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This article was included in issue 1 of the Finance Brief.
In recent years, with volatility in the stock and property markets, borrowers are increasingly choosing to offer as collateral for loans a different kind of asset - the type found hanging on their walls. In this article we look at the common issues that arise when lenders are considering whether to finance a loan secured on art.
The art market stood up reasonably well in the financial turmoil and the UK continues to be a major player in the global market for works of art. According to the European Fine Art Foundation, the UK currently holds a 22% share of the market and only the US (the biggest player) and China have a greater market share.
This area of lending has developed significantly in recent years and some banks and financial institutions have begun to view art as a potentially attractive type of collateral, particularly as values in the market for many categories of works of art have either stayed static or risen during the crisis years.
Lenders choose to structure loans secured by works of art in various ways, taking security over a specific work of art, several works of art or a whole collection. Some lenders have taken a more innovative approach. For example, ‘The Guardian’ recently reported that renowned photographer Annie Leibovitz secured a loan against the copyright, negatives and contract rights in every photograph she has ever taken or will ever take.
We briefly consider below the most common issues that arise for lenders, whatever the structure of the loan.
Title
A key issue is the title to the work of art offered as security. As part of the due diligence, a lender will need to be assured that the borrower is the legal and beneficial owner of the work or works of art in question. Evidence of title may be built up from the wills, trust deeds, deeds of gift, purchase invoices and the like. Where the chain of title is incomplete, it may be possible for the borrower to allay the lender’s fears by demonstrating a good faith purchase that took place at least six years prior to the proposed transaction. As additional comfort, some insurance companies may be prepared to provide insurance against the risk of disputed or faulty title.
A lender should also check whether or not the work of art is registered with any register of stolen art, such as the Art Loss Register in the UK.
Authenticity
Authenticity is the second obvious issue, particularly given that the value, say, in a painting, rests upon it being a work of a particular artist. Provenance is everything with works of art. Evidence of authenticity should be fully documented. In the absence of such documentary evidence, advice should be sought from an acknowledged expert. The loan documentation should also contain warranties and/or indemnities which would leave the borrower liable for any inadequacy in the security should the work of art prove not to be authentic in the event that any security is called upon. Obviously if the borrower is an SPV such warranties and indemnities may be of little use in practice unless backed by a guarantee from an ultra high net worth individual.
Valuation
Liquidity will be an important factor for a lender to consider before accepting the relevant work of art as collateral. The value of a work of art may fluctuate over time and six-monthly valuations are advisable. The value of the work of art and the availability of a ready market will be affected by factors such as the work of art itself, the status of the artist and the desirability factor of the artist’s works in the market. A further factor that may affect the value of a work of art is whether any export restrictions affect the relevant work of art or whether it is considered to be part of a country’s national heritage.
Form of security
Under English law, security may be in the form of a mortgage (legal or equitable), charge (fixed or floating) or pledge. A key issue when deciding the appropriate form of security will be where the art is stored, whether it will be stored by or on behalf of the lender or left in the possession of the borrower. Given the very nature of a work of art and its aesthetic appeal, parting with a work of art may not be an attractive option for the borrower, but the legal and practical advantages of this from a lender’s perspective are obvious. A lender requiring watertight security over a work of art is best advised not to leave the work of art in the borrower’s control, due to its movable nature as an asset. If the lender has possession of the asset (i.e. in its vaults or in a gallery or archived where it is held to the lender’s order by a third party), it could take a pledge over it.
Where security over art is given by an individual, the Bills of Sale Acts 1878-1882 will generally mean that it will be impracticable to take security over it unless by a pledge. This is because unless the relevant work of art falls within one of the very limited statutory exemptions, the mortgage or charge over “personal chattels” owned by an individual or partnership will be subject to the Bills of Sale Acts and the security over the work of art will be void unless it is in precisely the form prescribed by, and is registered under the Bills of Sale Acts. In practice, the formalities are so rigid (e.g. a floating rate of interest cannot be secured) that taking a mortgage or charge over works of art from an individual or partnership, whilst possible, is seldom practicable or attractive to lenders.
It is possible to avoid the difficulties caused by the Bills of Sale Acts by taking security in the form of a pledge. A pledge requires the actual or constructive delivery or possession of the item to the lender, with the intent to create a pledge. The delivery may be constructive in that a third party may be in possession of the art, but such third party will have given an undertaking to the lender to hold the art to the order of the lender (a process known as “attornment”).
It is important to note that, where a loan secured by art is extended to an individual or a partnership of up to 3 people, the Consumer Credit Act 1974 (as amended) will regulate the loan, unless an exemption applies that would take the loan outside the scope of the protection of the Consumer Credit Act. All the usual consumer credit regulation considerations should be taken into account in this regard.
Art “sans frontieres”
Additional issues arise where the work of art is located abroad. In addition to the usual issues such as conflicts of laws, jurisdiction, validity and enforceability of documentation that arise in international transactions, local legal advice will need to be taken to check that the lender’s security over the work of art will be effective in the foreign jurisdiction – it may not be. Many jurisdictions are hostile to any “non-possessory” forms of security, i.e. those where the borrower is left in possession of the work of art, given the increased risks associated with this.
Exhibiting art
If, during the life of a loan, the borrower wishes to lend a work of art which is used as collateral for display at an exhibition, and the lender agrees, the lender should be satisfied that its security will remain effective, particularly if the galley or museum is located outside of England (in which case, the issues outlined in the Art “sans frontieres” section above will be relevant). In addition, the lender should ensure that the work of art will be held securely by the gallery or museum. Insurance will also be important. Ideally, the insurance policy would be in the joint names of the lender and the borrower.
Enforcement
Specialist advice should be obtained by the lender when it chooses to realise its security over the work of art. In certain “debtor-friendly” jurisdictions, recovery may be difficult and time-consuming. In addition to issues arising under any applicable foreign law, issues in respect of any required export licences, pricing (should the work of art be sold), valuation, whether the work of art should be sold at auction rather than a private sale should also be considered by the lender.
Conclusion
We have outlined in this article some of the key issues which lenders should consider when deciding whether to accept a work of art or portfolio of art as security for a loan. Whilst the use of art as collateral has not been a traditional method by which lenders have chosen to secure lending, business practices are changing to keep up with emerging opportunities, and new ways of raising money on the security of works of art and associated intellectual property rights are being considered by some major lenders. In the words of Andy Warhol, “making money is art and working is art and good business is the best art”. With the right due diligence and effective, carefully drafted loan and security documentation, it certainly would be possible for art banking to be a lender’s good business – the best kind of art.