More than seven years is a long time to wait for a loaned painting to be returned. But after such a long wait, Sandro Botticelli’s Madonna and Child (1485) is being returned to its owner, Kraken Investments Limited (Kraken).   Kraken had consigned the painting to a gallery for sale, but the gallery’s bankruptcy intervened. For a time, it seemed that the painting would never be returned to Kraken, and that instead the gallery’s lender’s security interest would take priority, leaving Kraken within only an unsecured claim in the bankruptcy case. That dispute has only recently been resolved, with a reversal giving the Botticelli back to Kraken. [See Kraken Investments Ltd. v. Jacobs (In re Salander-O’Reilly Galleries, LLC), Case No. 14-cv-03544 (S.D.N.Y. Nov. 25, 2014)] It has been, for many, a cautionary tale.

Recent years have seen the collapse of several major art galleries, some from financial conflicts with lenders or other parties, other from shady business practices and outright fraud. Perhaps the most spectacular was the collapse of Salander O’Reilly Galleries, LLC (SOG). In 2007, SOG was facing numerous lawsuits alleging that SOG and its founder and principal Larry Salander (Salander) had double-pledged works, and had sold others but failed to pay their consignors the proceeds from the sales. Several of SOG’s creditors filed an involuntary bankruptcy petition against the gallery in the United States Bankruptcy Court for the Southern District of New York (the Bankruptcy Court), which was subsequently converted to a voluntary petition under chapter 11 of the Bankruptcy Code. At the time of the bankruptcy petition, SOG possessed more than 4,000 artworks, some of which it owned (in whole or in part), but many were not owned by SOG, and had been consigned to SOG by artists, artists’ estates, collectors, or other dealers. SOG’s victims included Earl Davis, who consigned more than 90 of his father, Earl Davis’s paintings (Davis v. Carroll) , Robert De Niro, Jr., who consigned 12 of his father, Robert De Niro, Sr.’s paintings, and John McEnroe, who had entered into a joint-ownership arrangement with Salander to acquire two paintings by Arshile Gorky, only to find himself a victim of double-dealing. The fall of SOG presents, in microcosm, almost every possible way in which a secured transaction, consignment or entrustment of art or cultural property can go awry, and it spurred amendments to the art consignment provisions of New York’s Art and Cultural Affairs Law. [1]

Kraken consigned the painting to SOG in May 2006, agreeing that SOG would exhibit the painting for sale for a period of up to one year. The asking price for the painting was to be $9.5 million. The consignment agreement provided that Jersey law would govern and all disputes would be submitted to arbitration. When the consignment period expired, SOG asked for a brief extension, to which Kraken consented. After that extended period expired, Kraken demanded that SOG return the painting. SOG did not return it.

After SOG’s bankruptcy case commenced, several factors complicated Kraken’s efforts to have the painting returned. First, and most crucially, when Kraken consigned the painting to SOG, it failed to comply with the provisions of New York’s Uniform Commercial Code (the UCC), which require the consignor of goods (including art and cultural property) to file a UCC-1 financing statement, giving public notice of that interest. Such public notice “perfects” the consignment and makes it enforceable against third parties. Under the UCC, in a consignment, the consignee (here, SOG) is “deemed to have rights and title to the goods identical to those the consignor [Kraken] had or had power to transfer.” [N.Y. U.C.C. Law § 9-319(a)]  Kraken, as the consignor, has only a purchase-money security interest in the Botticelli. [See N.Y. U.C.C. Law §§ 1-201(37); 9-103(d)] Kraken could have perfected this purchase-money security interest by filing a financing statement, thereby preventing SOG’s other creditors from obtaining superior rights to the Botticelli. Unfortunately, that is the step that Kraken had not taken.

Second, Bankruptcy Code § 544 provides that a bankruptcy trustee has the rights of a lien creditor and is empowered to avoid unperfected liens. (11 U.S.C. § 544) This allowed the SOG bankruptcy trustee (the Trustee) to have priority over Kraken’s unperfected consignment interest in the Botticelli. Third, the Trustee additionally stood in the shoes of SOG’s secured lender, whose loan to SOG was secured by a security interest in substantially all of SOG’s assets. The lender had assigned its lien to the Trustee.

