Establishing Clear Title to Works of Art

Establishing Clear Title to Works of Art

Ownership issues may lower the value

The landscape of title disputes in the art world is changing in the frequency, severity and complexity of these claims. National and international news publications are raising awareness of ownership challenges in the art market on a daily basis. Prior to 1988, when the second wave of Nazi-era restitution claims were raised, scholars believed that traditional provenance research was enough to verify ownership. But, such research only identifies potential gaps in physical possession of the works, not actual theft. More importantly, it doesn’t address the ultimate question of clear legal title. In fact, only 25 percent of ownership claims in the art market are related to historical and contemporary theft; 75 percent are based on traditional liens and encumbrances and more general questions of legal authority to sell. 

Issues involving ownership of the art could affect its value. When your client hires an appraiser before selling, gifting or donating art, the appraiser should take the ownership risks into consideration in determining the value. Here’s what you need to know about dangers involving title, the appraisal process and how title insurance can help your client minimize the risk.   

Non-Theft Title Risks

Because most title claims aren’t theft-related, there are significant consequences when creating and implementing tax, trust, estate plans and financial arrangements around art (such as art lending and funding life insurance contracts). When these consequences are coupled with the lack of transparency and transactional standards in the art market, it becomes nearly impossible to navigate that morass. The most common non-theft title risks or claims include:

Authority to sell: A claim against a purported seller as to whether that person/entity has the authority, as owner or agent of the owner, to sell or transfer ownership of the property. 

Multi-collateralization of art. An owner/borrower uses his property to secure a loan with multiple creditors without full disclosure of prior, existing liens.   

Family disputes. Personal property disputes involving inheritance, divorce or other family matters. 

Gallery conversion cases. Cases involving galleries that sell a consignor’s art without paying the consignor or in violation of the consignment agreement, such as without the consignor’s consent or below a minimum agreed-on price point.

Government seizure. The forcible taking of property by government law enforcement because, for instance, the property was stolen or associated with violations of money laundering or source country patrimony laws. 

Import/export. A claim that movement of art across borders violated regulated import and export of goods internationally. 

Loans/gifts to museums. A dispute about whether property in a museum’s possession was loaned (for exhibition only) or gifted (ownership transferred to the museum).

Storage disputes. Whether a storage company has the legal right to sell property in a unit if storage fee payments are delinquent for a certain period.

Real Estate Comparison

A comparison to real estate transactions highlights the challenges of regarding art and collectibles as an asset class when clear legal title isn’t anchored. In the real estate market, which is transparent, legal title must be transferred by a deed and recorded in central registries. All transactions are recorded publicly, and in most states, the deeds are recorded at the County Recorders or Recorder of Deeds Office where the real estate is located. Abstracts of title are created; that is, the condensed history of the title for a particular parcel of land, including a summary of the original grant, all subsequent conveyances, encumbrances affecting the property and a certification by the abstractor that the history is complete and accurate. In the United States, the abstract of title furnishes the raw data for the preparation of a policy of title insurance. The closest parallel to this system in the art market is the preparation of catalogues raisonnés, but these compilations are subject to the accuracy (or inaccuracy) of information gathered piecemeal in the industry. In addition, any system of information that’s inherently a snapshot only of changes of possession (confused in the art world as changes of ownership) is flawed because many things can occur around personal property that’s mobile, unlike real estate, which is immobile and around which a public recording system of change of ownership is based. 

The art market doesn’t use a deed of conveyance but rather (hopefully) a receipt or a sales contract for a work of art; still, there’s no required public registration of art. The closest document to an abstract is a listed provenance; however, provenance is only the chronology of ownership, custody or location of an object with the primary purpose to provide contextual, historical and circumstantial evidence for its creation. A provenance isn’t a legal document, and authors don’t certify that the provenance is complete and accurate. Understandably, due to the lack of transactional documentation and the gaps in information, it’s not the role of an appraiser or any other art professional to certify a provenance similar to an abstractor of real estate. Further, the general opacity of the art market and the privacy concerns of many collectors impede the ability of appraisers to do so.

USPAP

Appraisal organizations and the Internal Revenue Service adopted Uniform Standards of Professional Appraisal Practice (USPAP) standards. These standards begin to align the appraiser’s responsibilities closer to those of a title abstractor. The changes in USPAP for 2014-2015 clarify a number of points and expand the requirements for appraisers to stand behind their appraisals, potentially creating significant liability. The following analysis of USPAP is limited to issues around establishing title to works of art. 

Three Rules

When considering title issues while making an appraisal, your client’s appraiser must comply with three USPAP rules: (1) the scope of work rule, (2) the competency rule, and (3) Standards Rule 7 (use of extraordinary assumptions). 

Scope of work rule. The appraiser must: (1) identify the problem(s) to be solved, (2) be prepared to demonstrate that the scope of work is sufficient to produce credible assignment results, and (3) stand behind those results. As part of the scope of work, the appraiser must identify the type and extent of data researched and the type and extent of analysis applied to arrive at her opinions or conclusions. If the appraiser is provided only with limited
transactional documents or recognizes that even with additional research, there’s inevitably unknowable information, then the appraiser will need to discuss with the client that there’s no way around the use of an “extraordinary assumption,” which is a defined USPAP term. If an extraordinary assumption directly related to a specific assignment as of the effective date of the assignment results is found to be false, it could alter the appraiser’s opinions or conclusions.

