually owned by the gallery, or by a consignor to the gallery, or whether the painting has any encumbrances or UCC filings against it? Almost certainly not, and of course this would not be required or expected of a potential buyer -- but why?
Assume the woman purchases the painting. A few days later she takes it to a framer, who also happens to sell some paintings and other artwork at his shop. She leaves the painting with him to be framed, but when she comes back to retrieve it a few weeks later, he tells her he sold it to someone else. Now what? Can she get her painting back?
In the United States, the Uniform Commercial Code ("UCC"), adopted by all U.S. states, governs the sale of tangible personal property such as art. The purpose of the UCC is to facilitate commerce and, in general, the free trade of goods. To achieve this goal, the UCC is generally very protective of good faith purchasers. For example, under the Code’s "entrustment doctrine," when an owner of property entrusts goods to a merchant, defined by the UCC as someone "who deals in goods of that kind"(FN 1) (e.g., an art dealer), the dealer can transfer all of the owner’s rights -- even if the owner did not authorize such a transfer -- to a "buyer in the ordinary course of business." UCC § 2-403(2).(FN 2) A buyer qualifies as a buyer in the ordinary course if he can show that he acted "in good faith and without knowledge that the sale to him [was] in violation of the ownership rights" of a third party, and that the transaction was made "in ordinary course, from a person in the business of selling goods of that kind." UCC § 1-201(9). This is not a hard standard to meet.
"Entrusting" is also defined broadly to include "any delivery and any acquiescence in retention of possession regardless of any condition expressed between the parties to the delivery or acquiescence and regardless of whether the procurement of the entrusting or the possessor’s disposition of the goods [has] been such as to be larcenous under the criminal law." UCC § 2-403(3). The reason for the entrustment to the dealer is irrelevant to the analysis -- any time an owner leaves goods in the possession of a dealer, for any reason, the entrustment doctrine applies. This is true even if the owner did not know at the time of the entrustment that the dealer was in fact a dealer. UCC § 2-403(3).(FN 3)
A classic example of the operation of the entrustment doctrine occurs where an owner consigns a painting for sale at a gallery, instructing the gallery that the painting should not be sold for less than a certain amount, and the gallery then sells the painting for less than the owner had instructed. Although the owner has a claim for breach of his contract against the gallery, the owner does not have any recourse against the buyer to reclaim his painting (even if it was sold in clear breach of the agreement between the owner and the gallery).(FN 4)
Most cases are not this simple, however, and the entrustment doctrine can appear where one least expects it. "Entrustment" generally includes any kind of delivery or acquiescence in a merchant or dealer’s possession of goods. Collectors often leave artwork in the possession of others -- to be appraised or restored, for display, or for general safe keeping, all of which may qualify as "entrustment" under the UCC. If the recipient of the artwork is also a part- or full-time dealer, the entrustment doctrine will come into play. For example,an owner might deliver a painting to a conservator for conservation. If the conservator also happens to be a dealer who regularly sells paintings, the entrustment doctrine will likely apply. Under such circumstances, the owner would not have a claim against the buyer for return of his painting (but, of course, would have a claim for damages against the conservator for breach of contract).
Owners of artwork also often choose to display their artwork at galleries, museums, or in private collections. This too can be considered an entrustment in cases where the entrustee is also a dealer or occasionally sells artwork. For example, in one case from Rhode Island, a corporate owner of several paintings had left them on display at an artist’s home. The artist subsequently sold the paintings to a third party without the owner’s knowledge or permission. Because the artist was "well-known" as an artist, collector, and part-time dealer, and because the good-faith purchaser was not on notice of the paintings’ true provenance, the court held that the paintings’ owner could not recover the painting or monetary damages from the third-party purchaser.(FN 5)
The primary exception to the entrustment doctrine’s rule giving title to the buyer is that under U.S. law a buyer cannot obtain good title from a thief. The difficulty in establishing this exception is that the owner will likely have to prove that the art was stolen from him; where an owner has voluntarily left his goods in the possession of another this will be difficult. Consider, however, the recent New York case of Alexander v. Spainierman Gallery LLC et al.,(FN 6) in which the owner of a Degas sculpture left the sculpture with an antiques dealer for authentication. Without authorization, the dealer then sold the sculpture to a third party. The court ultimately held that the entrustment doctrine was inapplicable, its analysis turning on the fact that the dealer had pled guilty to the theft of the sculpture, and thus could not convey good title to the sculpture. Had the dealer not pled guilty to theft, this court almost certainly would have reached a different outcome and the owner would have lost the painting.
"Theft," however, is defined specifically under the law and differs from other non-criminal acts such as "conversion," which is any act that deprives someone of his property without his consent. Even in cases of conversion, the entrustment doctrine is very generous to good-faith purchasers. As an owner, having a written consignment, repair, or appraisal agreement is important, but a written agreement alone is generally not sufficient to protect the owner’s rights to a work. If a gallery sells artwork in violation of a consignment agreement, the original owner will have a claim for breach of contract against the gallery, but will not be able to recover the artwork from the buyer. Of course most owners of fine art have insurance policies, often so called "fine arts" policies. With no recourse against the buyer and assuming, as is often the case, that the gallery is insolvent or bankrupt (such that the contract claim against the gallery would not make the owner whole), the owner turns to her fine arts insurance policy. Unfortunately for the owner, she will likely not have insurance coverage for the loss, even under "all risk" policies.
