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New York’s Southern District Court Rules that Artworks Consigned to Galleries May Be Reached By Creditors

Last Tuesday, July 10, federal district judge Cathy Seibel ruled that New York state law may permit a bankrupt art gallery to sell an artwork to benefit its creditors, even if the piece was provided by a consignor. As a result of this ruling, “Madonna and Child” (c. 1500)–a painting attributed to Sandro Botticelli valued at $9.5 million–may provide relief to Salander-O’Reilly Gallery creditors, victims of one of the most infamous scams to rock the New York art world.

The painting at the heart of the controversy–“Madonna and Child”–originally sold at Christie’s New York in 1991 for $231,000, attributed only to the “workshop of Botticelli” at that time. However, it was later ascribed to the master himself, raising its value significantly. 
The painting was consigned to Salander-O’Reilly by Kraken Investments in 2007 with an asking price of $9.5 million, according to a letter of agreement filed in federal court. The 14×10 inch work was to be displayed in an exhibition titled “Masterpieces of Art: Five Centuries of Painting and Sculpture,” which was to open in October, 2007. However, the Botticelli masterpiece became entangled in complex bankruptcy proceedings, as lawsuits began to mount from angry Salander-O’Reilly customers and partners and a state judge ordered the gallery closed in 2007.

The Salander-O’Reilly Galleries scandal was called “New York’s biggest ever art fraud,” leaving many creditors collectively defrauded of millions of dollars. In 2010, proprietor Lawrence Salander pleaded guilty to stealing more than $100 million from investors and customers, including high-profile celebrities such as Robert De Niro and John McEnroe. Salander, who is currently serving 6-18 years in state prison, admitted to taking proceeds from selling art he did not own and selling half-shares in the same work three or more times. The dealer used the funds to acquire dozens of Renaissance works, lavish homes, jewelry for his then-wife, rare books, furniture, and private jet rentals. Although some creditors were able to retrieve art through a claims process in bankruptcy court, only the lawyers, auctioneers, and others involved with the gallery’s bankruptcy filing have received money, leaving scores of creditors still to be compensated.
Kraken Investments initially sought that ownership of “Madonna and Child” be decided in the Channel Islands, in accordance with its Salander-O’Reilly consignment agreement stipulating that disputes be arbitrated there. However, U.S. Bankruptcy Judge Cecelia Morris in New York denied Kraken’s motion, ruling that bankruptcy court was the proper forum to determine ownership. Kraken appealed this ruling to U.S. district court, where last Tuesday, the bankruptcy court’s decision was affirmed.

Southern District Court Judge Cathy Seibel held that “a creditor could obtain a security interest in a consigned item senior to that of a consignee who does not file a UCC financing statement.” The law provides that when a consignor delivers goods to a gallery but does not file a financing statement, the consignor’s security interest is “unperfected,” which creates a security interest in a gallery’s creditors, provided the creditors filed a proper financing statement. In such a case, as here, the “creditor’s rights are senior to the consignor’s.”

“The court well understands why Kraken is perturbed, even outraged by the idea that Salander-O’Reilly creditors may enjoy the proceeds from the sale of a valuable painting concededly owned by Kraken,” wrote Judge Seibel. But the rationale of this rule is to protect gallery creditors, as undisclosed consignment agreements between consignors and galleries can create secret liens on a gallery’s inventory.
Petra Davenport, one of Kraken’s lawyers, declined to comment on whether Seibel’s decision will be appealed.