This essay is about the fraught circumstance wherein an art owner finds that the gallery to whom he has consigned his art for sale has become bankrupt. If the owner had properly filed a UCC-1 financing statement (and it hasn’t expired five years later) the owner has minimal risk. But, if not, the rest of this essay addresses what happens, or should happen, in the owner’s dispute with the bankruptcy trustee.

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The ever-present but rarely litigated issue of whether an owner who consigns art to a dealer for sale is entitled to get the work back if the dealer goes bankrupt and the owner hasn’t taken proper steps to protect himself is gaining some new attention. In this essay, we analyze new developments in the recent case of Jacobs v. Kraken Inv. Ltd. (In re Salander-O’Reilly Galleries, LLC),¹ and provide some thoughts on where this issue can go, and where it ought to go. We have discussed this case previously,² but the United States Bankruptcy Court for the Southern District of New York has now finally determined the issue of whether the owner/consignor which failed to protect its ownership by filing a UCC-1 financing statement is nevertheless entitled to get the work back from the bankruptcy trustee. The court held that it may, but in doing so, the court has raised more questions than it answered—particularly with regard to whether the current consignment provisions of the Uniform Commercial Code make sense in today’s business world.

In its March 2014 decision, the bankruptcy court told the trustee that if he wanted to hold onto the Botticelli painting that had been consigned by the plaintiff, he would have to prove that a form UCC-1 financing statement should have been filed by the plaintiff. That’s because, as defined in the Uniform Commercial Code, a consignment requires a public filing only if the consignee (here, the gallery) “was not generally known by its creditors to be substantially engaged in selling the goods of others.” So if the trustee could prove that a majority of the creditors of the gallery did not in fact know that the gallery was substantially engaged in selling works on consignment, he could retain possession as against the owner who had failed to follow the statutorily required method of perfecting an interest in consigned goods.

The March bankruptcy court decision, however, did not tell the trustee how he was supposed to prove this critical element. And although the court did not issue a written opinion following the October 2014 hearing, and there is no transcript of that hearing available, we have been provided with a summation of the hearing and the court’s oral decision by Dr. Ronald Fuhrer, a noted Israeli art expert and museum director who acted as a consultant to Kraken in this proceeding. According to Dr. Fuhrer’s analysis, the trustee provided no testimony concerning the knowledge of those creditors who were not involved in the art business, but instead simply asserted that such non-art-savvy creditors had no reason to know that the inventory of art dealers in general, and the Salander Gallery, in particular, consists largely, and in some cases almost exclusively, of consigned works. The court, however, was unwilling to accept such an assertion without actual proof, and accordingly awarded the Botticelli to its owner, Kraken.

So far as it goes, this decision makes perfect sense. Just because creditors of an art gallery are not themselves in the art business, there is no reason to assume that such creditors (who may be caterers, car services, utility providers, and the like) are unaware of the manner in which that business operates. But requiring proof of the state of knowledge of these various creditors may be ruinously time-consuming and expensive for a bankruptcy trustee. A bankrupt business may and very likely will have hundreds if not thousands of creditors. If a trustee is required to conduct formal discovery proceedings of each creditor as to the state of its knowledge on this point, the time and money expended on such a quest could outstrip the value to the bankrupt estate of pursuing such a claim. And a less formal method of gauging the state of knowledge—a questionnaire sent to all creditors, for instance—could easily be attacked as not being a reliable method of collecting evidence.

But the real question here is whether or not the state of knowledge of creditors should be the determining factor in deciding whether a consignor’s failure to file a financing statement may be excused. The “knowledge of creditors” standard derives from statutes dating back to at least 100 years, to the turn of the 20th century—a time when trading partners might realistically be thought to be making decisions on whether to do business with a retailer by walking into the store and examining the inventory on display. Indeed, until the 2001 overhaul of the Commercial Code, the relevant statute still provided that another method by which a consignor could protect its merchandise from the claims of the consignee’s creditors was to require that the retailer display a sign informing customers that the goods next to the sign were there on consignment (!), so that potential vendors or lenders would know that the goods so identified could not be seized to satisfy claims of creditors of the retailer.

In our opinion, no state of affairs could be less descriptive of the way in which 21st-century companies decide whom to do business with. The globalization of business drastically reduces the likelihood that consignees will be ordering goods and services from other businesses in their neighborhood. Potential lenders, and some others, demand detailed financial statements and very often specifically request information about the level of consigned goods in a prospective borrower’s inventory. Smaller vendors may be happy enough to have the business and not do any checks. In any event, it is unrealistic to think that any creditors make business decisions by examining whether their counterparty sells consigned goods or purchases their wares outright.