Some insurance policies expressly deny coverage based on conversion or losses stemming from entrustment. The typical so-called "dishonest acts" exclusion excludes coverage for dishonest acts by the insured and "anyone entrusted with the property." Even those policies that do not have a dishonest acts / entrustment exclusion may not cover title to art that has been lost following an entrustment.
In a 2007 case from an Illinois District Court, Frigon v. Pacific Indemnity Co., the court held, probably erroneously, that an "all risk" insurance policy did in fact cover an owner’s claim for loss where the owner had consigned several paintings to an art gallery and the gallery had sold them for less than the consignment agreements specified, then failed to pay the owners.(FN 7) Because the gallery was insolvent, the Frigons sought compensation from their insurer. In concluding that the insurance policy in question covered losses from conversion, the court found that "As far as plaintiffs are concerned. . . the conduct of the Gallery toward their paintings is no different than had the Gallery taken the paintings on consignment and destroyed them. The fact that the Gallery may owe plaintiffs the value of the lost paintings is no more significant than the fact that a thief would owe the victim of his theft the value of stolen property."(FN 8)
The Frigon holding likely goes too far -- while the Frigons had a breach of contract claim against the gallery, it is not clear that the court was correct in its conclusion that the gallery "converted" the paintings. Conversion is broadly defined by state law such that a party who properly receives possession of property, for example through a loan of the property, may lose the right to continue to hold the properly when the lender demands its return. But in a situation such as that presented by Frigon, the new owner, as a buyer from a merchant entrusted with the property, is certainly not liable for conversion. Prior to any demand for the property’s return, the UCC gives a dealer the right to pass title to property voluntarily delivered to him for sale on consignment. The only possible "conversion" in this scenario is the dealer’s improper retention of the proceeds of a legal sale, but even that makes no sense. The insured property itself was not converted by the dealer. And if we say the dealer converted the proceeds, how is that different from the original owner selling her art directly (without a consignment or entrustee involved) to a buyer who does not pay -- clearly a business bad debt, not a conversion? Frigon thus represents an ordinary breach of contract claim, reflecting the common scenario where an item is sold on credit and the buyer does not pay the agreed-upon price. Most insurance policies, including "all risk" policies, would probably not cover such a claim.
This issue came up again in a 2009 case from New York, Zurich Am. Ins. Co. v. Felipe Grimberg Fine Art.(FN 9) There, the Second Circuit Court of Appeals held that an insurance policy did not cover a Botero painting that an owner had delivered to a dealer with the intent to sell it to that dealer. The dealer never paid for the work and subsequently disappeared with the painting. The court held under UCC section 2-401 that title had passed to the dealer at the time of physical delivery and, similarly, under the insurance policy, the painting did not fall under the definition of "property insured" because "‘the seller’s insurable interest in goods usually ends with their delivery to the buyer no later than the time of delivery.’"(FN 10)
A similar issue is currently pending in Philadelphia Museum of Art v. AXA,(FN 11) a case in which the Philadelphia Museum of Art is challenging its insurer’s refusal to cover the loss of paintings that the Museum agreed to sell on consignment, but for which the Museum never received any payment from the (subsequently bankrupt) consignee gallery. The insurer refused to cover the loss because the Museum had "voluntarily parted" with the paintings and "the gallery’s failure to remit any proceeds . . . or their failure to return the consigned artworks represents a breach of contract," which is not a "fortuitous" physical loss that would be covered, but rather "a financial loss resulting from the breach of contract."(FN 12)
Thus, a fine arts policy insurance claim for lost title due to an entrustment may result in a denial of coverage. You should be sure you always know the location of your artwork, who has possession of it, and whether or how it is being displayed (e.g., is it listed for sale?). Consignment agreements often run for years and artwork may be moved between various locations as a series of consignments from your dealer to other dealers (whose identity is not known to you) over the course of several years. The more informed you are about these re-consignments, the more likely you will be able to protect your interests.
New York, New York
December 2010
Elizabeth C. Black
Carter Ledyard & Milburn LLP
Two Wall Street
New York, NY 10005
email: black@clm.com
website: http://www.clm.com
NOTES
(1) The UCC defines a "merchant" as "a person that deals in goods of the kind or otherwise holds itself out by occupation as having knowledge or skill peculiar to the practices or goods involved in the transaction or to which the knowledge or skill may be attributed by the person's employment of an agent or broker or other intermediary that holds itself out by occupation as having the knowledge or skill." UCC § 2-104(1).
(2) "Any entrusting of possession of goods to a merchant who deals in goods of that kind gives him power to transfer all rights of the entruster to a buyer in ordinary course of business." UCC § 2-403(2).
(3) The entrustment doctrine does not apply, however, where the entrustee is not a merchant. See Porter v. Wertz, 53 N.Y.2d 696, 698 (1981) (noting that the UCC entrustment provision is "designed to enhance the reliability of commercial sales by merchants … while shifting the risk of loss through fraudulent transfer to the owner of the goods, who can select the merchant to whom he entrusts the property. It protects only those who purchase from the merchant to whom the property was entrusted in the ordinary course of the merchant’s business").
(4) See, e.g., Brown v. Mitchell-Innes & Nash, Inc., No. 06 Civ. 7871(PAC), 2009 WL 1108526 (S.D.N.Y. April 24, 2009) (owner had no claim against purchaser who bought painting from dealer in breach of consignment agreement).
