Art market

Auction guarantees are dividing the art trade

Insurance for sellers or market manipulation?

The return of the tiny symbols discreetly decorating the catalogue entries for the top lots in the recent London auctions shows that guarantees, which disappeared during the downturn, are creeping back. And it is not for the first time: they have fallen in and out of favour over the past 40 years, along with the swings of the market. This time, however, they are different and far more complex.

Guarantees were first introduced in 1971 at Sotheby’s, according to an unnamed source, when 47 Kandinskys and other works from the Guggenheim Museum were offered with a guaranteed minimum: similar arrangements followed in 1972 and 1973 for the Ritter and Scull collections. Buyer’s premium did not exist in those days; Sotheby’s put its own money at risk in exchange for a higher commission from the seller or a division of the profits above the guaranteed amounts, and its compensation came from the vendor. But after the 1970s oil crisis, guarantees disappeared until the 1980s, rising again as the Japanese entered the market.

Guarantees’ most visible and disastrous day was when LVMH tycoon Bernard Arnault bought Phillips (as it then was) in 1999 and merged it with art dealership De Pury and Luxembourg, making it Phillips, de Pury and Luxembourg. In an attempt to propel the firm to the level of rivals Sotheby’s and Christie’s, Arnault offered huge guarantees to clinch consignments. The strategy backfired seriously, particularly in the case of the 2001 Smooke sale, which bore the biggest auction guarantee in history, over $180m, but raised just $86m. Arnault sold the company to Simon de Pury in 2002 after chalking up some $400m in losses.

Ups and downs

The auction houses were not put off and as the market started reheating after the 9/11 slow-down, so did their guarantee policy. In 2007, Sotheby’s issued $902m-worth of guarantees, double the 2006 amount and up from $131m in 2005, according to Noah Horowitz’s book Art of the Deal (due to be launched on 3 March at Sotheby’s). He says this underscores “how the art market had been artificially propped up during the bubble by the generous financial arrangements orchestrated between the auctioneers and their marquee clients.”

The bubble burst, and guarantees were almost entirely taken off the table in 2008-09. Now, they are back: at the London impressionist, modern and contemporary art evening sales at the beginning of February, guarantees or irrevocable bids were given to the level of £34.2m.

The auction houses have changed their strategies, however. Rather than playing with their own money, they are now selling off the risk to third parties. They had their fingers badly burnt when the market crashed in September 2008 and their warehouses were full of non-performing, oil-on-canvas assets.

Among art dealers, there are few more divisive subjects. Some are in favour: “It’s a creative way to do business,” says secondary-market dealer Christophe van der Weghe. Others claim that, in more regulated sectors, such practices could be at the limit of legality. “It sails quite close to the wind,” says one dealer. Another is “quite sure that people attending the sale do not understand that they might be bidding against someone who has the inside track, knowledge of the reserve etc—and may pay less than they would for the same lot.”

“Collectors deserve transparency, clarity and an even playing field when they are bidding at auction. Currently information about guarantees and third-party guarantors is buried in the back of the heavy catalogues,” says Lucy Mitchell-Innes, the president of the Art Dealers Association of America (ADAA), suggesting that the auction houses are not doing quite enough to ensure that “both phone and room bidders fully understand the circumstances of the competition”.

Guarantees are most common on the big ticket items, so who has deep enough pockets to give them? “You have to be a collector to be a third-party guarantor—either you want to own the work, or to play a little bit on the market,” says Emmanuel Di Donna, who recently jumped ship after 17 years at Sotheby’s to become a partner in private dealership Blain Di Donna. “What are dealers going to do with a $10m work that’s been marketed internationally? It’s unlikely they can sell it at a profit within three to five years.”

Such collectors are known to include Stefan Edlis, hedge-fund supremo Steve Cohen and publishing magnate Peter Brant. In addition, a handful of canny and wealthy dealers including Robert Mnuchin of L&M Arts, William Acquavella of the eponymous gallery and the Nahmad clan regularly back works. Guarantees, according to Helly Nahmad of the London gallery, are good: “They bring an extra option into the marketplace, increase liquidity and give comfort to the seller. It’s very simple: they are like an insurance.”

