What happens when there is a sudden, dramatic shift in a market’s direction and the paradigm switches from “A rising tide lifts all boats” (JFK) to “It’s only when the tide goes out that you learn who’s been swimming naked” (Warren Buffet)? Until late October 2008, major international auction houses, private dealers, collectors and powerful galleries had been riding the high tide of recent financial markets. However, by early November volatile global economic conditions had left the art market’s biggest players scurrying for their proverbial swim trunks.
Among the many reasons people engage an attorney is to deal with risks and uncertainties. In the art world, this can mean advising clients on purchase, consignment or loan agreements, on decisions to sell or donate, and on tax issues. It can also mean dealing with trouble.
For example, several weeks ago Lawrence Salander of the well-known New York gallery Salander-O’Reilly, was arrested and charged with larceny, fraud, forgery, falsifying business records and perjury. He is accused of stealing $88 million through consignments of artworks to his gallery and selling the same artworks to multiple buyers. His clients included collectors, artists’ heirs, artist foundations and investors; he allegedly defrauded at least 26 clients. Among the charges is the accusation that Salander inflated the value of artworks to enable him to gain greater investments from victims of the scheme.
When a problematic situation arises, careful clients circle back and review plans that have been crafted to deal with life cycle events or business matters. From the perspective of a client’s total asset base, it is likely that now more than ever, the art collection portion may have increased as a percentage of overall net worth, as the past 18 months have seen a brutal decline in the value of real estate and other financial assets.
If a client’s net worth may be compared to a three-legged stool, with real estate, financial assets and personal property supporting the seat, then if the first two legs crack, the third is going to end up bearing added weight.
Until recently, art ownership was generally regarded as a passion or a pastime. For those who looked at art as an investment, if only a passive one, the collection may now be summoned to active duty.
More than ever, it is vital to understand the value of art, but the quest to ascertain value is a complex endeavor. With information at the fingertips of anyone with a computer, distinguishing the relevant from the irrelevant is as much related to expertise as it is to facts. The critical issue for attorneys is how the decisions clients make will be affected by value and vice versa.
In the Auction Market
Last November, auctioneers reportedly began making last minute phone calls to consignors (who probably then called their attorneys) just days before the sales, warning them to drop reserves (the private, confidential price at which the consignor agrees to sell) by anywhere from 15 to 40 percent if they hoped to sell their Impressionist, Modern, Post War and Contemporary paintings and works of art in the upcoming sales. Notwithstanding contract terms that had presumably been agreed upon four to eight months earlier when the art market was still frothy, the state of the markets compelled last minute adjustments.
Part of the appeal of selling at auction is the hope of a contagious enthusiasm in the auction room pushing prices higher and higher. When experts resort to calling sellers en masse seeking lower reserves, it is clear that the tide is going out on that business model.
For those with a stake in the art world, possessing an accurate sense of value is essential. For instance, some might say Richard Fuld (Lehman Brothers CEO) and his wife Kathy, or Henry Kravis, of KKR, were lucky or prescient consignors when they negotiated favorable price guarantees before selling blue chip works at auction during the November sales.
The use of guarantees by consignors to shift financial risk onto the auction houses and their third party partners and guarantors is a recent auction business strategy, now abandoned. With guarantees, consignors typically agree to split the proceeds above the guaranteed amount with the auction house in exchange for the certainty of receiving the guaranteed amount. The use of guarantees reflected a competitive business environment for high value consignments in a rising market. Collectors with power and influence on the top rung of the art world buffered themselves against the tough luck experienced by other consignors without guarantees when the market curdled.
However, even a guarantee did not always “guarantee” an outcome. A client of Christie’s who had a guarantee last November alleges that his family has been short-changed. George A. Weiss, the managing member of Weiss Family Art (Bacon) LLC, has sued Christie’s Inc., the U.S. unit of Christie’s International PLC, for reneging on payment of the minimum price guarantee of $40 million for Bacon’s “Study for Self Portrait” (1964) in the sales agreement signed in mid-September.
After reviewing proposals from Sotheby’s and Christie’s, Weiss signed with Christie’s. He alleges that he was told for the first time on Sept. 23 that Christie’s wouldn’t honor its $40 million minimum price guarantee “due to the changed climate of the art market.” At the sale the bidding rested at $27 million; the lawsuit is seeking $40 million, plus interest and damages.
Issues Then and Now
Sudden changes in market conditions from 1991 to 1992 generated numerous disputes among collectors, auction houses and various parties the last time around. Some of these played themselves out in lawsuits throughout the decade.
At the time, the financing vehicles were pre-sale advances based upon appraised values or auction estimates, not guarantees. The crux of the matter often concerned valuation; estimates and corresponding advances based upon a percentage of the estimates were pegged too high. The discrepancy, known or unknown at the time, was problematic. When sales eventually took place the sales proceeds failed to satisfy the amount of the advance; claims and counterclaims ensued.
