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Viability and Feasibility: How much is an Art Museum Worth?

October 8, 2014

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By Elizabeth Lash, Esq.

Who can say how much a piece of artwork is worth?  Who owns public art?  In one particular case, that of the Detroit Institute of Art (the “DIA”), these questions were not merely academic or philosophical.

Over the past year or so, the possible answers to these questions were argued in countless appraisal reports, legal briefs, journalistic commentary, and, since this past September, hearings presided over by a bankruptcy judge.  At the heart of this debate lay the fate of the art museum in question–the DIA and its collection of more than 60,000 works, consisting of pieces from almost every continent and time period, from antiquity through today.

As one of the top six museums in the country, with an annual operating budget of about $32 million, situated in one of the most financially challenged municipalities in the country, the DIA looked like the answer to everyone’s prayers since the City of Detroit (the “City”) went into bankruptcy last year.  Primarily, most parties involved wished to sell or collateralize the DIA’s collection to repay debts–either that of private creditors, or for City retiree pensions and capital projects.  The City stood alone in attempting to use the value (without a sale) of the DIA as part of its proposed “grand bargain” to exit bankruptcy.

Specifically, the City faced off against, among others, major bond insurers, Syncora Guarantee, Inc. (“Syncora”) and Financial Guaranty Insurance Co. (“FGIC”), City retirees, and hedge funds, in its plan to transfer the ownership of the DIA back to its original owner, the DIA Corp., a nonprofit charitable corporation, in exchange for $816 million in funding from the State of Michigan (the “State”) and other private donors, for the City to use to offset City retiree pension reductions.

While much of the contentiousness in this dispute has been ameliorated since Syncora, the largest and most vociferous objector to the “grand bargain,” along with City retirees, reached potential settlements with the City, not every issue is quite settled yet.  The remaining bond insurer, FGIC, and some hedge funds continued to fight the City on its plan until recently (although FGIC is now in closed door talks with the City), so if the deal falls through, the issues raised could still pose barriers to an approval of the City’s proposed plan by the presiding Judge Rhodes.    

To understand whether and how the DIA was proposed to be utilized, it is helpful to understand how municipal bankruptcy works (as opposed to corporate bankruptcy).  An ordinary corporate debtor can be forced to sell its assets to satisfy its creditors under the “absolute priority rule”. (So, as in this instance, a corporate debtor could ordinarily have been forced to liquidate the DIA’s collection to repay its bondholders first.)  Municipalities, however, cannot be so forced, because such a decision by a branch of the federal government could otherwise infringe upon the Tenth Amendment, i.e., upon a state’s ability to govern its internal affairs.  Instead, a bankruptcy judge is limited to deciding whether a municipality is eligible to declare bankruptcy and whether its plan of debt adjustment is fair and equitable, as well as feasible. (The judge also oversees implementation of the plan.)

For Judge Rhodes to confirm the City’s plan, he must determine that the proposed plan is fair, equitable, in the best interests of creditors, and feasible.  Whether a plan is in the best interests of creditors could be met by a showing that the amount to be received by creditors under the plan is all they could reasonably expect given the City’s circumstances, including its ability to impose additional taxes or cut services (although some courts simply require a municipality’s plan to be better than the alternative–i.e., if bankruptcy were to be dismissed and creditors were not repaid at all).  And in this case, the alternatives are quite limited as far as raising taxes–the City has testified that it only collects 50% of its property taxes, and dares not raise its taxes any more.

As to whether a plan is feasible?  That would be a plan that would allow a debtor to repay its pre-petition debt while continuing to provide essential government services.  Some observers have commented that Judge Rhodes laid the groundwork throughout September’s hearings to demonstrate that selling off the DIA and its collection would undercut the potential viability of the City in exiting bankruptcy–which may indicate which way he would veer when deciding to approve the City’s plan.   

But regardless of whether the artwork should be sold to repay the City’s debts–could it have been sold?  The ownership history of the DIA is a bit tortured when you begin reviewing the facts.  The DIA began its life via legislative fiat as a “public art institute,” known as the Detroit Museum of Art (“DMA”), to be managed by a nonprofit charitable corporation (the “DIA Corp.”), who could not sell or dispose of the DMA’s collection.  For some time, the City funded the DMA with taxpayer monies, but this was not looked upon favorably by the state’s highest court (and, one assumes, the taxpayers).  To resolve this issue, the state legislature had to pass another law to permit the DMA to transfer some of its collection to the City, and the City in turn had to create a municipal agency (the Arts Commission) to operate the DMA –and, of course, to receive taxpayer money.

