USA NATIONWIDE: An Introduction to Art and Cultural Property Law
Art Law Hot Topics
By Steven R. Schindler and Katherine Wilson-Milne
The commercial art world is both constantly evolving and consistently traditional. As lawyers working regularly with artists, collectors, art advisors, art dealers, galleries, and art institutions, we witness both the innovations and the challenges inherent in high-end art market transactions. On the one hand, the art market is diving head first into digital art, most recently in the form of non-fungible tokens, accepting cryptocurrency (to some extent) and structuring ever more complicated financial transactions, including in art financing. On the other hand, the commercial art world remains steadfastly old fashioned in its opacity and preference for handshake transactions. Where other industries worth over fifty billion dollars have long relied on formal written agreements and legal counsel, these practices still remain relatively rare in the fine art market, which relies on trust and private, undisclosed relationships. This leads to an intimate and familial way of dealing, but also to a relatively higher risk of fraud, money laundering and simple mistakes where various parties may have a different opinion of what was agreed upon. The presence of numerous intermediaries in many high-value private art sales further complicates this picture. It is not uncommon to have two or more intermediaries brokering a deal between an ultimate seller and a buyer with no one in the chain, including the buyer and seller, knowing the identity of any other participant or the fee they are taking. Governments have taken note of this opacity and lack of formality by both investigating and, in some cases, implementing money laundering regulations applicable to the art market.
We will take this opportunity to briefly describe some of the legal developments relevant to high net worth individuals engaged in the art world. As always, we highly encourage consultation with experienced art lawyers who are familiar with the practices and risks typical in high end art transactions.
Non-fungible Tokens (NFTs) And The Blockchain
In March 2021, Christie’s auctioned Mike Winkelmann (a.k.a. Beeple)’s NFT, “Everydays: The First 5000 Days,” for $69,346,250 (or, 42,329.453 ETH) – the third highest price paid for a work by a living artist. And while NFTs have been bought and sold for several years, Christies’ sale catapulted NFTs to the top echelons of the art and finance worlds. But while the interest in NFTs has accelerated, in large measure due to the increase in the value of cryptocurrencies often used to purchase NFTs, the legal issues surrounding the purchase and sale of NFTs are still playing catch-up. Here are just a few.
• Unlike cryptocurrencies, which are fungible tokens, an “NFT” is a non-fungible token representing a unique digital asset that is registered on the blockchain, creating a permanent record of the ownership of that asset. At their best, NFTs present a solution to a problem faced digital artists: How do you sell art in a medium that allows for endless duplication and distribution of digital files? In other words, how do you create scarcity – the quality that so often determines value in any market – so that collectors will pay for a work of art that is so easily shared?
• NFTs are also governed by so-called “smart contracts” – open-source code recording transactions executed on the blockchain – that contain the terms and conditions of sale. One of the celebrated features of these evolving contracts is the automatic payment of resale royalties to an artist when an NFT is resold. Unfortunately, these automated payments only occur when the NFT is sold on the same platform on which it was created.
• Because the blockchain cannot store large amounts of data, the NFT does not contain the digital artwork, but rather provides a link to where the digital work is located. If that digital work is deleted or the hosting company (often a start-up) disappears, the link will become broken and the NFT may become worthless.
• As with the purchase of traditional artwork, the purchase of an NFT does not transfer any of the author’s rights under the US Copyright Act. While this may seem more obvious to traditional collectors, it is a little harder to understand this when you are purchasing a digital work that is often duplicated and widely shared. Various NFT market platforms are evolving their smart contracts to better define the limited licences given to purchasers of an NFT.
In addition, various regulatory legal issues involving securities (surrounding emerging fractional NFTs), anti-money laundering, and sanctions laws are starting to arise. Given the lack of transparency and decentralization associated with the blockchain, it will be incumbent on all market participants to be mindful of these potential hazards.
Art Fraud
The art market’s relative opacity has long enabled bad actors to take advantage of buyers and sellers of fine art. Where there are middlemen, often more than one, and very little in the way of contracts, the ultimate buyers and sellers have a very hard time verifying title, authenticity and end price independently. In reality, they simply cannot verify these facts most of the time. When dealing with a reputable auction house, the trust on the part of buyers and sellers may be well founded, but when dealing with private intermediaries this trust may involve more risk. The value of an art work is only as good as its clear, unencumbered ownership and authenticity. Meaning, if you don’t really own a work or if it is not by the artist you believed it to be at the time of purchase it is likely worth very little if nothing at all to the possessor. Even where there is simply a mistake, the costs of sorting out these types of disputes can be prohibitive.