For example, in 1992 Christie’s Inc. advanced $3.1 million to Dr. Carlo Croce, secured by his Old Master paintings and drawings, which had been appraised by Christie’s Inc. and Christie, Manson & Woods, Ltd. (together, “Christie’s”) at a value ranging from $4.6 to $6.6 million. A consignment agreement and secured promissory note and security agreement were executed and it was agreed that the paintings and drawings were to be auctioned off to repay the advance, with paintings to be sold first and the drawings to be sold only if the proceeds of the auction of the paintings were insufficient to repay the advance, which is what transpired.
After all the paintings and drawings were sold, there remained a shortfall of some $612,000 on the advance. Dr. Croce refused to pay it and Christie’s sued for the shortfall as well as attorney’s fees and interest. Dr. Croce counterclaimed for, among other things, fraud, negligent misrepresentation and breach of fiduciary duty.
The case (in which this author was an expert witness) was tried from April 16 to 28, 1998. Among other findings, the jury returned a verdict in favor of Dr. Croce on his negligent misrepresentation claim and awarded him partial damages. Christie’s Inc. v. Croce, 5 F. Supp. 2d 206 (S.D.N.Y. 1998), 1998 U.S. Dist. LEXIS 7657.
The interesting question of the moment is to what degree negotiated guarantees represent an artificial floor set by the auction house for its own business reasons, when the salesroom price would otherwise be lower than the guaranteed price. Assuming it is paid, the guaranteed price is the final price and the auction house becomes the owner of the property. How is one to regard such works as comparables? The reluctant new owners may not be able to realize the guaranteed price for a period of time if market conditions are unfavorable. The question “what is it worth?” may be hard to answer.
However, there was in fact good news priced into the sales last November. For sellers who lowered their reserves and for buyers willing to bid, the fall of the auctioneer’s hammer signified the items were sold, not passed (unsold). This demonstrated that markets had adjusted quickly when a willing buyer and a willing seller found a number that enabled both parties to complete transactions.
As it turned out, the financial guarantees of Christie’s and Sotheby’s last autumn were poorly timed; failed guarantees of property reportedly produced losses of approximately $100 million in the final quarter sales.
Valuation for Insurance Purposes
Another valuation issue relates to the pursuits of collectors who were avid buyers in the past few years or who updated their insurance schedules in 2007-2008 to increase protection against loss or damage. They are discovering that prices and values may no longer reflect their collections’ worth in today’s challenging atmosphere.
A strong push from insurers prompted clients to update values to achieve greater consistency with the booming market. Now that the market has turned, particularly for the most recent examples of contemporary art, values may exceed the market. This circumstance makes both clients and insurers nervous.
Insurers are concerned about the possibility of losses being “developed.” Many of today’s mixed media conceptual art pieces have sold for high prices and are fabricated with fragile components. 1 It is easy to have a mischance, through lack of proper climate controls or other slip-ups.
As Jessica Darraby, art lawyer and author of “Art, Artifact, Architecture and Museum Law” (Thomson West, 14th ed., 2009), observes:
However, we would caution that the spirit of thrift should not embrace the meat cleaver approach. Lopping off an arbitrary percentage of values that may add up to hundreds of thousands of dollars in lost coverage to save a few hundred dollars in insurance premiums is ill-advised. Rather, a delicate surgical approach is required.
First, not all collecting categories are in a correction. Second, even if there are declines, they have not contracted at the same rate or to the same degree.
Moreover, one should not lose sight of the fact that a price correction does not mean worthless. As Steve Pincus, Managing Director, DeWitt Stern Insurance and Risk Advisory, New York, observed,
For galleries, that may mean trade show containment, reduced inventory, or a credit for good loss experience.
Locating Price Information
Art owners need accurate and reliable price information in order to make wise and timely decisions. In the post-boom market there are two emerging trends.
One is that sales are moving from public to private arenas. Anyone with the slightest bit of discretion, both in the sense of option to sell and with a desire for privacy, is not keen to put good works of art up for sale in public at the time when price guarantees have evaporated and risk of failure is real.
In valuing works of art in this sort of climate, if one were to examine only auction price data, it might reflect fewer lots of property and sales by distressed sellers or shopped around property, none of which may be relevant to the subject works being valued. Lackluster property does not encourage blockbuster prices. Still, estate property consignments will be more sought after than ever because they typically represent property fresh to the market and that is considered desirable.
Dealers and galleries have redefined the public/private market boundaries in recent years though the proliferation of art fairs. The publicity and attention they attract have generated a hybrid space where art fairs straddle the line between public and private sales. We like this option because it enables clients to test the market in a semi-public semi-private space where disappointment is recorded only on people’s eyeballs, not on the Internet where images and price records permanently acknowledge failure for all to see. For the purposes of price research, it is important to research art fair gallery sales as another extension of the public market, and these prices should be included in one’s value results, when appropriate.
