Of course, a dealer to whom art has been consigned for sale does not own the art, having only the contractual right to transfer the owner’s title. This essay is about the art dealer’s obligation to perform buyer-due-diligence in the face of “red flags” about the authority of a consignee/dealer to deliver good title. Where the consignee/dealer is selling to another dealer, and there are questions about the consignee/dealer’s authority to deliver good title, the dealer/buyer, will need to exercise real due diligence about these title questions to defeat a claim by the owner for return of the owner’s art. On the other hand, under the Uniform Commercial Code (UCC), a collector, who is not also a dealer, does not have a due diligence obligation.

• • •

As one would confidently suppose, the art collector purchasing in the customary manner from an art dealer acquires good title to the art so long as the collector buys in good faith and without actual knowledge that the sale violates the rights of a third party. (Unless, of course, the art has been stolen, in which case, under American law, no subsequent buyer can get good title.) That is to say, the collector is under no obligation to exercise due diligence to determine that the selling dealer has authority from the owner, via a consignment agreement, to pass the owner’s title to the collector.1

The essence of a typical art consignment agreement between a selling owner and an art dealer gives the dealer the right to transfer the owner’s title to one who buys from the dealer. These contractual terms are amplified by Uniform Commercial Code (UCC) Section 2-403, which provides that a buyer from the dealer in the ordinary course of business will prevail over a claim of the owner who entrusted the art to the dealer. As a New York appellate court explained:

[t]he “entruster provision” of the Uniform Commercial Code is designed to enhance the reliability of commercial sales by merchants (who deal with the kind of goods sold on a regular basis) while shifting the risk of loss through fraudulent transfer to the owner of the goods, who can select the merchant to whom he entrusts his property. It protects only those who purchase from the merchant to whom the property was entrusted in the ordinary course of the merchant’s business.2

The drafters of the UCC intended to enhance confidence in commercial transactions by protecting the innocent purchaser who buys from a “merchant” (the dealer) dealing in goods of that kind (even if the dealer acts unscrupulously, or indeed, contrary to the express limitations, say, a minimum sales price, imposed on the dealer by the owner). Of course, if the dealer has violated the consignment agreement limitation, the entrusting art owner would have a breach of contract claim against the dealer, but the entrusting owner has no claim against the dealer’s buyer for the return of his art.

A buyer “in the ordinary course of business” means a person who buys from a person in the business of selling goods of that kind “in good faith” without actual knowledge that the sale violates the rights of another. A person buys “in the ordinary course” if the sale comports with usual or customary practices of business in the art market.

Dealer Buying From Dealer

But if the buyer from the consignee/dealer is not a collector but another dealer, the UCC applies a higher standard of “good faith” to the buyer. Buying art “in good faith” means something more when the buyer is an art dealer rather than a collector. In effect, the code requires the dealer in “certain circumstances” to perform a due diligence investigation to confirm the selling dealer’s ownership (or right to transfer title under a consignment agreement with the owner). These “circumstances” or indications of title questions are usually referred to as “red flags.” The definition of “good faith” is modified for art dealers (“merchants”) to mean honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade. Merchants are thus held to a higher standard of “good faith” than the non-dealer. “In other words, to prevent lackadaisical standards in the art business from affording a shield to either misconduct or fraud-conducive indifference, New York courts will not allow a merchant buyer who conducts trivial due diligence to insist that failure to look into a [dealer’s] authority to sell a painting was consistent with the practice of the trade.3 “Thus, under New York law, compliance with custom is relevant, but not dispositive, because a customary practice might fall short of what a reasonable commercial standard would require for fair dealing”.4 Rather, as Judge Oetken stated in 2013 in Davis v. Carroll, a dealer might be required by the UCC to take additional steps to verify that the selling dealer has authority to sell the art. This heighted duty of due diligence is triggered where there are warning signs about problems in a sale.5 A measure of due diligence is a prerequisite to any claim of a dealer/buyer for ordinary-course-of-business status, and there is an escalating duty of inquiry when the dealer/buyer faces warning signs of foul play—often described as red flags.6

