The Art of Bankruptcy: Consigned Artworks and Bankrupt Galleries

October 24, 2019

By Laurel Wickersham Salisbury.

When commercial art galleries display works of art for sale, they are either purchased by the galleries from artists or collectors outright or accepted on consignment. Due in large part to financial considerations, including sharing in the risk and reducing financial exposure, consignment has become a favored way for galleries to maintain their stock. Consignment is largely the moda operandi of commercial art galleries today. Whether dealing in works on the primary or secondary market, artists and collectors looking to sell artworks often entrust a dealer or gallery to sell the work on their behalf by taking possession of the art until the work is sold, at which time the former owner receives payment of an agreed-upon percentage of the sale price. This business arrangement tends to work often to the benefit of all involved, but there are times when consignment agreements become complicated: the art market and its businesses often face unsustainable profits and some galleries will have to file for bankruptcy. The question then arises: What happens to an artwork held on consignment when an art gallery files for bankruptcy? Consignors might expect that their unsold property would be returned to them, but bankruptcy law and the Uniform Commercial Code (“UCC” or “the Code”) may disappoint trusting and hopeful consignors. In fairly recent years, the bankruptcy proceedings of prominent galleries such as New York’s Berry-Hill and Salander-O’Reilly as well as Los Angeles-based ACE Gallery controversially demonstrate that repaying creditors may take precedence over compensating consigning artists and collectors.^[1]

Laying Down the Basics

As a rule, in a bankruptcy proceeding, the goal of one creditor is, essentially, to establish priority over the claims of other creditors. The applicable laws governing the ways in which claims are ranked tend to favor more business-savvy creditors and, thus, who gets the return of their assets first. With respect to consignors of artworks, artist-consignors and collector-consignors are not necessarily treated the same with regard to the status of their claim to their consigned artwork in a bankruptcy proceeding. In fact, thirty-one states^[2] have enacted statutory legislation to protect artists-consignors from the claims of creditors, while collector-consignors receive no such legal benefit. However, as a collector-consignor, if the proper paperwork is filed and maintained, this consignor too should feel confident in their right to seek the return of their artwork.

While the art world tends to set itself apart from other industries, conducting business a little differently, bankruptcy law and the UCC applies with equal and standard force to all businesses engaged in the sale of goods, art dealerships included. As Duke Law alumna Hilary Jay argues,^[3] the policy rationales for the law as set forth in the UCC may be undercut by differences in the nature and conduct of business in the art market as compared with other industries. One such difference is that the art world “at times seems allergic to paperwork,”^[4] often relying instead on an honest handshake. The art market is also set apart by the fact that the goods transacted for are unique (prints and multiples aside, but even then editions are limited and varied) and often highly valuable. Furthermore, the value derived is not only monetary but also social and sentimental, and due in large part to the uniqueness of the art object. Finally, as mentioned above, galleries and dealers often deal primarily in consigned works. Pertinently, these are all facts widely known about the art market. However, current law leaves these facts mostly unaccounted for and lets the courts answer the question of fairly applying the law to this unique market.

Artist-Consignors

While sometimes treated by the law as a general commercial good, art is distinguishable from other goods. The unique hardship suffered by artists unable to recover their artworks placed on consignment with galleries prompted protective legislation in the late-20th century. As a result, in a majority of U.S. jurisdictions, artists are now in a uniquely protected position by state law with regard to their claims to their own artwork as against other creditors in the consigning art dealership’s bankruptcy. While not perfect nor applicable in every state, statutory protections exist most notably in New York and California, the two states often considered to be central to the U.S. and international art world. The effect of these statutes is to override the application of the UCC. If no such state statutory protection exists in the gallery’s jurisdiction, artists are treated like general consignors, and the UCC as enacted by the state still applies (see below).^[5] Additionally, some legal scholars have pointed out the vulnerability of these statutes to preemption by the UCC^[6] notwithstanding their express intent to override the Code’s application to the circumstance at bar in order to offer artists a “safe harbor.”^[7] The applicability of the statute may also be subject to some constraints; certain states’ statutes, for example, require the artist and dealer to have a written consignment agreement establishing the nature of their relationship for the protections to apply.^[8]

