Muses in Bankruptcy Court: a look at US arts and cultural institutions finding themselves in bankruptcy and out

March 28, 2014

By Lesley Sotolongo

Cultural institutions rely on both public and private funding to keep their doors open, however, public funding has become increasingly more difficult to obtain. For example, in 2013, the National Endowment for the Arts (NEA) with a budget of $138.383 million, awarded 2,153 grants totaling $112.734 million to the arts. On March 4, 2014 President Obama released his fiscal year 2015 budget request of $146.021 million for the NEA, the same amount as the current year’s budget. In response to this announcement, Senior Deputy Chairman Joan Shigekawa stated “[i]n these challenging economic times, it is heartening that President Obama has put forward level funding for the National Endowment for the Arts, allowing the NEA to continue our mission of providing all Americans opportunities for arts participation.” The effects of recent events – such as the government shutdown – has led to budget sequestrations visible throughout the US, as private and public sectors are faced with massive deficits. Consequently, arts and cultural institutions, for profit and nonprofit, that cannot operate within their existing contracts and obligations are finding themselves in Bankruptcy Court.

The requirements under US bankruptcy laws vary depending on the type of entity seeking to file. Common filings for nonprofit applicants are made under Chapter 7 (11 U.S.C.A. § 707) or Chapter 11 (11 U.S.C. § 1109). These sections of the US Bankruptcy Code allow nonprofit organizations to eliminate or repay their debts under the protection of the federal court. Specifically, filing a Chapter 7 bankruptcy allows the entity to liquidate property in order to pay back debt, except for property that is protected by state law. On the other hand, filing a Chapter 11 bankruptcy permits companies, including nonprofits and individuals, to reorganize, cut debt, and continue operating. In other words, Chapter 7 is used to wind down operations while Chapter 11 is used for restructuring purposes. A restructuring plan reorganizes the legal, ownership, operational, or other structures of a company for the purpose of making it more profitable, or better organized for its present needs. All organizations seeking to restructure their debt must offer a valid reorganization plan under the governing bankruptcy law and also receive approval from the bankruptcy judge assigned to the case.  Government owned entities, privately owned businesses and individuals have different filing requirements.

Applicants seek bankruptcy protection for a variety of reasons, but regardless of the motive, bankruptcy filings raise important questions regarding the utility of a bankruptcy filing as an effective means of dealing with outstanding liabilities or debt. Issues unique to nonprofits that may arise in bankruptcy cases can range from the nonprofit’s eligibility to file for bankruptcy to more complex matters concerning what assets are properly included as part of the debtor’s bankruptcy estate. Another concern for nonprofit arts organizations in Chapter 11 cases concerns a workable exit strategy, especially if debt repayment funding depends on donor contributions. The guiding case law on this issue stems from a recent Fifth Circuit decision In re Save Our Springs (S.O.S.) Alliance Inc., 632 F.3d 168 (5th Cir. 2011). In that case, the court affirmed the denial of a nonprofits Chapter 11 plan because “voluntary pledges [from donors] alone are too speculative to provide evidence of [plan] feasibility.”  This is relevant because pursuant to Section 1129(a)(11) of the Bankruptcy Code, a reorganization plan may be confirmed only if it meets the feasibility requirement – that there is a “reasonable assurance” of its success.  The following four case studies illustrate notable art/cultural profit/nonprofit bankruptcies filed from 2007 to now.

