Leasing as a finance tool for artworks requires specific legal scrutiny for four reasons:
- Purchase Option
The basic idea behind leasing is to offer the lessee the opportunity to purchase an artwork without incurring any financial risks as a lessor. This implies that the purchase option at the end of lease period should allow the lessor to reinstate the capital invested. However, the value of an artwork is not based on its intrinsic value, the value is entirely based on buyer and sellers’ personal interests and market trends. When structuring a lease, the lessor will have to take into account certain mutually beneficial arrangements between lessor and market players. If the fair market value of the artwork has increased, the lessor has no risk and the lessee wil most certainly exericse the option. The gallery, however, will not be able to prevent possible untimely resales whcih would run counter its intent to cultivate a longer-term market confidence. If the fair market value of the artwork declined (in comparison with the initial purchase price), the lessor is not adequately protected and risks to incur a financial risk if the purchase option is not exercised. To remedy both problems (price decline and decrease) and provided the artwork was initially purchased on the primary markt, it would be advisable to obtain a repurchase obligation from the art dealer. If the price declines, the art dealer would most certainly be interested in a repurchase in order to prevent a negative market impact on the pricing of the artists’ artwork. If the price would be in a bubble, the gallery would be able to buy back at a lower price and continue cultivating a longer-term market confidence. In case the price increased but was not subject to unsustainable bubble-like prices, the gallery could allow the exercise of the option by the lessee and a possble resale on the market.
Another related issue is the determination of the value of the artwork. Most leasing companies set the value for artworks without a secundary market at the wholesaleprice (i.e. the retail price less the commission for the art dealer). For artworks who are traded on the secundary market it is more difficult to determine a FMV.
- Authenticity – Legal title
A lessor wants to obtain legal title as a security in case the lessee defaults. Legal title in relation to an artwork should be read in conjunction with the authenticity of the artwork. If the artwork is not authentic (i.e. there is a discrepancy between the description of the work and the actual state of affairs), the lessor runs a severe financial risk. It is therefore necessary to obtain an express warranty from the lessee that the work is authentic. In practise, this means that the author, nature, size, of the work should contractually be agreed upon. This process is called in art terms, the process of attribution an artwork. Moreover, it is not sufficient to obtain a clear attribution. The legal rules governing this process do not provide sufficient guarantee. Even with a clear attribution, the lessor migth be held to a certain investigative duty. In other words, it is important, like in an M&A transaction to perform a due diligence on the artwork and negotiate specific disclosures, materiality, sandbagging, etc.
- Third-party liability
On the art market there are unfair dealers. It is therefore not uncommon that stolen art is being traded or resold to thrid parties without having title on the artworks. The legal doctrine on ‘third party liability’ can be applied to such practices. The likelyhood that a claim is succesful depends of the fact of the lessor is capable of prooving that the third party was aware of the fact that title belonged to the lessor. As there is no central register, such proof is difficult iunless the practice of labelling the artwork (as is done in the context of leasing of machinery) is used.
- Application of securities law to art purchases (through leasing structures)
Art leasing structures contain sometimes features that are typical for art investment vehicles: repurchase obligations which shield the lessor against unexepected downturns in the market, unbundling of investment value (lessor) and aesthetic value (lessee) and the artwork as borrowing base in combination with installment payments. These features of art purchases could be regarded as a private placement and therefore be subject to securities law.
(image “All Eternal Love” by artist KUSAMA – rechtszaak tussen Fine Art Partners GmbH en kunsdealer Philbrick).