Assets to Auctions: The Role of Art in Bankruptcy Proceedings

March 19, 2024

Debtor's Prison, 1840 Paul Gavarni, French, 1804-1866 Lithograph printed in black ink on wove paper Image: 8 1/2 × 7 7/8 inches (21.6 × 20 cm) Sheet: 14 × 10 3/4 inches (35.6 × 27.3 cm) Gift of Mrs. Virginia Booth Vogel

By Iris Ziwei Che

In the world of financial instability, the U.S. Bankruptcy Code serves as a source of hope, offering structured pathways for recovery and solvency. Navigating the complexities of bankruptcy law reveals a multifaceted system carefully crafted to address the financial troubles of individuals, businesses, cities, and non-profits alike. This article explores the role of law in balancing debt resolution with economic value preservation, through an analysis of significant bankruptcy cases. These include the financial failure of Lehman Brothers, Paddle8, Detroit, and New York City Opera, as well as Salander-O’Reilly Galleries’ legal disputes, and controversies involving art dealer Lisa Schiff. Through these cases, this article dissects how bankruptcy law acts both as a lifeline for those facing severe financial difficulties and as a way to redistribute assets while ensuring creditors are treated fairly.

Bankruptcy Basics

The Federal U.S. Bankruptcy Code offers a legal framework for addressing financial distress for both individuals and entities. Key chapters of this code include Chapter 7 (governing individual liquidation) and Chapter 11 (governing individual and corporate reorganization) tailored to different options for entities facing bankruptcy.

Chapter 7, often referred to as ‘liquidation bankruptcy’, is designed primarily for individuals and businesses that do not have the means to pay off their debts. Under this chapter, a trustee is appointed to liquidate the debtor’s non-exempt assets and distribute the proceeds to creditors, effectively discharging the debtor from most debts.

Chapter 11, alternatively known as ‘reorganization bankruptcy’, primarily caters to businesses, allowing them to restructure their debts while continuing their operations. This chapter is notable for its flexibility, enabling companies to reorganize their financial structure and operations to return to profitability while maintaining control over their assets by allowing for a three to five-year plan to pay previously-acquired debts. .

Additionally, the Bankruptcy Code encompasses a special provision for municipalities, known as Chapter 9. This chapter enables financially distressed municipalities to reorganize their debts while considering the unique nature of public entities and their obligations to constituents. A critical component within these frameworks is Section 363, which guides the sale of assets in bankruptcy. It allows the debtor to sell property “free and clear” of liens, claims, and encumbrances, often leading to more efficient and profitable asset liquidation.

Local bankruptcy rules, such as New York’s Rule 1007, supplement the federal bankruptcy provisions by addressing specific procedural requirements within their jurisdiction. For instance, Rule 1007 in New York outlines detailed procedures for filing lists of creditors and requirements for debtor’s statements, ensuring compliance with both local and federal bankruptcy laws. These local rules play a vital role not only in smoothing the functioning of bankruptcy proceedings but also by tailoring the federal framework to the specific needs and legal nuances of each jurisdiction.

The Bankruptcy of a Corporation – The Case of Lehman Brothers

Lehman Brothers, once the fourth-largest U.S. investment bank, filed for Chapter 11 bankruptcy on September 15, 2008.^[1] At the time, the company reported $639 billion in assets.^[2] A later reorganization plan estimated that about $50 billion in assets could be recovered.^[3] Among these assets, a significant amount of corporate-owned artwork was among the assets pending auction. In early November 2009, Freeman’s auctioned the first group of about 280 corporate-owned artworks.^[4] The auction raised approximately $1.3 million, twice the expected amount.^[5] Later in 2009 and in February 2010, Freeman’s hosted two more auctions of Lehman’s collection, featuring paintings, sculptures, and prints. In the fall of 2010, Sotheby’s sold more than 400 works from Lehman’s collection, raising over $12 million.^[6] The sale featured pieces like Richard Prince’s 2003 Joke Painting on gatorboard, a turquoise cabinet by Damien Hirst, a painting by famous Chinese artist Liu Ye, among others.^[7] The money raised was used to pay off the corporation’s debt to secured creditors.

The liquidation of the Lehman Brothers brokerage unit concluded on September 28, 2022. All 111,000 of Lehman’s customers were fully repaid the $106 billion owed to them, and secured creditors received full payouts. Unsecured creditors recovered $9.4 billion.^[8]

The Bankruptcy of a “Consignee” – Paddle8

Paddle8, founded in May 2011, aimed to be a leading online marketplace for contemporary art auctions, focusing on the middle market with artworks priced between $10,000 and $100,000.^[9] By 2016, it had raised $44 million in funding over three rounds.^[10] Despite its rapid annual growth, Paddle8 had never turned a profit and relied on debt financing for its operating expenses.

