This essay addresses the, by-now-common-concern of an art owner’s consigning to a gallery for sale and failing to file a Uniform Commercial Code financing statement giving public notice of the ownership/consignment. However, in a bit of good news for art owners, at least one court has recently decided that a trustee in bankruptcy for the gallery must prove that the gallery’s creditors did not know the gallery was selling consigned art.

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Three years ago in these pages,¹ we discussed the perils that await a consignor of art to a gallery who fails to perfect his ownership interest by filing a Uniform Commercial Code financing statement with the appropriate jurisdiction. A recent case in the Salander-O’Reilly Gallery bankruptcy has brought this issue into vivid relief.

To briefly recap, the Uniform Commercial Code (UCC), in the interests of fulfilling its mission to ease the flow of goods in commerce, attempts to strike a balance between the interests of those who put goods into the stream of commerce and those who may deal with them along the way. In the same way that a lender secures his rights in collateral by filing a financing statement to give notice to other potential creditors that assets have been pledged as security for his loan and thus are not available to secure the borrower’s obligations to other creditors, a consignor is well-advised to protect his ownership interest in the art he delivers to his consignee by filing the same financing statement form (the form in use by virtually all states has a box that can be checked to indicate whether the interest of the secured party is that of a consignor). Failing to do so may result in creditors of the consignee/dealer acquiring interests in the consigned goods superior to those of the consignor, and thus effectively depriving the consignor of his ownership of the goods.

Jacobs v. Kraken Inv. Ltd. (In re Salander-O’Reilly Galleries, LLC).² The bankruptcy judge overseeing the Salander Gallery case was faced with the exact situation described in our earlier essay: a consignor who had delivered a Botticelli painting to the Salander Gallery under a consignment agreement had failed to file a financing statement, and became locked in a battle with the bankruptcy trustee over the priority of interests in the painting. Because no financing statement had been filed, the court held that the consignor did not necessarily have a right to the return of his work, but, at the same time, gave the consignor a possible leg up in its quest.

When there is no financing statement filed, the court is left with the task of determining whether the arrangement between the owner/consignor and dealer is in fact a “consignment” as defined by the UCC. The elements of UCC consignment include a determination that the consignee is a merchant; that is, a person customarily engaged in selling goods of the type consigned (no question about that in the case of an art gallery); a finding that the goods are not “consumer goods” (a tougher call when the consignor is an individual collector, but not in this case, where the consignor was an investment firm); and, most importantly, a requirement that the consignee “was not generally known by its creditors to be substantially engaged in selling the goods of others.” The framers of the code determined, as a matter of commercial policy, that if creditors dealing with a merchant know that he is regularly selling goods on consignment, then the need to file a publicly available financing statement is eliminated since that would be largely duplicative of what most everyone involved already knew. Only if the dealer’s creditors would not be expected to know the nature of the dealer’s business is a filing necessary to protect the consignor’s interest.

Because the owner/consignor in this case failed to take the few minutes and few dollars it would have cost to file a financing statement, the owner will now be faced with an evidentiary hearing on the issue of whether the elements of a UCC consignment had been met. But there is one relative bright spot for the consignor: although courts are split on the issue, the Salander court decided (without much discussion, but generally referencing the principle that the party arguing the affirmative side of a proposition has the burden of proof as to that proposition) that the burden would be on the trustee to prove the elements of the consignment; that is, the trustee would have to prove that the gallery’s creditors did not know that the gallery was selling consigned goods.

In our earlier essay in the Spring 2011 Issue of the journal, we identified this burden as belonging to the owner/consignor, and there are indeed cases that have placed the burden there. In the Salander case, the court went the opposite way. So, here, the trustee will be faced with the task of assembling all the Salander Gallery’s creditors (consignors who are owed the proceeds of sales, banks, utility companies, and incidental creditors (such as fast-food vendors), and allowing the court to determine how many of those creditors would be expected to know that the gallery was mostly selling consigned works. Whatever the outcome, the owner/consignor, by failing to take a simple step to protect its rights, has already lost a significant battle. Whether or not the owner/consignor also loses the war, this contest starkly illustrates the ease by which any litigation could have been avoided in the first place.

New Developments

In recent months, some commentators have suggested that filing a financing statement is less of a cure than it seems, because the elements of a consignment as defined by the UCC include the “not generally known” element, and therefore if the proof shows that a majority of creditors were aware that the gallery was selling primarily on consignment, the financing statement may well be ineffective or unnecessary. But the “not generally known” prong is not as easily brushed aside as these commentators make it appear. While it is undoubtedly true that a significant majority of people involved in the art world know that most dealers sell substantially, if not exclusively, on consignment, the same cannot be said for those whose only contact with the art world may be that a gallery is a customer of theirs. Should companies that sell office supplies or deliver fast food or supply electricity, bottled water, or telephone service to a gallery be chargeable with the way in which a gallery conducts its business?  If not, and if, as is often the case, such “non-art” businesses make up the bulk of a gallery’s creditors (by number of creditors, not by amount of debt), then it may well be that a seller’s consignment agreement may be held to be one that meets the UCC definition.

Of course, the most striking aspect of this line of commentary is that it fails to appreciate that filing a financing statement is a no-lose proposition. If it turns out that a majority of a dealer’s creditors knew that the dealer was selling on consignment, then perfection by filing would not be necessary, and the worst case scenario for the consignor would be that he spent a small amount of money to have a financing statement prepared and filed that turned out not to be necessary. But if the “not generally known” element is satisfied, and the consignor hasn’t filed, he will have lost the preferred position of a secured creditor. Therefore, filing takes away any incentive a bankruptcy trustee or other party would otherwise have to litigate the “not generally known” element.

The other limiting element of a UCC consignment is that the works delivered to the dealer must not be “consumer goods.” Beyond reciting the standard definition that consumer goods are those which are acquired for “personal, family, or household purposes,” the code offers no guidance. But uncertainty over whether a work of art consigned to a dealer will ultimately be determined to be a consumer good is not a reason not to file. As pointed out above in connection with the “not generally known” element, the worst case scenario is that a filing will turn out not to be effective if the consigned works are determined to be consumer goods. But if they are not so determined—and there are many people in the art world who collect, buy, and sell on a regular enough basis that their holdings may be determined not to be consumer goods—then the failure to file can have grave consequences indeed.

In fairness, many of the commentaries that play down the effectiveness of filing financing statements do so in the context of a call for new legislation that would remove many of the uncertainties associated with the current system—certainly a worthy goal. But until new legislation happens, filing is the best way to guard against an unanticipated loss of secured party status, and give a consignor maximum peace of mind.

New York, NY
August 2014

Aaron R. Cahn
Carter Ledyard & Milburn LLP

Notes

¹ 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. 1 (Spring 2011).

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

Editor’s Note

This is Volume 5, Issue No. 1 of Spencer’s Art Law Journal.

As noted in earlier volumes of this journal, the legal structure we call art law (an amalgam of personal property law, contract, estate, tax, and intellectual property law) supporting the acquisition, retention, and disposition of fine art, often fits uneasily with art market custom and practice. The result is that 21st-century art market participants are frequently unsure of their legal rights and obligations.

The two essays in this Spring/Summer Issue deal with selling your art by consignment. The first essay looks at the issues involved with consigning your art to a dealer or auction house. The second essay deals with making sure to get your art back if your consignee gallery goes bust.

Three times a year, issues of this journal address legal questions of practical significance to collectors, dealers, scholars, and the general art-minded public.

— RDS