The most recent Art Basel Miami Beach in 2008 confirmed a second trend that is newer than the art that was on view: power is decisively shifting away from hot artists and bold-faced galleries back to collectors with cash and a willingness to spend it.
Just as bidding in the front row of the auction room may be regarded as poor form for a CEO whose company faces publicly announced layoffs, buying at an art fair has become too public for comfort. Wandering amidst friends, colleagues and the watchful eyes of the press from aisle to aisle is a diminished thrill. Deals are happening offstage and out of the public eye.
Further, with the certainty of “selling out” the entire booth now gone, dealers are no longer keen on meeting tourists and tire-kickers. They must decide which pieces they are willing to risk showing in public, and to contain costs they are being much more selective about fair participation.
For an industry notorious for operating behind closed doors, finding relevant price information becomes more difficult when sales take place in private. This makes it more complicated for attorneys, too.
With even less price transparency than before, the art and science of valuation become more technical and arcane. Formulae, rules of thumb, online price records and Web sites claiming to track and index the public art market may capture data points but probably will not provide clients and their attorneys with adequately nuanced information that is reliable, actionable, and current.
Other tactics that worked during the boom, such as free appraisals from galleries and auction houses performed as a courtesy for important clients and their collections, in our experience, do not measure up in times like this. They provide information too limited in scope and applicability to be useful to achieve the optimal outcome for the legal purposes our clients seek to achieve. Like a doctor who may prescribe a combination of medicines at various dosage levels to fight an infection, a good valuation report must be able to deploy a range of methodologies in order to zero in on an accurate value for the purpose at hand in a specified market at a particular point in time.
When faced with making a decision about whether to keep, restore, sell, donate or bequeath a work of art, utilizing the last three auction prices and calling it a day is not likely to be of much help, particularly if the shared characteristics of the subject work and the price records include little more than authorship and size. Without interpretation and qualification, a recent auction record provides little more information than that on a certain day, at a certain time, in a certain place, someone paid a certain amount of money for a work of art described as by somebody.
Even if attorneys have been satisfied with a firm’s work product in the past, in order to avoid surprises, now is the time to inquire in advance about work practices and research, not just fees. Ask about the state of the market for the subject works to be valued and drill into more technical matters, such as contemplated methodology and approach to establishing values in a fast moving marketplace. An appraisal is a snapshot in time so clarity about stipulated dates has never been more crucial.
Engaging an independent consultant to review an auction house or other appraisal for a second opinion can have a valuable benefit for both attorney and client. Clients of ours who have their own sense of what their objects are worth tell us how surprised they were when a document was handed over with values of 25-75 percent less than what they expected. On the other hand, colleagues have mentioned that clients forget or fail to share relevant, indeed crucial information, such as a unique provenance or scholarly opinion that would have markedly changed the appraised value. A second opinion can highlight a discrepancy or inaccurate value.
Alas, the client may not always be available or even alive, but if possible, when we are engaged to do a valuation or provide a second opinion, we always request a meeting with the principal decision maker. Once, an executor and heir handed us a brown paper grocery bag she discovered in the back of a bedroom closet while cleaning up. It contained a jumble of over 50 purchase invoices, dating back to the 1950s and ’60s, on the letterheads of famous galleries, many no longer in business. Not only did these papers establish the attribution, date of acquisition and cost basis for each item but together they illustrated the deceased’s special personality as a collector, which added nuance to our appraisal report.
We gather exactly this sort of personal information that is often overlooked but proves to be highly relevant to the valuation. Attorneys and advisors like to act as gatekeepers to their clients, which is understandable, but can be counterproductive. Dissatisfied clients and unsatisfactory results can often be avoided by facilitating contact and providing as much information as possible. It usually saves time and money, and everyone agrees that is a good thing in today’s economy.
The Bottom Line
In up or down markets attorneys are primarily interested in the bottom line.
The number on the bottom of the cover page gets plugged into a variety of calculations, the results of which produce consequences for clients. Recognizing the illiquidity of art, even of a masterpiece, we always say it is better to sell when you don’t need the money.
Similarly, now is an excellent time to research the value of an art collection. For most people, the details of the valuation process combine the suspense of a lecture on accounting with the sleight of hand of a magician pulling a rabbit out of a hat. Reports may not spell out every step or aspect of research undertaken, but it certainly gives report users more confidence in the values when they are able to follow the reasoning and/or formulae applied to document the findings.
People of good will may disagree about values, but right now, more than ever before, the numbers and the reasoning behind them matter. Good arguments will make the difference between what is accepted by reviewers as fair and reasonable based upon the use of appropriate comparables, and what is rejected as vague or unsupported. Good numbers will help attorneys serve their clients’ best interests.
Beverly Schreiber Jacoby is president of BSJ Fine Art, an independent consulting and appraisal company specializing in art advisory, collections management and valuation services. She can be reached at firstname.lastname@example.org
1. See Beverly Schreiber Jacoby, “Here Comes the Future,” New York Law Journal, Asset Valuation special section, April 30, 2007, at p. S2.