In 2020, Paddle8 filed for Chapter 11 bankruptcy protection amid allegations of misusing funds from auctions. Its creditors included non-profit organizations and celebrities.^[11] Notably, Anthology Film Archives, founded by Jonas Mekas, sued Paddle8 for withholding funds from a benefit auction held in November 2019.^[12] Other creditors were the Bieber couple, Jay Z’s Shawn Carter Foundation, and the Rema Hort Mann Foundation.^[13] After the resignation of almost the entire management team, the court appointed an independent trustee, and the company was liquidated, including the sale of its intellectual property assets.

A significant legal issue in such situations is the risk of “secret liens.”^[14] Secret liens occur when a consignor (the owner of the goods) provides items to a consignee (the seller) but where the ownership rights are not properly disclosed. If this happens, goods that are still owned by the cosigner might be incorrectly included in the consignee’s bankruptcy estate and used to pay off the latter’s creditors. Consignors’ actual knowledge of the consignment arrangement can preclude the consignee from claiming a superior interest in the consigned goods. Fortunately in Paddle8’s case, there was no technical evidence suggesting that such a “secret lien” was created.

The Bankruptcy of a City – Detroit

Detroit’s filing for Chapter 9 bankruptcy protection in July 2013 marked the largest municipal bankruptcy in U.S. history. This brought attention to the Detroit Institute of Arts (DIA), which was owned by the city since 1919 and possessed a valuable art collection. DIA considered selling some of its collection to help cover part of the city’s $18 billion debt.^[15]

A pivotal debate arose: whether the city could legally sell its artworks or if it was obliged to preserve them for its citizens, who could potentially be deemed co-owners. Fortunately, this dilemma was avoided as DIA raised over $800 million, including $330 million from philanthropic foundations and $200 million from the state of Michigan, thus preventing the sale of its artworks.^[16] DIA’s operations were later transitioned to an independent charitable trust. The city’s bankruptcy plan was eventually approved in November 2014, eliminating $7 billion worth of debt.^[17]

Bankruptcy of a Not-Profit – The New York City Opera

The New York City Opera, founded in 1943 and known as “The People’s Opera,” aimed to offer innovative and affordable opera experiences. Besides ticket sales, its income relied on an endowment and contributions.^[18] The Opera filed for Chapter 11 bankruptcy in 2013 after an unsuccessful fundraising effort and an accumulated $44 million deficit.^[19] Significant losses included a structural deficit since 2003 and endowment losses in 2008.^[20] Creditors ranged from the New York City Ballet to former chorus members to ticket holders for canceled shows.^[21]

In October 2013, the general manager filed a voluntary bankruptcy petition.^[22] There was no request for a trustee or examiner, and no official committee was appointed. The Opera’s assets included a $4.5 million endowment and expected bequests.^[23] Plans included selling all its inventory and its thrift shop to a not-profit organization and transferring archives to Columbia University.^[24]

Roy Niederhoffer, founder of NYCO Renaissance, won the bid.^[25] The New York City Opera’s assets included its patent rights, such as the right to its name.^[26] These patent assets were of significant interest to potential buyers. This situation is common in bankruptcy auctions, where companies, including notable examples like Enron and Kodak, have sold the rights to their names and logos.

Niederhoffer stepped down in 2019, when the board had shrunk, and the endowment continued to decrease.^[27] Financial reports reveal a trend of decreasing revenue and endowment each year.^[28] In 2022, revenue was reported at $2.21 million, a stark contrast to the figure from 2011, which was about eleven times higher.^[29] The total assets now are worth roughly one-tenth of their value before bankruptcy.^[30] Both net income and assets have shown instability over the years.^[31] Additionally, its social media presence is less active than that of its main competitors in the city. The path to reviving the City Opera remains long and filled with challenges.