Recently, a prominent young art dealer by the name of Inigo Philbrick was arrested and now faces criminal as well as civil charges for purportedly selling artworks he did not own or had no right to sell. Mr. Philbrick’s star rose working for Jay Jopling at White Cube in London. He was well known for capitalizing on the rising market for few select artists, including Christopher Wool, Wade Guyton and Rudolph Stingel. For a time, he was very successful flipping these works on the secondary market. But when the market for these artists started to dry up he began a Ponzi scheme of sorts to stay afloat. He would often sell fractional shares of the same artworks to multiple different buyers totalling well over 100%. These were often works he had no rights to either because he had already sold them or they were not his to sell in the first place. His fraud caused tens of millions of dollars in losses to his victims, who believed they owned artworks they do not in fact own. How was he able to do this? Mr. Philbrick relied on the normality of intermediaries, secrecy about the identity of the ultimate parties to a transaction and the practice, on the part of some buyers, not to take possession or view a work prior to or after purchase if the aim was to resell for a profit. Mr. Philbrick’s promise to his clients was that he would make them money; if they bought a work, or a fraction thereof, from him but left it to him to resell, he would do so at a profit for all involved. Without possession of these artworks or having any verification of their actual ownership status, numerous innocent parties invested millions of dollars with Mr. Philbrick with nothing to show for it and now are fighting in court for rights to the same small group of works. Many will recover nothing and be out substantial legal fees.
Avoiding this type of fraud is difficult, but there are some clear steps that can and should be taken. Art purchasers should consult lawyers and have proper documentation of each transaction. They should, to the extent possible, take possession of works they own or at least file a UCC-1 financing statement indicating their rights to the work. Buyers should get an exact record of a work’s provenance and ownership history, conduct a UCC search and lost or stolen art due diligence on available databases as well as attempting to verify the ultimate party selling a work before spending millions of dollars.
Anti-Money Laundering Regulation
While money laundering is already a criminal offence, including if the laundering is done through fine art, the anti-money laundering (“AML”) regulatory frameworks in Europe and the United States did not, until recently, extend their due diligence and reporting requirement to the fine art market. That is changing.
In 2018, the European Union adopted the Fifth Anti-Money Laundering Directive, which, among other things, extended the EU AML regulations it required its member states to implement to art market participants. Notably, as of January 2020, the United Kingdom implemented the Fifth Directive. The new UK law requires art market intermediaries to assume a number of AML steps for transactions over ten thousand euros, including registering with HMRC, implementing AML policies and training and, most importantly or controversially, requiring intermediaries to engage in enhanced customer due diligence. This last change requires registered art market intermediaries to get information from clients showing who the ultimate beneficial owner behind any transaction is. Typically, high end private art sales are conducted through agents with the identity of the ultimate buying or selling party unknown to anyone else and, sometimes, even to the agents themselves. These practices will now have to change in the UK. Art purchasers can expect to have to produce much more identifying information on their ultimate beneficial owners, such as passports, when engaging in art transactions.
The United States, by contrast, has not yet extended the requirements of the Bank Secrecy Act, which enacts AML regulations to financial institutions in the US, to the fine art market. But that may soon change. As noted above, while money laundering is still a federal crime, the regulations around its prevention and reporting have not yet been extended to the US art market, although major auction houses generally already have AML programs in place. The Anti-Money Laundering Act of 2020, which came into effect on January 1, 2021, extended the AML requirements of the BSA to antiquities dealers, advisors and consultants. This legislation also required the Department of Treasury along with other agencies to investigate whether these regulations should be extended to the wider art market. The Financial Crimes Enforcement Network (“FinCEN”) has been tasked with implementing regulations to effect the new law for antiquities market participants.
Earlier in 2020, the Permanent Subcommittee of Investigations of the US Senate released a report titled “The Art Industry and U.S. Policies that Undermine Sanctions.” The report focused, as an example, on the ability of certain Russian oligarchs to avoid sanctions placed on them by using offshore entities to engage in numerous art transactions with total anonymity. The report recommended, among other things, that the Bank Secrecy Act regulations be extended to the art market to prevent this type of sanctions avoidance.
Given these recent US developments, many of us have a sense that the US art market is next in line for AML regulation. Art intermediaries, as well as sellers and purchasers, should consult legal counsel to discuss these changes and their legal obligations in Europe and the United States.
Steven R. Schindler and Katherine Wilson-Milne are partners and practise in the Art Law Group at Schindler Cohen & Hochman LLP, a premier litigation and art law boutique located in New York City. They also co-host The Art Law Podcast, where the above topics have been more fully discussed with leaders in the art world.