Two Court Decisions with Numerous Red Flags—One, the Dealer/Buyer Was Denied Good Title, and a Second, the Dealer/Buyer Obtained Good Title

Since a heightened duty of due diligence attaches where an art-dealer-as-buyer is presented with reason to suspect foul play in a sale, it will be instructive to examine two recent court decisions in which the courts identified such warning signs (“red flags”) for art dealers/buyers in Davis v. Carroll and Lindholm v. Brandt.7

Judge Oetken in Davis examined a number of red flags surrounding a 2006 sale of eight paintings by Salander O’Reilly Gallery to defendant, Joseph P. Carroll. The plaintiff, Earl Davis, son of the deceased artist Stuart Davis, who created the eight works, claimed that Carroll as a dealer should have been alerted to signs of foul play on the part of Salander. A red flag may exist where the buyer is aware of the seller’s financial difficulties at the time of sale. But Carroll stated that he was unaware of Salander’s precarious financial position, and had no reason to be aware of Salander’s financial difficulties in 2006, and Judge Oetken assumed these two factual assertions to be true (for the procedural purpose of Davis’s summary judgment motion).

Judge Oetken found that the single most important warning or red flag consists of indications that “the seller neither owns the work nor enjoys the authority to sell it.” For the judge, it was “beyond doubt that Carroll should have been alerted by numerous signs to serious questions about [Salander’s] authority to sell.” Carroll insisted that he understood five (other) works he purchased in 2001 to have been owned by [Salander], notwithstanding provenance statements for many of these works that simply listed “Estate of Owner” and catalog citations listing the son, Earl Davis, as the owner. Thus, for Judge Oetken, it was clear that Carroll, no later than 2002, understood these five works were owned (italics in original) by the Davis Estate and sold through (italics in original) Salander. In 2006, Carroll raised the ownership question of the eight disputed works with a Salander employee, and, as a result, Carroll switched his own provenance statements for the eight paintings from, “owned by [Salander]” to, “acquired directly from [Earl Davis] through [Salander].” From this switch in provenance documentation, the judge concluded that Carroll “encountered a scenario in which shifting claims to ownership of the Davis works—of [Salander], Davis, and the Davis Estate—raised a red flag.”8 The judge goes on to quote from the report of Davis’s expert on art market custom and practice, Debra Force, a New York City art dealer, who opined that these [Carroll’s] actions were “highly improper,” and added that the need to switch around owners in provenance documents constituted notice of questionable dealings.9 Judge Oetken cites Debra Force, to the effect that “no reputable art dealer” would have proceeded with the 2006 exchanges after the events of April 2006 “without express confirmation that Earl Davis approved the sales.”10

Another red flag recognized by New York law are “bargain basement prices.” Carroll purchased a number of works at bargain basement prices and then resold them within a short period of time at far greater prices. Judge Oetken states:

As a sophisticated market participant subject to a special duty imposed on merchants under the UCC, Carroll undoubtedly knew, or should have known, that these prices were too low, even when set against the art market’s variable pricing norms.11

It seems worthwhile to quote Judge Oetken extensively (below) in light of the heavily factual content of his decision analyzing the nature and extent of dealer/buyer Carroll’s actual due diligence investigation, as compared to his due diligence obligation imposed by law:

Carroll’s Due Diligence in the 2006 Exchanges Was Insufficient Under the Applicable Duty of Further Investigation

Carroll conducted three forms of due diligence: inspection of the [Salander] provenance and cataloguing for each work, physical examination of each work, and a search of UCC security filings. Rosenberg [Alex J. Rosenberg, Carroll’s expert on art market custom and practice] states that this amount of due diligence is more than usual in the field, though he offers no specific information about the level of due diligence that is customary, about how much added due diligence might be common in scenarios where red flags are present, or about why these forms of diligence would be expected to answer the questions raised by those red flags. Rather, Rosenberg merely summarizes Carroll’s due diligence and concludes that “Carroll performed more than the customary ‘due diligence’ that would be expected of an art dealer” in a scenario that did not present reason to question [Salander’s] ownership or right to sell. Rosenberg adds that it is “not the art industry norm” to contact the owner of a work on consignment to ascertain whether a seller enjoys the right to sell an artwork.