Bankruptcy of a Gallery – Salander-O’Reilly Galleries

The first Salander-O’Reilly gallery location opened on Madison Avenue in New York in 1976 and moved to the famous neoclassical townhouse on East 79th Street in 1989, showcasing modern and contemporary art. Later, a more luxurious location, focusing on Renaissance to 19th century art, opened on East 71st Street. By the early 2000s, they were among New York City’s most established and cherished art galleries, even being named the best gallery worldwide by The Robb Report in 2003.^[32] The rent alone cost over $200,000 a month.^[33]

In 2007, the Salander-O’Reilly Galleries filed for bankruptcy after it was discovered that they had sold over 90 artworks without proper authorization. In the U.S. Bankruptcy Court, Southern District of New York, a list of about 560 artworks was submitted for claims, with the Elaine de Kooning estate being a major creditor. Claimants had to provide detailed information to support their interests in the artworks.^[34] Additionally, there were thousands more pieces with disputed ownership. Several plaintiffs, including Carol Cohen, the widow of former Madison Square Garden CEO Alan Cohen; Nella Longari, the Milan-based gallery; Monty and Sarag Diamond, art collectors, and others argued that Mr. Salander’s debts should not be dismissed by the bankruptcy court because they were incurred as a result of fraud.^[35]

Some creditors struggled to recover their losses even years later. In 2015, the Supreme Court declined to hear a case involving claims against insurer AXA Art by the investor group Renaissance Art Investors (RAI), who were attempting to recover $21.6 million for about 155 artworks involved in the scandal. However, the insurer argued that the gallery’s failure to return art or sales proceeds was not covered by their policy.^[36]

Bankruptcy of a Dealer – Lisa Schiff

The scandal involving New York art advisor Lisa Schiff has stood out prominently in the art world since May, 2023. Schiff, once a top dealer, faced allegations when Candace Carmel Barasch, a long-time client, discovered the disappearance of a Ghenie painting and other concerning financial transactions. Barasch, along with other plaintiffs, took legal action to restrain Schiff’s assets, partially granted by Judge Lucy Billings. Schiff allegedly owes significant amounts, including $1.8 million for a Ghenie painting sale and $2.5 million for art acquisitions.^[37][38] Other major creditors include American Express.

Schiff filed for Chapter 7 bankruptcy in the United States Bankruptcy Court for the Southern District of New York, revealing nearly $7 million in claims, over $1 million owed to the IRS, and additional state and city debts. By late 2023, discussions about selling Schiff’s 231 artworks, including pieces by artists like Anicka Yi and Ivy Haldeman, were underway. The collection, expected to be sold in eight auctions at Phillips starting February 2024, could raise up to $1.5 million.^[39]

Conclusion

These landmark cases reveal bankruptcy law’s critical function in addressing financial crises. Whether through liquidating assets or reorganizing debts, bankruptcy proceedings aim to provide a fair resolution for both debtors and creditors. The experiences of entities like Detroit and Paddle8, as well as the legal battles of Salander-O’Reilly Galleries, underscore the complexities and the essential nature of bankruptcy law in facilitating fresh starts and preserving economic value. Through these cases, we gain insight into how the law not only helps those facing severe financial difficulties but also ensures a level of creditor satisfaction, underscoring its importance in maintaining economic stability.

(For more information, see Center for Art Law’s 2014 article looking at the function of bankruptcy law and some landmark cases: Muses in Bankruptcy Court: a look at US arts and cultural institutions finding themselves in bankruptcy and out).

About the Author

Iris Ziwei Che is currently a first-year JD student at the University of Illinois College of Law in Champaign-Urbana. She holds a Master’s degree in Art History from Boston University and has experience working in museums and at Christie’s prior to her law school journey. Her main areas of interest are Art Law, Bankruptcy Law, Trust and Estate Planning, and Business Law. She can be reached at zche3@illinois.edu

Select Sources:

1. Graeme Wearden, David Teather, and Jill Treanor, Banking Crisis: Lehman Brothers Files for Bankruptcy Protection, The Guardian (2008), available at https://www.theguardian.com/business/2008/sep/15/lehmanbrothers.creditcrunch ↑
2. Andrew Clark, Lehman Brothers’ Art Collection Goes Under the Hammer, The Guardian (2009), available at https://www.theguardian.com/business/2009/oct/30/lehman-brothers-art-collection-sale ↑
3. Id. ↑
4. Candace Jackson, Wall Street’s Orphaned Art, The Wall Street Journal (2009), available at https://www.wsj.com/articles/SB10001424052748703574604574501793038152958 ↑
5. Id. ↑
6. Ramin Talaie, Art Auction Raises $12M against Lehman Debt, Bloomberg News (2010), available at https://www.nj.com/business/2010/09/art_auction_raises_12m_against.html ↑
7. Id. ↑
8. Jonathan Stempel, After 14 Years, Lehman Brothers’ Brokerage Ends Liquidation, Reuters (2022), available at https://www.reuters.com/markets/us/after-14-years-lehman-brothers-brokerage-ends-liquidation-2022-09-28/ ↑
9. Case Conference at 14, In re P8H, Inc., Case No. 20−10809−dsj (Bankr. S.D.N.Y. June 22, 2020) (Doc. No. 102). ↑
10. Paddle8 Raises $34 Million in Series C Funding, GlobalNewswire (2015), available at https://www.globenewswire.com/news-release/2015/10/28/1201947/0/en/Paddle8-Raises-34-Million-in-Series-C-Funding.html ↑
11. Eileen Kinsella, Paddle8 is Filing for Bankruptcy — and It Owes Tens of Thousands of Dollars to Justin Bieber, Jay Z’s Foundation, and Others, Artnet (2020), available at https://news.artnet.com/art-world/paddle8-bankruptcy-1806951 ↑
12. Id. ↑
13. Id. ↑
14. A “secret lien” is a statutory or equitable lien that arises without any notice to the public and requires no perfection. ↑
15. Jordan Weissmann, Detroit Exists Bankruptcy, Thanks to Its Art Museum, Slate (2014), available at https://slate.com/business/2014/11/detroit-exits-bankruptcy-city-s-pensions-saved-in-part-thanks-to-detroit-institute-of-art.html ↑
16. Id. ↑
17. Id. ↑
18. In re New York City Opera, Inc., Case No. 13-13240 (Bankr. S.D.N.Y. October 03, 2013) (Doc. No. 2) ↑
19. Michael Cooper, New York City Opera Files for Bankruptcy, The New York Times (2013), available at https://www.nytimes.com/2013/10/04/arts/music/new-york-city-opera-files-for-bankruptcy.html ↑
20. In re New York City Opera, Inc., Case No. 13-13240 (Bankr. S.D.N.Y. October 03, 2013) (Doc. No. 2) ↑
21. Michael Cooper, New York City Opera Files for Bankruptcy, The New York Times (2013), available at https://www.nytimes.com/2013/10/04/arts/music/new-york-city-opera-files-for-bankruptcy.html ↑
22. In re New York City Opera, Inc., Case No. 13-13240 (Bankr. S.D.N.Y. October 03, 2013) (Doc. No. 2) ↑
23. Id. ↑
24. Id. ↑
25. Jennifer Smith, Rival Visions to Reboot New York City Opera Detailed, The Wall Street Journal (2015), available at https://www.wsj.com/articles/rival-visions-to-reboot-new-york-city-opera-detailed-1446417707 ↑
26. Jennifer Smith, New York City Opera Suitors Prepare Bids, The Wall Street Journal (2015), available at https://www.wsj.com/articles/new-york-city-opera-suitors-prepare-bids-1421448468 ↑
27. Michael Cooper, City Opera Faces Its Biggest Challenge Since Bankruptcy, The New York Times (2019), available at https://www.nytimes.com/2019/02/15/arts/music/city-opera-bankruptcy-challenge.html ↑
28. Profile of New York City Opera Inc., PROPUBLICA, available at https://projects.propublica.org/nonprofits/organizations/132974347 ↑
29. Id. ↑
30. Id. ↑
31. Id. ↑
32. Roger Kimball, A Commercial Art Gallery That Feels Like A Museum, The Wall Street Journal (2005), available at https://www.wsj.com/articles/SB112777388125952580 ↑
33. James Panero, An Old Master in Ruins, New York Magazine (2008), available at https://nymag.com/news/features/45324/ ↑
34. Eileen Kinsella, Artists and Heirs Claim Hundreds of Works from Salander-O’Reilly, ARTnews (2008), available at https://www.artnews.com/art-news/news/artists-and-heirs-claim-hundreds-of-works-from-salander-oreilly-1290/ ↑
35. Id. ↑
36. Eileen Kinsella, Supreme Court Declines Investor Claim for $21.6 Million from Salander-O’Reilly Swindle, Artnet (2015), available at https://news.artnet.com/market/supreme-court-declines-salander-fraud-280749 ↑
37. Eileen Kinsella, Collector Candace Barasch Lays Out More on Dethroned Art Advisor Lisa Schiff’s Lavish Lifestyle in a Blistering New Court Filing, Artnet (2023), available at https://news.artnet.com/art-world/candace-barasch-lisa-schiff-ongoing-legal-feud-2340249 ↑
38. Alexandra Tremayne-Pengelly, Phillips to Bring Lisa Schiff’s Artwork to Auction, Observer (2023), available at https://observer.com/2023/12/phillips-lisa-schiff-artwork-auction/ ↑
39. Alexandra Tremayne-Pengelly, Phillips to Bring Lisa Schiff’s Artwork to Auction, Observer (2023), available at https://observer.com/2023/12/phillips-lisa-schiff-artwork-auction/ ↑