When public funding dried up (read: i.e., the City and the State ran into some small financial issues), the DMA (now known as the Founders’ Society), was asked to come riding to the DIA’s rescue.  This was accomplished via an operating agreement, executed by the Founders’ Society and the City, on behalf of the Arts Commission.  The deal was that new pieces acquired by the DMA would be owned by the DIA (i.e., the City), while pieces currently owned by the DMA would continue to be owned by the DMA.  (The Founders’ Society still owned some of the artwork at the DIA, since not all pieces had been transferred to the City–not confusing in the least!)  The DMA agreed to run the operations and pay for the costs of the DIA.  Further, the legislature, in 2012, passed a law permitting the levying of property taxes to fund the DIA, and some counties agreed to use their property taxes to do just that.

There was, however, one issue which was not addressed by the operating agreement, which was what would occur in bankruptcy?  (One could argue that such a circumstance could reasonably have been foreseen, considering the purpose for the operating agreement, but we won’t quibble over that one.)

The Michigan Attorney General came out with an opinion, just prior to the entry by the City into bankruptcy, that the DIA’s collection could not be sold to satisfy the debts of the City, deeming the DIA and its works to be held in charitable trust for the people of the state of Michigan. (Even if it was nowhere stated that this was so.)  Such an opinion was key to avoiding a sale, as property held in trust is not considered an asset of a bankruptcy estate.

However, despite the issuance of the legal opinion, considering the history of this institution, the issue may not have been so clearcut.  Syncora, in fact, attempted to subpoena the Attorney General for documents related to the issuance of this opinion, and it was likely that this issue would have been further litigated, had Syncora not decided recently to settle with the City.

Besides the question of ownership, the question that simultaneously had to be answered was how would the art be valued, and by whom?  If the art could be sold in bankruptcy, then who would buy it, and for how much?  Would selling it in liquidation devalue the work, or would the collection still attract top dollar?  And if the art could not be sold, because the City owned the collection, but would only be used by the City to satisfy other obligations, how much should the collection be valued at then?    

Valuations of the art varied wildly, depending on who was valuing it and for what purpose.  For instance, Christie’s Inc., the auction house, valued the DIA’s collection between $454 million and $867 million, a figure which some claimed was artificially low merely to support the City’s proposed plan. A city-commissioned report valued the collection much higher ($2.8 to $4.6 billion), but estimated that in liquidation, the collection would only fetch between $850 million and $1.8 billion.  Some appraised the entire collection at close to $2 billion, and at least one prospective investor was prepared to bid $1 billion or more just for key pieces in the collection.   Finally, another report, commissioned by the bondholder FGI, estimated the value of the collection at $8 billion.

While this may no longer matter, since many of the parties have already agreed to the City’s plan (which does not count the DIA as an asset in bankruptcy), nonetheless, one can be sure that FGIC used this as a bargaining chip to get more from the City, since a showing of an artificially low valuation could have upended the City’s proposed plan.   

As we watch the hearing move forward with the remaining players (FGIC and others), the lens through which to read the news about the proposed settlement(s), whether they relate to the DIA or not, are what is considered fair, equitable, in the best interests of the creditors, and feasible.  In California, the decision was made to put pensions ahead of bondholders, with the result that the cities can no longer borrow; in Rhode Island, the pensions had to take steep cuts along with bondholders, and the city was able to keep borrowing, but at a steep price to its retired police and firefighters.  In this case, one would hope that it would be fair and equitable for the DIA to remain as is, safe from the reaches of the bankruptcy court, and it is likely so–but we shall see.   

Sources:

About the Author: Elizabeth R. Lash, Esq., is with Kroll Associates, Inc. (formerly of Lash & Associates, LLC, where she worked as a consultant on commodities consulting and regulatory issues).  She currently drafts, reviews, and negotiates agreements relating to cyber security and data breach notification.DISCLAIMER: This article was prepared by Ms. Lash in her personal capacity; the opinions are the author’s own, and do not reflect the view of Kroll Associates, Inc. or of its affiliates.

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