Art Lenders Undertake New Precautions in Light of Amendment to NYACAL’s Consignment Provisions

November 2012Art & Advocacy, Volume 13

Introduction

Governor Cuomo recently signed into law an amendment to the New York Arts and Cultural Affairs Law (“NYACAL”) and parallel provisions of the New York Estates, Powers and Trusts Law (“EPTL”) that was introduced by the New York State legislature late last year. The new law (collectively referred to in this article as the “Amendment”) became effective on or about November 6, 2012.1

The Amendment is intended to protect artists2 and their “successors in interest” (heirs, trust beneficiaries, testamentary beneficiaries, and personal representatives) who consign works of fine art to galleries and other art merchants3 by improving the existing trust property and trust fund provisions of NYACAL. Notwithstanding its apparently laudable purpose, however, the Amendment may have adverse consequences for lenders to art dealers. This article highlights those consequences and proposes certain safeguards.

Background

According to the report on the proposed legislation issued by the Art Law Committee of the New York City Bar Association, the history of various legal proceedings, including those involving the involuntary Chapter 11 bankruptcy of the Salander O’Reilly Galleries LLC,4 and parallel statutes enacted in approximately 30 other states, formed the impetus for the introduction of the Amendment.5 See Report on Legislation by the Art Law Committee (hereinafter, the “Art L. Comm. Rep.”).6

Before the Amendment was enforced, New York Law provided that consigned art constituted “trust property” and that proceeds of such art, once sold, constituted “trust funds in the hands of the consignee for the benefit of the consignor.” The existing law, however, lacked any mechanism to enforce such trust fund provisions or any penalty for abrogating them.7

Historically, dealers’ common practice was to commingle sales proceeds of consigned artwork with their own working capital and other funds. In a distress situation, for practical purposes, nothing constrained an unscrupulous art dealer from using another person’s sale proceeds to fund its failing operations. Moreover, within the context of a bankruptcy, disparate and disorganized creditors, which may include individual artists, their heirs, and personal representatives, may lack sufficient leverage to overcome the claims of competing creditors to sales proceeds or to the artworks in the possession of the failed gallery.8

The Amendment

In response to these issues, Articles 11 and 12 of NYACAL were amended to provide that works of art (and their proceeds) consigned by artists, crafts persons, or their “successors in interest” to art merchants are property held in “statutory trust”9 that shall not become the property of the consignee or become subject to the claims or security interests of the consignee’s creditors.10 The Amendment expressly overrides contrary provisions of other law, including New York’s Uniform Commercial Code.

Moreover, the Amendment specifies that such statutory trust property/funds are not subordinate to “claims, liens or security interests” of an art dealer’s (or other consignee’s) creditors.11 Subject to certain exceptions, the Amendment permits the artist (or other consignor) to waive the trust fund protections, but the waiver must be clear and conspicuous, and in a writing signed by the consignor.12

Accordingly, under the state law, as amended, such consigned assets should not become property of a dealer’s bankruptcy estate upon its becoming subject to protection under the Bankruptcy Code.13 Arguments that lenders and others had deployed under the earlier state law to defeat the claims of artists and their children to consigned works of art should no longer prevail.14

In addition, NYACAL § 12.01 (2) submits the consignee to the fiduciary requirements of Section 11-1.6 of New York’s EPTL with respect to such consigned property. These provisions require the consignee to segregate such property, and state that any person who violates its provisions is guilty of a misdemeanor.15 Section 12.01 (3) of the Amendment also provides for a private cause of action for persons injured by its violation, and allows for injunctive relief in addition to recovery of actual damages and attorney’s fees.

Recommendations

Generally, art lenders and other financial participants are familiar with problems arising from attempting to perfect a security interest in cash proceeds that are commingled. To avoid having to pursue tracing procedures that often prove unavailing, the prudent lender typically requires that proceeds of any sold collateral or other proceeds be deposited into a segregated bank account.