Case study – Salander-O’Reilly Bankruptcy

To start, one of the biggest arts related bankruptcies to make the news in the last decade was the Salander-O’Reilly bankruptcy in 2007. Gallery owner, Lawerenc Salander was involved in fraudulent business practices and admitted to selling artworks that he did not own while keeping the proceeds of those sales. He allegedly exchanged the works to satisfy outstanding debts; solicited investments to purchase artworks or shares in artworks that he then improperly resold to other clients; and then failed to inform or pay consigners when their works were sold. The gallery filed bankruptcy with many creditors filing claims. Ramifications of this case were felt throughout the art market, as these fraudulent sales affected private owners, artists, gallerists and auction houses, as well as the gallery creditors. The mess created by Salander even precipitated legislative changes in New York State and an amendment to the Arts & Cultural Affairs Law, N.Y. Arts & Cult. Aff. Law § 12.01 (2012). This amendment affects the consignment relationship, which creates critical new duties and liabilities for art dealers operating on consignment. Most importantly, it makes using any form of agreement drafted under the old law risky, particularly for the gallery or consignee. The amendment was made as an effort to protect artists and their families consigning art in bankruptcy proceedings.

Case Study – The Philadelphia Orchestra  

April 2011 marked the first time a major US orchestra filed for bankruptcy protection. The Philadelphia Orchestra was formed by Fritz Scheel in 1900 and is based at the Kimmel Center for the Performing Arts. The Philadelphia Orchestra’s board of directors voted in 2011 to file for Chapter 11 reorganization due to the organization’s large operational deficiency. The United States Bankruptcy Court for the Eastern District of Pennsylvania’s Honorable Eric Frank reviewed personal and real property assets of the Philadelphia Orchestra, totaling approximately $15.9 million with liabilities to creditors at approximately $704 million. (See Schedules). Ultimately, US Bankruptcy Judge Eric L. Frank approved the association’s reorganization plan 28 June 2012 and the Philadelphia Orchestra was able to emerge from bankruptcy. Specifically, it reduced its orchestra size by about 10% from 105 musicians to 95 and also cut their salaries by about 15%.

Case Study – New York City Opera 

Another important cultural institution filing for bankruptcy under Chapter 11 in 2013 was the New York City Opera (Opera). The Opera was founded in 1943 with the purpose of making opera accessible and as a center for American composers and singers.  By 2011,  The dwindling opera company began facing financial difficulties and ultimately filed in October 2013 an application in United States Bankruptcy Court in the Southern District of New York documenting assets worth $7.7 million and liabilities of $5.6 million. According to the Court papers filed by the Opera, represented by Anne M. Aaronson of Dilworth Paxson LLP, the Opera is evaluating the restrictions on its approximately $4 million endowment fund, generally, protected from creditors. Ultimately, the fate of the Opera rests in the hands of the bankruptcy judge. The New York City Opera serves as an example of the struggle faced by the art community given the fact that the Opera is  one of America’s pre-eminent cultural institutions forced to make the difficult decision of filing for bankruptcy protection in order to remain open.

Case Study – Detroit and the Detroit Institute of Arts

Most recently, the City of Detroit (Detroit) filed Chapter 9 bankruptcy protection on 18 July 2013, with a calculated $18 billion debt. This development set off a ripple effect with adverse impact on the Detroit Institute of Arts (DIA).  In 2003, the DIA was ranked as the second largest municipally-owned museum in the United States, with an art collection valued at more than one billion dollars. Its collection is regarded as one of the United States most significant art collections.

Detroit filed for Chapter 9 bankruptcy, because of its status as a municipality. The threshold requirements for a Chapter 9 bankruptcy petition include i) demonstrating insolvency and a desire to effect a plan of debt adjustment, and ii) negotiating, attempting to negotiate, or establishing the impracticality of negotiating, in good faith with creditors holding a majority of interest in claims.

In light of the significant debts owed by the Detroit to its pension plans and its other creditors, the city considered the option of selling artwork from the DIA in order to climb out of debt. Creditors consider the entire collection to be worth billions of dollars.  Christie’s Inc. conducted an appraisal of the museum’s collection based the report commissioned last July by Detroit emergency manager Kevyn Orr. The report contains 2,773 individual pieces totaling in the appraised value ranging from $454,277,995 to 866,997,240. Notably, all of these works were acquired with funds provided by Detroit over the course of the museum’s history. Christie’s appraisal was made available to the public in December 2013. (See News).