In practice, the state protective statutes essentially work to ensure that in private commercial agreements artists receive “superpriority” to ownership of their own artwork^[9] on consignment with a dealer before creditors may make claim to the proceeds of the artwork as a general asset held by the gallery. The New York statute known as the New York Arts & Cultural Affairs Law^[10] establishes this superpriority to artists by presuming that when an artist delivers works to a dealer for the purpose of sale, a consignor-consignee relationship is formed and certain fiduciary duties and agency responsibilities accompany such a relationship. The statute proceeds to establish that based on this relationship, the artworks are held in trust by the dealership for the benefit of the artist until sold, and once sold, the proceeds to which the artist is entitled are also to be held in trust by the gallery until paid out to the artist. The statute then expressly states: “no such trust property or trust funds shall be subject or subordinate to any claims, liens or security interest of any kind or nature whatsoever.”^[11] The California statute works similarly.^[12] For an artist, existence and application of a protective statute of the sort seem as good as gold. It cannot be understated, however, that diligence is still required; artists must be aware of and conform to the applicable state’s statutory requirements before being able to claim the artwork back.

As an example, Ace Gallery filed for bankruptcy in 2013, and after failing to settle his debts per court order to the tune of $17.5 million, founder Doug Chrismas “lost the keys to his gallery,”^[13] and a bankruptcy trustee took over as “de facto C.E.O. of the business.”^[14] Once again, the opaque and dishonest business practices and eventual bankruptcy proceedings resulted in consignors making claims in court to funds owed or items left in possession with the gallery. Ace Gallery dealt primarily in the works of contemporary artists, which meant that it was, in many cases, artists seeking the return of their own artwork, or proceeds owed from the sale thereof. De Wain Valentine was one such artist who claimed to be owed $1.45 million for eight of his sculptures. Chrismas refused to pay that sum because he believed the artist owed the gallery money as repayment for advances, a contention which the artist strongly denied.^[15] Chrismas’ less-than-stellar approach to paying artists seems to have been his preferred method for decades; as far back as 1979, Andy Warhol commented on his reprehensible business practices in a journal entry, and, as of 2003, it was reported that Chrismas had been sued more than 55 times by various parties with whom he had business dealings. In this case, it was to the benefit of many of Ace Gallery’s claimants that California had enacted an artist-consignor protective law, and artists making claims in the bankruptcy proceedings relied on such statutory provisions. But the existence of the law proved, at least at first, to be of only limited comfort for artists as the inventory held by the gallery was not well documented and sorting consigned artworks from owned artworks was no easy feat for the bankruptcy trustee.^[16] However, so long as the works were found to be on consignment with the gallery, their return is the artist’s legal due.^[17]

Collector-Consignors

Artists consigning works within States who have not enacted specific legislation overriding the UCC and art collectors who choose to consign their artworks for sale on the secondary market through a dealer are subject to the UCC rules in the event of the dealership’s bankruptcy. Under the UCC, artwork consignments can either fall under the ambit of Section 2-326 or Article 9. The UCC was amended in 2001; at this time, the drafters sought to improve the UCC’s treatment of consignments. However, the analysis of artwork consignments still proves at times confusing and unsettled.^[18]

UCC Article 9

As amended, most consignment transactions are now governed by UCC Article 9. Under this article, a consignor’s claim priority turns on whether their security interest in the good is perfected or unperfected (to “perfect” means to declare ownership with the appropriate authority). If unperfected, then “while the goods are in the possession of the consignee, the consignee is deemed to have rights and title to the goods identical to those the consignor had or had power to transfer.”^[19] This means that if a consignor’s security interest in their consigned artwork is left unperfected, third-party creditors with superior claims may attach (read: make claim to) the artwork to the dealership’s bankruptcy proceedings as a generally held valuable asset, and the consignor’s claim to their artwork becomes effectively outranked. However, if a consignor’s security interest is perfected, the consignor then may claim superpriority over all other third-party creditors to their artwork.^[20]