This discussion necessarily implicates the question of whether it makes any sense to retain the “knowledge of creditors” standard as an alternative to a consignor simply filing a financing statement. The real lesson of the Kraken case appears to be that although a creditor may be able to invoke the “knowledge of creditors” element as an excuse for having failed to file a financing statement, any attempt to actually litigate the issue quickly becomes prohibitively expensive and difficult. And while the art owner, Kraken, prevailed because a bankruptcy trustee was unwilling to spend the time and money to provide the proof that the court demanded, there remains a substantial possibility that the owner would have lost its art had evidence rather than supposition been presented to the court. So, other than as a negotiating point, permitting a consignor, who has failed to protect its interests by filing, to claim, nevertheless, that it didn’t need to file because everyone knew that the gallery was selling works on consignment, would seem to have little value from either a legal or a societal perspective.

Under such circumstances, eliminating the outmoded and irrelevant “knowledge of creditors” prong of the consignment test would seem to be very much in order. While that action would deprive careless consignors of a fallback position when they neglect to properly protect their interests, it might also serve to impose greater discipline and awareness of commercial realities on a business that has been slower than most to free itself of the illusion that business can still be done on a handshake.

But this result seems both unduly harsh on consignors and, perhaps more importantly, just as disrespectful of modern commercial realities as is the current “knowledge of creditors” test. As we’ve discussed, the only creditors in this day and age who are likely to concern themselves with the manner in which an art gallery acquires its inventory are either lenders whose business it is to understand the operations of their borrowers, or those who are already engaged in the art business and thus likely to understand or at least be sensitive to the consignment versus purchase dynamic. All other creditors—caterers, utilities, maintenance companies, and so forth—may or may not know, but most certainly will not care how the dealer acquired the works in his display rooms. So it is perhaps worthwhile to enunciate a test here that, while still encouraging consignors to protect themselves with the available statutory tools, nevertheless provides them with a reasonable and more user-friendly escape hatch if they don’t.

A salutary proposal is to gear the need to file a financing statement to an identification of the usual customs and practices in the industry in which the consignee is engaged. Thus, instead of providing that a delivery of goods to a merchant is a consignment requiring a consignor to file a financing statement if the merchant is “not known by its creditors to be substantially engaged in selling the goods of others,” the statute could provide that a delivery of goods is a consignment if the custom and practice in the consignee’s industry is generally not to sell goods on consignment.

Such a standard would be much more readily provable than is the current requirement, which, if the Kraken decision is followed, would mandate the individual examination of each of hundreds or even thousands of creditors. It would reflect the commercial reality of the art business, where those who are engaged in and follow it know that virtually all dealers sell on consignment. And as discussed earlier, those creditors not involved in the industry and for whom the gallery is just another customer for general goods and services are not likely to care where the dealer’s inventory came from, so they should not be heard to complain about, or seek to obtain a litigation advantage against, a consignor who fails to file a UCC-1 financing statement.

The realities of today’s legal system are such that it always pays for a consignor to file a financing statement. The cost and burden on the filer are minimal, and there are enough litigants out there determined to press a perceived advantage against a non-filer to make the effort of filing worthwhile, if only for the peace of mind. But changing the standard of proof to determine what is or is not a statutory consignment would reduce the burden of litigation to an acceptable level in the case of someone who, for whatever reason, fails to file.

Aaron R. Cahn is a member of Carter Ledyard & Milburn LLP’s Insolvency and Creditors’ Rights Group where he often advises on art-related matters.

Notes

¹ 506 B.R. 600; 2014 Bankr. LEXIS 1101; 59 Bankr. Ct. Dec. 82 (decided March 21, 2014).

² Aaron R. Cahn, A Funny Thing Happened on the Way to the Gallery – A Bankruptcy Fable (Or Not); Spencer’s Art Law Journal, Vol. 2, No. (Spring 2011).

Editor’s Note

This is Volume 5, Issue No. 2 of Spencer’s Art Law Journal. This winter issue contains three essays, which will be available on artnet in March 2015.

The first essay (Mistakes Were Made) discusses the often-made claim of mutual mistake by both seller and buyer about the authenticity of art sold, and whether the sale can be rescinded by the disappointed buyer.

The second essay (It’s Becoming Easier to Get Your Consigned Art Back from the Bankrupt Gallery) examines consigning art to a gallery. One of the risks is the bankruptcy of the gallery (think Salander-O’Reilly). Getting your art back from the bankruptcy trustee may be getting easier.

The third essay (Legal Liability of Art Experts—Is Insurance a Solution and Will Opinions Be Less Dangerous Things to Give?) is an introduction to the use of insurance as protection for the art expert. This kind of protection should encourage opinions from experts.

Three times a year, this journal addresses legal issues of practical significance for institutions, collectors, scholars, dealers, and the general art-minded public.

— RDS