Lessons From History: Protecting Artists and Art Owners from Losing Their Art

By Cathy Ta and Alexander Brand 

Artists and art owners (“Owners”) commonly exhibit artwork through consignment agreements with art galleries.  However, when Owners fail to protect their interests in consigned pieces, they stand to lose all of their interests as well as all of their entitlement to their own artwork, particularly in the event the gallery files for bankruptcy.  Accordingly, it is imperative that Owners understand the risks associated with consignment agreements and the steps Owners can take to protect their interests.
 
A Case Study:  The Salander-O’Reilly Galleries Bankruptcy
In April 2006, Salander-O’Reilly Galleries (“Gallery”) entered into a loan agreement with First Republic Bank (“Bank”), whereby the Gallery granted the Bank a security interest in the Gallery’s personal property including its art inventory.[1]  The Gallery specifically represented and warranted that it was the sole owner of such personal property, which was free and clear of all liens and claims, and that it was authorized to pledge it as collateral.[2]  The Bank perfected its security interest in the collateral by filing a UCC-1 financing statement.[3] 
 
A few weeks later, the Gallery and Kraken Investments Limited (“Kraken”) entered into a consignment agreement, whereby Kraken delivered to the Gallery a Botticelli called “Madonna and Child,” which was worth at least $8.5 million.  Under the consignment agreement, the Gallery would have a term of years to sell the painting.[4]  Unlike the Bank, Kraken failed to file a file UCC-1 financing statement and failed to perfect its security interest.[5]  When the consignment agreement expired, the Gallery refused to return the painting.[6]
 
Ultimately, the Gallery encountered financial difficulties and was forced into bankruptcy.  Later, the bankruptcy court approved a plan to liquidate the Gallery’s assets including the Botticelli.[7]  Kraken then engaged in a series of legal maneuvers to try and remove the Botticelli from the sale of the Gallery’s assets.[8]  On appeal, the district court found that each of Kraken’s legal maneuvers was improper and affirmed the bankruptcy court’s decision in including the Botticelli in the asset sale.[9]  A key reason why the bankruptcy court’s decision was upheld was because Kraken had failed to perfect its security interest in the Botticelli.[10]  As a result, Kraken lost all of its interest and entitlement to the Botticelli.
 
Steps Owners Can Take to Avoid Becoming the Next Kraken in a Gallery Bankruptcy
The Salander-O’Reilly Galleries bankruptcy case illustrates an Owner’s worst consignment nightmare – losing a piece of art as a result of failing to understand consignor rights and how to protect them, particularly in the event of a gallery bankruptcy. Two major ways in which Owners can protect their rights and avoid being the next Kraken in the event of a gallery bankruptcy are by:  (a) timely filing a UCC-1 financing statement when consigning a piece of art; and (b) entering into consignment agreements under state laws that provide automatic protections for consigned pieces of art.
 
UCC-1 Financing Statement         
When an Owner consigns a piece of art to a gallery, the law affords the Owner a consignor's security interest in the piece of art.[11]  However, this interest is not automatically protected.  Rather, the Owner must perfect their interest by filing a UCC-1 financing statement describing the piece (before delivering the piece to the gallery), and by sending a notice to the gallery’s secured creditors describing the piece as well as stating the Owner’s intention of retaining a security interest in the piece.[12]  If an Owner fails to take the requisite steps to perfect their interest, they will stand to lose their interest in the piece of art to any creditor who is earlier in time in perfecting their own security interest in the piece and particularly in the event the gallery files for bankruptcy.[13]   
 
In an environment where galleries are filing bankruptcy at an unprecedented rate, Owners can avoid Kraken’s fate by taking the above-described steps to perfect their security interest in consigned pieces of art and they should do so where appropriate as soon as possible.[14]  By perfecting their security interest, Owners make it more likely that they will protect their rights to consigned pieces of art in the event that the gallery files for bankruptcy.
   
State Laws That Protect Owner-Consignors
In addition to UCC-1 financing statements, Owners can also protect their interests in consigned pieces of art by consigning them under state laws that automatically protect art exhibited with consignment agreements.  For example, states like New York and California have enacted statutes that automatically protect an Owner’s interest in consigned art.  Specifically, New York amended its consignment statute so that now, when an Owner consigns a piece of art to a gallery, the gallery holds the piece in trust for the benefit of the Owner.[15]  Similarly, California passed a statute that declares that a piece of art consigned to a gallery is held in trust by the gallery for the benefit of their Owner.[16]  Additionally, California expressly provided that the trust relationship between a consignor and consignee “shall not be subject to claim by a creditor of the consignee.”[17]  
 
Statutes like these automatically protect Owners and their interest in consigned pieces of art, by categorically defining consigned pieces as property held in trust by galleries for the benefit of their Owners.  Consigned pieces are thus never property of galleries and therefore not subject to claims of creditors of galleries – even in the event of their bankruptcy. 
 
Owners must take caution when consigning pieces of art to galleries.  Owners should be prepared to file UCC-1 financing statements to perfect their consignor’s security interests.  Owners should also take advantage of entering into consignment agreements under state laws like those in New York and California that automatically protect consigned pieces of art by holding them in trust for their benefit.