The issues involved in using works of art to secure loans

Borrowing money on the strength of one’s art is a bit like bungee-jumping

Artist and film director Julian Schnabel sold this Picasso in May to finance a real estate development

The art market has stood up reasonably well in the current financial turmoil, while the value of other asset classes has fallen dramatically. It is, of course, the value of those other assets that is at the centre of the credit crisis. It is therefore perhaps unsurprising that unprecedented numbers of works of art are now being used as security for loans. Reports suggest that lending in this area is up between 40% to 50% in the past six months. People from every stratum of society who need liquidity are looking to see what cash value their assets may have. With ­traditional forms of investment income from property and stock markets in the doldrums, art is becoming an increasingly viable option to use as collateral for loans.

Historically, the use of works of art to secure loans has been somewhat infrequent. Art was seen as everything a banker disliked—volatile, not liquid, far from homogeneous and with no enforceable documents of title. Such deals that did exist in this area took a rather standard approach whereby specific works were pledged as collateral, with the lender requiring physical possession of the item. By the very nature of a work of art’s aesthetic appeal, it is not very difficult to see that parting with possession of the work is not an attractive option for a borrower, though its advantages are obvious as far as the lender is concerned.

With the credit crisis now working its way through the real economy, this area of lending has developed significantly and rapidly. Some recent high-profile examples include the cash-strapped Metropolitan Opera in New York, which has put up two valuable murals by Chagall as collateral for an existing loan of $35m from JP Morgan Chase; and the American artist and film director Julian Schnabel, who has used works by Picasso, Warhol and Dalí from his collection, some insured for millions of dollars, to help finance the development of an apartment block in Manhattan.

Innovative lending structures and forms of security are now becoming increasingly common. For instance, according to reports in the Guardian and the New York Times, renowned photographer Annie Leibovitz has recently secured $15.5m of finance to help her pay her mortgage and other outstanding loans, partly against properties she owns but also by putting up as collateral the copyright, negatives and contract rights to every photograph she has ever taken or will take in the future.

Certain common issues arise whatever the structure of the loan, and we consider these next.

Evidence of title

As part of its due diligence, the lender will need to be assured that the borrower is the legal owner of the work of art offered as collateral. Evidence of title may be built up from the provenance, wills, trust deeds, deeds of gift, purchase invoices and the like. Demonstrating legal ownership of a work of art can, however, sometimes be difficult. A fully documented and unbroken chain of title is not always available but, even where it is, unforeseeable problems can exist. A lender will therefore be very cautious if complex issues of title need to be unravelled.

It is also important to note that, after the expiration of six years, a purchaser in good faith will be protected from claims (even by the true owner) that they are not the rightful owner of a work of art. Therefore, where the chain of title is not complete it may sometimes be possible to allay a lender’s fears by demonstrating a good faith purchase that took place at least six years prior to the proposed loan transaction. Some insurance companies may now be prepared to provide insurance against the risk of disputed or faulty title.

Questions of authenticity

Given that the value of a work of art rests in the main upon it being an autograph work of the artist, authenticity is obviously a key issue of focus for lenders. In the absence of fully documented evidence of authenticity, advice will be required from acknowledged experts. Should the work of art prove not to be authentic in the event that the security is called upon, the loan documentation is likely to have contained warranties and/or indemnities leaving the borrower liable for any inadequacy in the security.

Valuation and marketability

Lenders view art as a volatile asset. For a work of art to be used as collateral, lenders routinely require at least six-monthly valuations and will involve leading auction houses and dealers in this process. Liquidity will be of prime importance to the lender—there must be an active market for the goods. The availability of a ready market will be determined by a number of factors, including the status of the artist in question, the work itself and the current “desirability” of the works of the artist in the current market. The value of a work of art may fluctuate greatly over time and, naturally, this will factor heavily in any decision to lend. Loan lending ratios have typically been 40% of the low auction estimate.

Difficulties may arise where the works intended to be used as collateral are subject to export restrictions or where they are considered to be part of a country’s national heritage. Investigations may be necessary to establish the legality of any imports/exports that have taken place or whether the security is at risk of a claim for its return under a country’s cultural property laws.

Purpose of the loan

The purpose for which the loan is required must be legal and sensible. A lender will usually require the borrower to be of good character, have the ability to manage their own affairs and, most importantly, service the proposed loan.

Those in possession of substantial portfolios of art, for example art galleries, museums or even art collectors, may wish to take advantage of the value of their collection as security for a loan. In this situation, a fixed charge over their stock, or collection, will be impractical as it would unduly restrict the borrower’s ability to carry on business, including the buying and selling of the assets included as collateral. However, here, a floating charge can be used, which attaches to classes of current or future assets, sometimes in combination with a fixed charge over certain works of art which the dealer does not intend to sell for a certain time.

Art has no boundaries

Transactions in the art world are often international in character. Therefore, as is common with any international transaction, issues such as conflicts of laws, jurisdiction, validity and registration of legal documentation, enforceability and (often) insolvency need to be carefully investigated and legal advice obtained.

The use of art has not been a traditional method by which banks have secured loans. However, business practices have changed rapidly in accordance with emerging opportunities, and new ways of raising money on the security of works of art and on their intellectual property rights are now being considered by some of the major lenders. The banking world is one in which players, big and small, are influenced by each other’s conduct both at national and global level. Borrowing money on the strength of one’s art is a bit like bungee-jumping in that, while it is not difficult to comprehend that it works in practice, most prudent people prefer to watch others doing it without any apparent harm before trying it themselves.

Philip Davis is a partner in the commercial litigation department of the law firm Davies Arnold Cooper. Graham Ludlam is a professional support lawyer at Davies Arnold Cooper


Artist and film director Julian Schnabel sold this Picasso in May to finance a real estate development
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