Competency rule. The appraiser must discuss with your client how the lack of information impacts the client’s clear legal title to a work of art. Moreover, there are many idiosyncrasies in art transactions so that no appraiser will ever have the absolute knowledge to be able to stand behind the report without making assumptions. The alternative is to take the time to conduct and incur the cost for all of the research necessary to find, to the extent possible, fragmented, often minute pieces of information. One recent example is the S.C. Johnson Company lawsuit filed against Sotheby’s in late 2013 to stop the impending sale of a rare 1928 Frank Lloyd Wright desk and chair from S.C. Johnson’s Administration Building. S.C. Johnson alleged that the furniture was stolen because its policy is generally not to gift, sell or otherwise transfer Wright-commissioned furniture. Only an appraiser with very specific knowledge, not just about that period of furniture but also about Frank Lloyd Wright’s professional relationship with S.C. Johnson, could have identified this potential defect in title.

Standards Rule 7. This rule poses the greatest challenge for an appraiser because the appraiser must recognize changes in the legal framework as well as identify the characteristics of the property that are relevant to the type and definition of value and intended use of the appraisal, including the ownership interest to be valued and any known restrictions or encumbrances.

Standards Rule 7.3 outlines the rules for the use of extraordinary assumptions. The rule states that if the information available doesn’t fall within the (ordinary) assumption definition, which is only allowed if known to be true (ownership doesn’t fall within that definition), then the use of an extraordinary assumption is required. 

An extraordinary assumption is akin to a qualified auditor’s report in the accounting profession. If an auditor’s annual audit report contains a qualification, the business is adversely impacted because investors, lenders, other creditors, vendors and customers are likely concerned about the raised qualification. By analogy in the art world, to avoid highlighting a similar qualification, an appraiser will want to weigh and evaluate three available options:

1. Include an extraordinary assumption, which could invalidate the valuation. 

2. Accept the liability, including potential penalties under the Pension Protection Act. 

3. Recommend title insurance because it can stand behind the assumption of clear title, therefore, allowing the appraiser to substitute the extraordinary assumption with an (ordinary) assumption. 

For any type of asset valuation, the analysis is based on fundamentals of the asset and risk characteristics. Appraisers and advisors are experts in analyzing the fundamentals of the object, but the risk characteristics are more challenging and unfamiliar. Moreover, recent decisions, such as the one in Estate of Elkins v. Commissioner,1 in which the Tax Court overruled the IRS and allowed a 40 percent discount of a partial interest based on the willing buyer test, show that the use of USPAP valuations standards provide a basis for using tools available for all other assets classes. Conversely, if the title insurance removes the risk characteristic of ownership, purchasers may be willing to pay more to acquire an object. If an item has already been acquired, title insurance eliminates ownership risk from the equation, increasing value by eliminating psychological friction for the buyer and making resale or
exhibition easier. There’s growing evidence that works sold with title insurance for the benefit of the buyer at auction or with a private dealer achieve higher prices than those sold without a third-party title guarantee.

The complexity of art market transactions and the convergence of USPAP and IRS appraisal standards make it challenging for appraisers to manage potential title defects. Similar to the real estate industry, title insurance for fine art and collectibles covers gaps in transaction documents and unknowable information to protect the possessor; transfers the financial risk for tax, trust and estate plans; and creates finality and certainty to the transaction.

Title Insurance 

Title insurance can be used in a variety of ways and purchased by a variety of stakeholders to protect against the liability that can be incurred if a claim made by a past owner or creditor is made against the current owner. Once a client understands that he may not have clear legal title to the subject object, that possessor can’t responsibly, without lingering liability, sell, gift or donate works of art with 100 percent confidence in the transaction.

Here are some examples of how title insurance can benefit collectors:

1. Consignors to auctions should acquire title insurance to back-stop the absolute warranties of title (that is, because there are no abstractors to stand behind the warranty; only a title policy can bridge the gap in information). 

2. Many appraisers advise clients on purchases/sales and step into the chain of title for a nanosecond to protect the confidentiality of the seller or buyer. By doing so, the intermediary inadvertently creates personal liability, even if there’s a “hold harmless” or indemnity agreement with the client, because there may be defense costs and the challenge of collecting on the indemnity. 

3. When advising clients on a purchase of fine art or other important collectibles, identify the work and negotiate the price, but don’t transfer funds for payment until title insurance is approved. This caution will provide a second lens on the transaction and protect the purchaser and the advisor in the event of a discovered title defect. 

The mechanics of the title insurance underwriting process are simple. The collector should disclose all available information to the underwriter, including documentation and known (believed-to-be-true) information, such as the object’s identifying factors (for example, artist, title, dimensions, media, year and inscription), purchase records, appraisals, provenance research, any literature citations or exhibition history and an image of the work.

The insurer then conducts its own investigation and analysis, indicates the premium and issues coverage, typically all within 10 business days of receiving the requested information and documentation. An art title insurance policy has one up-front premium cost based on the purchase price or appraised value. The premium covers the life of ownership, and the policy automatically continues at no additional cost when the work is transferred to the owner’s legal heirs. The policy insures the policyholder’s clear legal title to an artwork or collectible; defends the owner against title claims; and, in the event of a valid claim, reimburses the full insured value of the work (fair market value at the time of policy inception). The insured incurs no defense costs, and there’s no deductible in the standard form.       

—The author acknowledges the contributions of Deborah Gerstler Spanierman, president of DGS Fine Art Consultants, Inc., an art advisory and fine art appraisal practice, in Pleasantville, N.Y.

Endnote

1. Estate of Elkins, Jr. v. Commissioner, 767 F.3d 443 (5th Cir. 2014).

 
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