Force points out that is not the custom in the New York City art market to physically mark artworks with signs of ownership. She adds that UCC security filings were rare in the art industry in late 2005 and early 2006, a fact evidenced by Carroll’s admission that he only adopted this practice in late 2005. Further, although Carroll insists that he examined all documentation that accompanied these works, he somehow overlooked the fact that the Stuart Davis works he acquired in January/February 2006 were listed as “owned by” [Salander] in the exchange paperwork—even though the provenance and cataloguing materials unmistakably identified Davis or the Davis Estate as the owner. In Force’s view, Carroll’s due diligence was not reasonably calculated to clarify [Salander’s] rights of sale.

The parties do not dispute that Carroll conducted adequate due diligence in the absence of red flags. Given the presence of red flags, then, the controlling question is what form a heightened duty of inquiry would have assumed and whether Carroll satisfied that duty.

In contrast to Rosenberg, who declined to offer expert testimony on what forms of due diligence would be common in the art industry in the presence of red flags and whether Carroll satisfied those obligations, Force offered detailed expert analysis of this issue. She explains that, in the presence of such red flags, Carroll would have been expected under art industry custom to take some combination of the following steps: (1) inquire directly of Salander and insist upon a clear answer or documentation regarding its ownership or rights of sale; (2) consult with the authors and preparers of the forthcoming, definitive Stuart Davis catalogue raisonné; (3) consult with Earl Davis “as Stuart Davis scholar and publicly identified owner of many of the works”; (4) review the publications cited in the cataloguing materials before agreeing to purchase works in the 2006 exchanges, instead of reviewing them after striking a deal; and (5) examine [Salander’s] list of retail prices for these works to more accurately ascertain whether the prices were so low as to provide cause for concern. In sum, Force opines as follows:

“Carroll failed to carry out the reasonable and necessary diligence that would be expected of an experienced art dealer under the circumstances to assure himself that the proposed transactions were proper and authorized. [Had] he carried out such proper diligence, he would have discovered that they were unauthorized and he should have abandoned entering into the transactions.”

Although Rosenberg’s testimony creates a genuine issue of material fact regarding Force’s opinion that Carroll should have consulted with Davis, Force’s expert opinion otherwise stands unrefuted. Force is thus the only expert in this case who has offered detailed testimony on the norms of due diligence in the art industry when a sale is clouded by signs of foul play. Because Carroll did not undertake any of the forms of heightened inquiry that Force describes as normal and customary in the industry, any reasonable juror would conclude that Carroll did not meet the duty of heightened inquiry imposed upon him under New York law by virtue of the numerous red flags that he knew, or should have known about during the 2006 exchanges.12

A Second Decision—Ownership Red Flags: Buyer/Dealer Gets Good Title

Whereas the New York court in Davis, with red flags hanging about the sale, decided that the art-dealer-as-buyer had not met his due diligence obligation, a Connecticut court, again seeing red flags fluttering over a sale, decided that the dealer-as-buyer had met his investigatory obligation. In Lindholm v. Brant in 2007, the Supreme Court of Connecticut addressed a claim of Kerstin Lindholm for the return of her Andy Warhol painting, Red Elvis, which had been fraudulently taken from her by her art dealer, Anders Malmberg, and then sold by him to art dealer, Peter Brant.13 (The court treated Brant as a dealer under the UCC’s Section 2-104 rather loose definition of “merchant.” This, of course, presents a risk to collectors who deal art as a sideline activity.)

The Brant case does not involve stolen art. It is a case where the selling dealer had no authority to sell to the buyer, Brant. Brant is a situation in which, in the words of the entrustment section 2-403 of the UCC, “the delivery [by the owner of the painting, Kerstin Lindholm] was procured [by the selling dealer, Malmberg] through fraud punishable as larcenous under the criminal law.” Thus, we are not, here, discussing stolen art, to which under American law, the buyer, Brant, could have never gotten good title.