In order for a consignor to perfect their security interest in their artwork, most commonly, the consignor must file a UCC-1 financing statement, usually with the secretary of state.^[21] This statement is intended to serve as notice to third-party creditors with the intent to eliminate surprising or unknown claims to the business’ assets other than their own.^[22]

There are a few requirements set forth by the UCC for artwork to qualify as consignment goods:

1. “the aggregate value of the goods” must be greater than $1,000;
2. “the goods are not consumer goods immediately before delivery” from the consignor to the consignee; and
3. the dealer must not be “generally known to its creditors to be substantially engaged in selling the goods of others.”^[23]

Particularly, the last two requirements threaten the application of Article 9 to consignments of artworks to galleries. “Consumer goods” are later defined as “goods that are used or bought for use primarily for personal, family, or household purposes.”^[24] While especially in today’s high-value art market, art collecting may be categorized as a form of investment, it is equally likely that an artwork be thought of as décor and thus considered a good for personal or household purposes.^[25] Additionally, because art galleries generally do “substantially engage” in business on a consignment basis, it is probable that creditors would have knowledge of such a fact if at all familiar with the nature of business in the art world. While Article 9 governance of consignment transactions is preferable to consignors who have perfected their interest, it is clearly not guaranteed.

When Berry-Hill declared bankruptcy in 2005, consignors began to realize their ownership interest may be in jeopardy. Berry-Hill was primarily deading on the secondary market, and most of its consignors were collectors seeking to resell works; therefore, consignments fell into the realm of the UCC. In the ensuing legal proceedings, some collectors faired better than others, but there was a common sentiment of frustration over the uncertainty of regaining title and possession to artworks collectors believed to be theirs while said artworks were still “trapped in bankruptcy court purgatory.”^[26] Meanwhile, commentators scoffed at the disappointing reality that some collector-consignors had not maintained their generally business-savvy ways in their art world dealings, while some other creditors failed to inform themselves of the UCC filings that had been made.^[27] In order to keep its doors open after its Chapter 11 filing in 2005, the gallery secured a $21 million dollar loan to avoid Chapter 7 liquidation. Several years later, the gallery once again found itself in court, this time against its new creditor for defaulting on its debt.^[28] Totaling nearly $10 million, the court honored the debt, and the gallery saw much of its inventory seized, turning over the property interest in such artwork to its creditor to in turn be sold so that they could recover on their loan.^[29]

UCC Section 2-326

In the event that Article 9 does not govern the consignment, UCC § 2-326 may do so. If the goods consigned fall under § 2-326, an artwork, though technically on consignment, is considered to be a part of a bankrupt business’ assets and thus a third-party creditor has the right to claim the asset or the proceeds from the sale of the asset ahead of the consignor. Article 2 governs the sale of goods, which is the reason for this unfortunate possibility in bankruptcy. Courts have, especially before the 2001 UCC amendments, considered consignee businesses as a “buyer for resale,” despite agreements using “consignment” language; the 2001 amendments sought to remedy this confusion, but its practical implications are not clear. Luckily for consignors, there is an exception here for businesses that are proven by the consignor to be “generally known by its creditors to substantially engage in selling the goods of others.”^[30] Courts, however, have been inconsistent in the application of this exception to art dealerships.

Bailment law

If neither Article 9 nor § 2-326 apply to the transaction, then the consignors claim will be governed by the common law of bailment.^[31] Under bailment law, the consigned goods would not be considered the property of the estate and the consignor has a right to return of the consigned goods upon termination of the bailment agreement. While the bankruptcy trustee has a right to stay immediate collection of the consigned artwork and the estate may be able to claim certain funds do to it under the bailment agreement, the consignor should eventually be able to make a successful claim for return of their goods.^[32]

