The onset of the global COVID-19 pandemic in early 2020 promoted significant change in the art market, including an abrupt shift to digital-only forms of engagement following the cancellation of in-person art fairs, gallery exhibitions and auctions. Compared with other sectors, the art market is seen as opaque; art transactions are often conducted privately and/or informally by commercial players, of which some of the largest and most influential are privately-held rather than publicly-traded.

Market uncertainty from pandemic-induced disruptions was exacerbated in March 2020, when news broke that prominent auction platform Paddle8 had sought Chapter 11 bankruptcy protection. This was compounded further in May 2020, when an independent audit of another leading auction house noted "substantial doubt" about the company's ability to continue as a going concern. 

Against this backdrop, sophisticated consignors sought greater clarity on the potential impact of bankruptcy on their artwork consignments. 

This was particularly the case for consignors with fiduciary obligations, such as trustees, executors, family office heads, and private bank art advisors.

In the United States, one of the bankruptcy law's fundamental aims is to protect creditors from interests in a debtor's property that could not reasonably have been known to them: so-called "secret liens." If a consignor has not placed a consignee's creditors on notice of the former's interest in the consigned property and the consignee sees bankruptcy protection, the consigned property may be deemed part of the bankruptcy estate. In this scenario, the consignor effectively loses title thereto and may be relegated to general creditor status, potentially limiting the consignor's recovery to a pro-rata distribution (typically at a pennies-on-the-dollar rate) following the liquidation of the bankruptcy estate assets. 

The risk of this worst-case scenario can be mitigated under certain circumstances.Fiduciary consignors are arguably obligated to explore common-law, statutory, and contractual protections for their consigned property, the availability of which depends on several factors, including the type of consignor, the type of consignee, and the location of the consignment. 

Common-law protections

  • US bankruptcy courts apply state law to determine the nature and extent of a debtor's interest in property. Some states have developed relevant common law precedents pertaining specifically to auction consignments.
  • For example, New York common law imposes an agent-principal relationship between auctioneers and their consignors, which continues through the property's sale until the auctioneer has remitted the net proceeds due to the consignor. Under this precedent, if an auctioneer does not segregate consignor proceeds, the consignor may benefit from the court's imposition of a constructive trust on these funds. Similarly, an auctioneer's agency may be presumed under New Jersey law, resulting in sale proceeds being held in constructive trust for the consignor's benefit even when the parties' consignment contract is oral.
  • However, common-law precedent varies from state to state, and other precedents are less favorable to consignors than in New York and New Jersey. For example, bankruptcy courts applying Nebraska and Oregon law have found that the agent-principal relationship between an auctioneer and a consignor may end when the consigned property is sold, if the parties' written agreement does not require segregation of consignor proceeds. In these cases, consignors are not entitled to constructive trusts and instead of recover (if at all) alongside other general creditors. 

Read the transcript of the full discussion on page 308 of the Deloitte Art & Finance Report 2021. The report may be accessed through the link below.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.