During the course of sale negotiations between Malmberg and Brant, a letter was prepared (presumably by the lawyer for the buyer, Brant) to be signed by the seller, Kerstin Lindholm, stating that she had good title at the time she sold the painting to Malmberg, but Kerstin Lindholm never signed the letter (although an unsigned copy was shown to Brant). When Brant’s lawyer requested a copy of the signed letter, Malmberg refused, saying that “it was none of [Brant’s] business.” In addition, Brant’s lawyer, in an effort to clarify that Malmberg owned the painting, requested a copy of the invoice from Kerstin Lindholm to Malmberg. Malmberg denied the request on the ground that such invoices are not normally and customarily disclosed in sales of art.

The Supreme Court of Connecticut described the expert testimony about customary art market practice presented by the expert for buyer/defendant Brant as follows:

…defendant presented expert testimony that the vast majority of art transactions, in which the buyer has no reason for concern about the seller’s ability to convey good title, are “completed on a handshake and an exchange of an invoice.” It is not customary for sophisticated buyers and sellers to obtain a signed invoice from the original seller to the dealer prior to a transaction, nor is it an ordinary or customary practice to request the underlying invoice or corroborating information as to a dealer’s authority to convey title. Moreover, it is not customary to approach the owner of an artwork if the owner regularly worked with a particular art dealer because any inquiries about an art transaction customarily are presented to the art dealer rather than directly to the principal. It is customary to rely upon representations made by respected dealers regarding their authority to sell works of art. A dealer customarily is not required to present an invoice establishing when and from whom he bought the artwork or the conditions of the purchase.

However, the Connecticut Supreme Court stated that this customary art market practice will not suffice when the dealer/buyer has indications of red flags:

We are compelled to conclude, however, that the sale from Malmberg to the defendant was unlike the vast majority of art transactions. The defendant had good reason to be concerned that [Kerstin Lindholm’s husband] might have claims to the painting. Several courts have held that, under such circumstances, a handshake and an exchange of invoice is not sufficient to confer status as a buyer in the ordinary course.14

• • •

We agree with these courts that a merchant buyer has a heightened duty of inquiry when a reasonable merchant would have doubts or questions regarding the seller’s authority to sell. We further conclude that the steps that a merchant must take to conform to reasonable commercial standards before consummating a deal depend on all of the facts and circumstances surrounding the sale.15

• • •

Because of his concern that Lindholm (Kerstin Lindholm’s husband) might make a claim to Red Elvis, the defendant took the extraordinary step of hiring counsel to conduct an investigation and to negotiate a formal contract of sale on his behalf. He also insisted on and obtained a formal contract containing representations and warranties that Malmberg had title to the painting. In addition, during the course of the investigation, the defendant’s counsel conducted both a lien search and an Art Loss Register search that revealed no competing claims to Red Elvis. Although the defendant was cautioned that the searches provided only minimal assurance that Malmberg had good title to the painting, such searches typically are not conducted during the course of a normal art transaction and, therefore, provided the defendant with at least some assurance that Lindholm had no claims to the painting.16

• • •

Moreover, the evidence presented at trial established that the reason that documentary proof of ownership customarily is not required is to protect the confidentiality of the owner and the buyer. Requiring a merchant buyer to obtain an invoice or other supporting documentation proving the seller’s ownership would, in every transaction, destroy the privacy and confidentiality that buyers and sellers have come to desire and expect. Accordingly, only when circumstances surrounding the sale cast severe doubt on the ownership of the artwork are merchant buyers required to obtain documentary assurance that the seller has good title.17

Critique of Connecticut Court’s Standard of Inquiry Imposed on Art Dealers in the Face of Warning Red Flags on Good Title

It is worthwhile to examine in detail the analysis by the Connecticut Supreme Court in Brant in arriving at “a heightened duty of inquiry when a reasonable merchant would have doubts or questions regarding the seller’s authority to sell.”

As the Court describes it, the art dealer “took the extraordinary step of hiring counsel to conduct an investigation” and negotiate a “formal contract of sale”…“containing representations that Malmberg had title to the painting,” and conducted a lien search and an Art Loss Register search that revealed no competing claims. The Connecticut Court concluded that it is “only when circumstances surrounding the sale cast severe doubt [emphasis added] on the ownership of the artwork are merchant buyers required to obtain documentary assurance that the seller has good title.”