Other Legal Intertwinements

Gallery bankruptcies often reveal illicit transactions and complicated situations. In 2007, when the premier Salander-O’Reilly Galleries fell from grace after owner Lawrence Salander’s nefarious business dealings came to light – exemplified first by an onslaught of civil lawsuits and typified by his later pleading guilty to numerous criminal charges including grand larceny and fraud – a bankruptcy filing was the natural result. In the proceedings, the judge ordered the doors padlocked to contain the gallery’s physical assets (read: the artworks) and the court concluded that Salander owed nearly $115 million in restitution.^[33] Years later, in 2014, it was noted that he had not made good on that judgment;^[34] notably, in 2010, Salander was convicted and sentenced to 6 to 18 years in prison,^[35] a sentence that he is still serving. Leigh Morse, the gallery’s director, was also found guilty of “scheming to defraud,” and ordered to pay $1.65 million in restitution to the estates of artists.^[36]

Amongst the claims against the gallery were living artists who came to realize that they were owed six-figure sums of money for artworks they had left with the gallery. However, artists at the time demonstrated reluctance in harming Salander himself any further. One artist, Paul Resika, who had been represented by the gallery for decades, stated: “I want to get back the stuff and not injure Larry,” “[i]t’s not personal.”^[37] Together with two other artists’ estates, Resika chose to sue an Italian gallery with which Salander-O’Reilly had conducted business and supposedly lent millions of dollars worth of artworks to without authorization.^[38] One happy result from the Salander-O’Reilly bankruptcy proceedings was the return of Botticelli’s Madonna and Child (1485), then valued at $9.5 million, to its consignor, Kraken Investments, against a claim by the bankruptcy trustee that the painting should be considered an asset of the bankrupt estate.^[39] This result was reached only after the district court for the Southern District of New York reversed the bankruptcy court’s holding that the painting could be used as collateral for a bank loan after a trial specifically convened on the matter of this painting.^[40] These are only a few of the multiplicity of claims entangled in the bankruptcy of Salander-O’Reilly. As such, it was in part due to this scandal that the New York legislature strengthened its consignor-protective law in 2012, increasing the formalities that must be obeyed as to funds from sales of artworks.^[41]

As evidenced by the precedent discussed, a gallery’s bankruptcy is generally not determined by one case nor by one applicable law. The details and complexities of the business necessarily mean that the law on the matter will vary from case to case. Art and its market are generally considered as valuable, sensitive, and sentimental in nature. Bankruptcy law as it stands now does not necessarily make room for such considerations, which begs the question of whether further art world-specific legislation should be pursued.

Conclusion

As usual, the law of bankruptcy and its interaction with art world businesses and consignment transactions will depend on the specifics of the case. Proceedings may be carried out in a variety of different ways and case precedent is inconsistent, unsettled, and not yet fully fleshed out. Yet, it should not be overlooked that laws do exist to protect the interests of both artist-consignors and savvy collector-consignors. In the first instance by simply classifying certain consignment agreements as unique and thus specially protected, and in the second instance by providing consignors with the opportunity to perfect and thus secure their property interest. Ultimately, while it is generally considered the most monotonous and least glamorous part of being an artist or art collector, diligence and paperwork is required by the law. The monetary and sentimental value of art is unequivocal, and it is simply not worth the risk to rely only on relationships and handshake deals, no matter how trustworthy a dealer may seem.

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Endnotes:

1. Berry-Hill filed for bankruptcy in 2005; read more here. Salander-O’Reilly filed for bankruptcy in 2007; read more here. ACE Gallery filed for bankruptcy in 2013; read more here. ↑
2. The thirty-one states that have passed artist-consignor statutory protections are: Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Florida, Georgia, Hawaii, Idaho, Illinois, Iowa, Kentucky, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Montana, New Hampshire, New Jersey, New Mexico, New York, North Carolina, Ohio, Oregon, Pennsylvania, Tennessee, Texas, Washington, and Wisconsin. ↑
3. Hilary Jay, A Picture Imperfect: The Rights of Art Consignor-Collectors When Their Art Dealer Files for Bankruptcy, 58 Duke Law Journal 1859-1893 (2009). ↑
4. Id. at 1862. ↑
5. See analysis below under “Collector-Consignors.” ↑
6. UCC § 1-104. “Construction Against Implied Repeal: The Uniform Commercial Code being a general act intended as a unified coverage of its subject matter, no part of it shall be deemed to be impliedly repealed by subsequent legislation if such construction can reasonably be avoided.” ↑
7. Jay (2009), supra note 3, at 1859, (citing Ralph E. Lerner & Judith Bresler, Art Law: The Guide For Collectors, Investors, Dealers, And Artists 41 (Practicing Law Inst. Ed., 3d Ed. 1998)). ↑
8. Laws Governing Art Consignment, FindLaw (last accessed Sept. 16, 2019). ↑
9. These statutes apply with equal force to artist’s heirs or representatives. See, e.g., N.Y. Arts & Cult. Aff. Law § 12.01. ↑
10. N.Y. Arts & Cult. Aff. Law § 12.01. “Artist-Art Merchant Relationships.” ↑
11. Id. ↑
12. Cal. Civ. Code § 1738. Title 1: “Consignment of Fine Art.” ↑
13. Jori Finkel, Artists Fight to Get Works Back From Ace Gallery, The New York Times, Apr. 20, 2016. ↑
14. Id. ↑
15. Id. ↑
16. Id. ↑
17. See Cal. Civ. Code § 1738. ↑
18. Jay (2009), supra note 3, at 1858, 1871. ↑
19. U.C.C. § 9-319 (2012). ↑
20. Jay (2009), supra note 3, at 1861-1862. ↑
21. Pictured is a sample UCC-1 financing statement from the State of New York. Available here. ↑
22. Id. ↑
23. U.C.C. § 9-102(a)(20). ↑
24. U.C.C. § 9-102(a)(23). ↑
25. Jay (2009), supra note 3, at 1871-1872. ↑
26. John Dizard, Paint Peels on a Genteel Market, FT.com, June 23, 2006. ↑
27. Id. ↑
28. Am. Capital Fin. Servs. v. Berry-Hill Galleries, Inc., No. 10 Civ. 2555, 2010 U.S. Dist. LEXIS 112128 (S.D.N.Y. Oct. 19, 2010). ↑
29. Erica Orden, Manhattan Gallery’s Artworks Seized, The Wall Street Journal, Apr. 7, 2010. ↑
30. U.C.C. § 2-326(3)(b). ↑
31. Jay (2009), supra note 3, at 1874. ↑
32. Id. at 1884-1885. ↑
33. James Barron and Patrick McGeehan, Big Dreams, Big Expenses: In a Lavish Town House, an Art Gallery in Trouble, The New York Times, Oct. 29, 2007. ↑
34. Philip Boroff, Will Larry Salander’s Fraud Victims Get Their Money Back?, ArtNet News, Apr. 18, 2014. ↑
35. John Eligon, Art Dealer Sentenced for $120 Million Scheme, The New York Times, Aug. 3, 2010. ↑
36. Philip Boroff, Salander’s Morse to Serve Weekends in Jail for 4 Months, Bloomberg, July 19, 2011. ↑
37. James Barron, A Gallery’s Money Crisis, and Shaken Trust, The New York Times, Nov. 7, 2007. ↑
38. Id. ↑
39. Kraken Invs. Ltd. v. Jacobs (In re Salander-O’Reilly Galleries, LLC), No. 14-CV-2544, 2014 U.S. Dist. LEXIS 181203 (S.D.N.Y. Nov. 25, 2014). ↑
40. Id. ↑
41. Boroff (2014), supra note 29. ↑

Further Readings:

1. Hilary Jay, A Picture Imperfect: The Rights of Art Consignor-Collectors When Their Art Dealer Files for Bankruptcy, 58 Duke Law Journal 1859-1893 (2009).
2. Aaron R. Cahn, Art Law on Getting Your Consigned Art Back from a Bankrupt Gallery, Artnet (Mar. 29, 2015).

About the Author: Laurel Wickersham Salisbury was a Summer 2019 Legal Intern at the Center for Art Law. She is a J.D. candidate at Duke University School of Law, Class of 2021. She holds her B.A. in Art History from Emory University (2015), and an M.A. in Art Business from Sotheby’s Institute of Art, Los Angeles (2017). Laurel can be reached at laurel.salisbury@lawnet.duke.edu.