Given that the Amendment seeks to insulate the rights of the artist consignor and its successors in interest from a lender’s adverse claims against the consignor’s property in the hands of the gallery or other dealer, it is now critical that the art lender insist that its borrower dealer—particularly one known to deal in artworks consigned by original artists—separate, in a special bank account established for such purpose, any funds of such consignors, including proceeds of sold consigned art, from any funds of the dealer.

In addition, in transactions post-dating the Amendment’s effective date, art loan documents should include express representations, warranties, and covenants requiring that such borrower is in compliance with the applicable provisions of NYACAL Articles 11 and 12 and corresponding provisions of the EPTL. Also, the lender may wish to require enhanced reporting with respect to transfers of consigned art to and from its borrower, as well as the borrower’s certification of its ongoing compliance with them as a pre-condition to any future advances.

With these protections in place, the lender’s collateral and its proceeds should be more easily accessed in the event of a dealer’s loan default, and the lender should be able to avoid becoming embroiled in controversies arising from the myriad of claims asserted by artist consignors.


1 The Amendment, which provides that it will become effective 60 days after its enactment, was approved by Governor Cuomo on September 7, 2012. See 2012 N.Y. ALS 450, *3; 2012 N.Y. LAWS 450, *3; 2011 N.Y. A.N. 8604, *3.

2 N.Y. Art & Cult. Aff. §11.01(1) defines “artist” as the “creator of a work of fine art or, in the case of multiples, the person who conceived or created the image which is contained in or which constitutes the master from which the individual print was made.”

3 N.Y. Art & Cult. Aff. §11.01 (2) defines “art merchant” as “a person who is in the business of dealing, exclusively or non-exclusively, in works of fine art or multiples, or a person who by his occupation holds himself out as having knowledge or skill peculiar to such works, or to whom such knowledge or skill may be attributed by his employment of an agent or other intermediary who by his occupation holds himself out as having such knowledge or skill.” This definition “includes an auctioneer who sells such works at public auction, and except in the case of multiples, includes persons, not otherwise defined or treated as art merchants herein, who are consignors or principals of auctioneers.” Id.

4 Bankr. S.D.N.Y. 2007 (Case No. 07-30005-CGM).

5 Art Consignment Statutes have been adopted in the following states: Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Florida, Georgia, Idaho, Illinois, Iowa, Kentucky, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Montana, New Hampshire, New Jersey, New Mexico, New York, North Carolina, Ohio, Oregon, Pennsylvania, Tennessee, Texas, Washington, and Wisconsin. See Art L. Comm. Rep. at 1- 3 and Appendix.

6 Art L. Comm. Rep. at 1 - 3 (May 2012), available at New York City Bar Association website: http://www.nycbar.org.

7 See Art L. Comm. Rep. at 2.

8 Id.

9 The Amendment added the term “successor in interest” to its “Definitions” section: “a ‘personal representative,’ ‘testamentary beneficiary,’ trustee or beneficiary of a ‘lifetime trust’ or an ‘heir’ (including heirs who acquire the work of fine art, craft or print from the artist or craftsperson or from another heir or beneficiary of the artist or craftsperson), which terms shall have the same meanings as set forth in the estates, powers and trusts law.” N.Y. Art & Cult. Aff. §11.01 (2012); see also N.Y. EPT Law §§1-2.5 and 2-1.1.

10 N.Y. Art & Cult. Aff. §12.01(1)(v) (2012).

11 N.Y. Art & Cult. Aff. §11.01(4) (2012); UCC §1-201(12).

12 N.Y. Art & Cult. Aff. §12.01(3) (2012).

13 Title 11, United States Code. 11 U.S.C. §§101 et seq.

14 See generally Art L. Comm. Rep.

15 N.Y. Art & Cult. Aff. §12.01(2) (2012); N.Y. EPT Law §11-1.6(a) - (e).

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