Although the UCC makes a warranty of good title expressly part of an art sale between dealers, one might well ask why negotiating a written contract for a US$4.6 million painting, is an “extraordinary step.” And, as to lien searches conducted by the art dealer/buyer, such searches are chiefly useful to discover publicly filed liens or claims against a named owner, not to discover whether the named owner has good title to the art.

In short, the duty of inquiry placed by the Connecticut court demanded not much (or, indeed any) more from the dealer/buyer than a dealer would have customarily undertaken in the complete absence of red flags raising concerns about ownership of the art being purchased.

It should be kept in mind, too, that Brant knew very well that Kerstin Lindholm was the owner (before her supposed sale to Malmberg), so that, had Brant received a letter signed by Kerstin confirming she had owned Red Elvis and a sale invoice from Kerstin to Malmberg, no confidential matters would have been disclosed. Malmberg’s explicit refusal to furnish the owner’s letter and invoice should have triggered more of an investigation on the part of Brant as dealer/buyer than the Connecticut court required.

If Carroll Had Sold the Art to a Collector Before Earl Davis Could Recover It, He Could Not Recover His Art From the Collector.

It would be interesting, hypothetically, to follow the Davis transaction a little bit down a buyer chain. That is, suppose the dealer, Carroll, in the ordinary course of business, had sold the Davis-owned-art to a good-faith purchaser, (non-dealer) and the owner, Earl Davis, had made a claim against this collector for return of his art. Article 2 of the New York Commercial Code which governs the right to transfer title in goods provides “A person with a voidable title has the power to transfer a good title to a good-faith purchaser for value.” Salander had such a voidable title, that is, “…Salander possessed “voidable, as opposed to void title, and [could] pass good title” to a buyer in the ordinary course of business.”18 Since Carroll was not held to be such an ordinary-course buyer, Carroll too, had voidable title with the result that, if Carroll, in turn, had sold to a good faith buyer (who was not a dealer), that buyer/collector would have gotten good title and the owner, Earl Davis, could not have recovered his art from the collector.

New York, NY
January 2014

Ronald D. Spencer
Carter Ledyard & Milburn LLP

Notes

1 Article 2, New York Uniform Commercial Code.
2 Porter v. Wertz, 53 N.Y. 2d 696, 698 (N.Y. 1981).
3 Davis v. Carroll, 937 F. Supp.2d 390 (S.D.N.Y. 2013) (citations omitted).
4 DeMott, Artful Good Faith: An Essay on Law Custom and Intermediaries in Art Markets, 62 Duke L. J. 607, 634 (2012).
5 Davis, slip op. at 53.
6 Id. at 55.
7 Lindholm v. Brant, 283 Conn. 65, 925 A.2d 1048 (2007).
8 Davis, slip op. at 64.
9 Id. at 66.
10 Id. at 66.
11 Id. at 70.
12 Id. at 73–75. Both reports were filed under seal, and, unhappily, are not available on the public record, but Judge Oetken extensively quotes the two expert reports.
13 Lindholm v. Brant, 283 Conn. at 70, 925 A.2d at 1052.
14 Id., 283 Conn. at 80, 925 A.2d at 1057.
15 Id., 283 Conn. at 82, 925 A.2d at 1058.
16 Id., 283 Conn. at 83, 925 A.2d at 1058-59.
17 Id., 283 Conn. at 84-85, 925 A.2d at 1059.
18 Davis, slip op. at 50.

Editor’s Note

This is Volume 4, Issue No. 3 of Spencer’s Art Law Journal. This issue contains two essays, which will become available by posting on artnet, starting in February 2014.

The first essay (Getting Good Title to Art You Purchase, as (a) a Collector, (b) an Art Dealer, or (c) a Bit of Both) addresses the title investigation required when there are “red flags” about good title.

The second essay (Sometimes it’s Not Too Late to Recover Your Art. Laches: The Stealth Defense Revisited) updates our analysis of the defense of laches available to a holder of art against a claim for return from the original owner.

Three times each year (since 2010), issues of this journal address legal questions of practical significance for institutions, collectors, scholars, dealers, and the general art-minded public.

— RDS