As recently as 22 January 2014 Detroit’s creditors were battling in court for the sale of the art. Bankruptcy Judge Steven Rhodes raised questions about whether he would even allow the sale of the museum’s art to settle city debt, emphasizing that he had not made up his mind on the matter yet.  The public outcry that erupted at the suggestion of selling the collection triggered an immediate response by the DIA. The Detroit Institute of Art announced that it would raise $100 million to help save itself. The museum has reached out to corporate leaders in Detroit that have committed to a multiyear effort to help with fundraising as a way to protect its collection. Private foundations have already pledged $370 million toward the effort. A condition of the deal is that Detroit would relinquish ownership of the museum, and instead, it would be owned by a nonprofit organization, as most large public museums across the country are. This would relieve the city of any future financial responsibility for the Institute while also shielding the institute from future municipal threats.

However, the courts must first approve this plan. On 24 February 2014, Judge Rhodes proposed a hearing to decide whether to approve the city’s plan of adjustment starting on 16 June 2014 and possibly extending to June 17-20 and June 23-27. This timeline for approval of the city’s bankruptcy plan may potentially limit the bickering and force all sides to negotiate and propose concessions.

Conclusion 

The term ‘bankruptcy’ is imbued with stigma, in part because of the embarrassment of having financial woes made public, and also because of the looming threat of closure. Bankruptcy is also dreadful because of the complicated legal proceedings. What is important to remember about bankruptcy is that filing for it may be a helpful and smart move for struggling institutions as it halts all creditor collection activity and legal proceedings in regards to the debt. Like swallowing a bittersweet pill, filing for bankruptcy may be the last resort used to save an organization from permanently closing its doors.  Sadly, not every organization can be saved through the bankruptcy proceedings. New York dance studio, the Dance New Amsterdam Ballet, is an example of this, unable to restructure its debt and was as a result forced to enter a settlement with its creditors and closed its doors on in September 2013.  The public is thus, encouraged to donate to the arts so that similar institutions do not become bankrupt, while arts organizations are encouraged to familiarize itself with US bankruptcy laws.

Sources:

1. See http://www.usatoday.com/story/news/nation/2014/01/22/detroit-bankruptcy-institute-of-arts/4771613/ (accessed March 2014).
2. See http://www.huffingtonpost.com/2011/04/16/philadelphia-orchestra-bankrupt_n_850133.html  (accessed March 2014).
3. See http://www.bbc.com/news/entertainment-arts-19078179 (accessed March 2014).
4. See http://articles.latimes.com/2013/jul/24/entertainment/la-et-cm-nea-funding-20130724 (accessed March 2014).
5. See http://arts.gov/news/2014/president-obama-releases-fy-2015-budget-number-national-endowment-arts (accessed March 2014).
6. See 11 U.S.C. § 1109 (West).
7. See 11 U.S.C.A. § 707(b) (West).
8. See http://www.philly.com/philly/blogs/entertainment/fine_arts/Philadelphia-Orchestra-Association-exits-bankruptcy.html (accessed March 2014).
9. See http://dnadance.org (accessed March 2014).
10. See 57 A.L.R. Fed. 2d 121 (West 2013).
11. See In Re Philadephia Orchestra Association, No. 11-13098 (E.D. Pa. 2011).
12. See http://www.uscourts.gov/FederalCourts/Bankruptcy/BanruptyBasics/Chapter11.aspx (accessed March 2014).
13. See http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a.95n8ZwIPv8
14.  See http://www.lexology.com/library/detail.aspx?g=d2242f36-7bbe-4c28-afc2-283cc5869fee
15. See http://www.artnews.com/2010/07/01/untangling-the-salander-mess/

About the Author: Lesley Sotolongo is a third-year law student at Benjamin N. Cardozo School of Law and may be reached at Lesley.Sotolongo@law.cardozo.yu.edu.

Disclaimer: This article is intended as general information, not legal advice, and is no substitute for seeking representation.