Kraken filed a motion in the bankruptcy court for relief from the automatic stay and authorization to arbitrate its dispute with the Trustee under Jersey law, as the consignment agreement required. The Bankruptcy Court denied Kraken’s motion, noting that neither the Trustee nor the lender was a party to the consignment agreement, and so they were not bound by its choice of law provision. [See In re Salander O’Reilly Galleries, 453 B.R. 106, 132 (Bankr. S.D.N.Y. 2011)] On appeal, the United States District Court for the Southern District of New York (the District Court) upheld the Bankruptcy Court’s decision, concluding that:

The District Court’s decision was not a final disposition of the date of the painting, but Kraken’s chances of getting the painting back looked increasingly dark.

Kraken filed both an art claim (pursuant to the Bankruptcy Court’s art claims protocol), asserting its ownership claim to the Botticelli, and a proof of claim, asserting its $9.5 million claim for consigned artwork. In January 2013, the Trustee filed an objection to both claims. Both Kraken and the Trustee filed motions seeking summary judgment, but the Bankruptcy Court denied both motions. [See Jacobs v. Kraken investments Ltd. (In re Salander O’Reilly Galleries, LLC), 506 B.R. 600 (Bankr. S.D.N.Y. 2014).] Two elements of the parties’ cross-motions and the Bankruptcy Court’s decision denying took on significance in the ultimate resolution of this dispute. For his part, the Trustee sought summary judgment solely based upon his role as assignee of the secured lender’s rights, and expressly disclaimed that he was seeking to assert any lien creditor rights under Bankruptcy Code § 544(a). [2] The Trustee asserted, and the Bankruptcy Court agreed, that the lender’s loan agreement gave it a security interest in all of SOG’s property, including consigned property. [See Id. at 611.]  Kraken, for its part, argued instead that the loan agreement excluded consigned works from the lender’s pool of collateral. On appeal to the District Court, this became the decisive issue.

On Nov. 25, 2014, more than seven years after the SOG bankruptcy case began, and nearly eight and a half years after Kraken consigned the Botticelli to SOG, the District Court reversed the Bankruptcy Court’s denial of Kraken’s motion for summary judgment, stating that:

The District Court remanded the matter to the Bankruptcy Court with instructions to enter summary judgment in favor of Kraken. In the end, what for a time appeared to be one of the most dramatic and best-publicized losses suffered in the SOG case turned on a question of contract interpretation.

However, the lesson of the Kraken Botticelli case is not that art consignors should hope that their galleries either do not end up in bankruptcy or that the galleries’ secured lenders’ collateral only extends to artworks actually owned by the galleries. Rather, it is that consignors need to protect themselves against the entirely forseeable and wholly unnecessary risk that Kraken took in failing to file a financing statement to perfect its consignment. Art consignors should not be lulled into complacency by the informal, relationship-based norms of art transactions. They need to be aware of (and comply with) the rules that are in place to protect them, just as they would in any other type of business transaction. Had SOG’s loan agreement read differently, Kraken’s Botticelli might not have come home.

[1]Following SOG’s collapse, New York amended its art consignment statute. The amendment (i) requires dealers and art galleries to maintain artist sale proceeds in segregated accounts, separate from the dealer’s/gallery’s operating accounts, (ii) provides that an artist’s own work consigned to a dealer or gallery and the proceeds from the sale of such works are insulated from attachment by the dealer’s/gallery’s creditors, (iii) provides for criminal penalties for dealers or galleries that fail to comply with their statutory obligations, and (iv) includes fee-shifting provisions, entitling artists to receive attorney’s fees in actions to enforce their rights under the statute. See NYACAL § 12.01. up

[2] See Jacobs v. Kraken investments Ltd. (In re Salander O’Reilly Galleries, LLC), 506 B.R. 600 (Bankr. S.D.N.Y. 2014). at 612. Kraken had argued that the consignment agreement with SOG had terminated pre-petition, and pointed to the decision of the United States Bankruptcy Court for the District of Delaware in In re Valley Media, Inc., 279 B.R. 105, 123 (Bankr. D. Del. 2002), in which that court had stated that nothing in the Uniform Commercial code “affected the ownership rights of the consignor in relation to the consignee.” The Bankruptcy Court acknowledged that “As between the Debtor and Kraken, the Court agrees that Kraken owns the Botticelli. . . . However, the claims made by the Trustee in this adversary proceeding are based on provisions of the Uniform Commercial Code that allow creditors of a consignee such as the Debtor to obtain rights in consigned goods that are superior to those of the actual owner of the goods if the owner fails to take steps to perfect its interest.” Jacobs v. Kraken investments Ltd., 506 B.R. at 607. up