Others say the practice is not so clear cut. A recent example is the “Carte Blanche” sale at Phillips de Pury, which opened its new Park Avenue premises last November with an auction “curated” by Philippe Ségalot.

Ségalot, formerly of Christie’s and now a trusted advisor to its owner François Pinault, had arranged consignments of 33 works from his own clients, including Pinault, Edlis and Jose Mugrabi. Seven of the works had guarantees financed by third parties. Ségalot and his assistant, Ali Rosenbaum, were taking telephone bids, as was Ségalot’s business partner Franck Girault. In the room, several of the consignors were bidding on works in the sale. This network of relationships is arguably complex.

Transparency is indeed the fundamental issue. Dealers claim that the third-party system at Christie’s is flawed, because it allows the possibility for the published price to be different to the one actually paid by a guarantor who then buys the work above the guaranteed level. Others say guarantees are open to manipulation by third parties who both back and bid for works by artists whose markets they have a stake in. “Most of our third parties do bid on the objects,” says Jennifer Zatorski, the international commercial director at Christie’s, but, she points out: “Announcements are made that someone with a financial interest will be bidding.”

The auctions are keen to grow the guarantee business: “We are trying to serve our clients as best we can so of course we want to try to increase our third-party base, but at the moment the volume is not there to create the impetus to do so,” says Zatorski.

Supply and demand

Some think a return to the days when the auction houses take the risk themselves is imminent. “It’s the area with the most returns. It’s where they can make the most money,” said one dealer. If this happens then some argue that there is a danger that the auction could breach their fiduciary duty to the seller, by favouring one work (the one they have guaranteed) above another (non-guaranteed).

Michael Plummer of advisory company Artvest points to the market crash of 2008 when there were significant “plain vanilla” guarantees outstanding: “With so much of the house money at stake at such a critical time, can you imagine how tempted they must have been to promote the guaranteed property at the expense of other works in the sale? This is the structural problem with auction houses doing guarantees themselves.” This is something Zatorski refutes: “Absolutely not. It is in everyone’s best interest to have a strong sale throughout.”

Did guarantees artificially stimulate sales during the boom? “People have shockingly bad memories. It fuels the appetite to push markets,” said one ex-auction house staffer. Others are more sanguine. “I don’t have a problem with them individually. It’s all buyer beware—it is a meaningful and complicated market place,” says private advisor Allan Schwartzman. He adds: “There is the appearance that auction is a transparent and visible market place, but that is not often the case. There are many different ways in which prices can be manipulated; guarantees are just one item on a wider menu of possible ways in which the market is not purely a marriage of supply and demand.”

What those little symbols really mean

Guarantee (circle): the “plain vanilla” guarantee means that the auction house promises the vendor a minimum, undisclosed price for the work, whether or not anyone else bids. If unsold, the auction house pays the vendor and keeps the lot.

Third-party guarantee: the auction house has found an outside investor to back the work at a certain level, either wholly or jointly with the house. The auctions structure their payment in different ways. Christie’s agrees a financing fee for the third party’s risk as well as a separate percentage of the upside (the

difference between the guaranteed price and the final price) if the work goes over the guaranteed level. Part of this percentage is taken out of the buyer’s premium. The guarantor is allowed to bid on the work. Phillips de Pury has a similar structure. At Sotheby’s a third-party guarantor is not allowed to bid, but they get a pre-agreed share of the upside. Neither Sotheby’s nor Phillips use symbols to distinguish whether guarantees are provided by the house or by a third party, whereas Christie’s does, using both circle and diamond symbols to indicate lots backed by third-parties.

Irrevocable bid (horseshoe): this instrument, which was introduced by Sotheby’s in 2009, is similar to a third party guarantee in that the guarantor agrees to bid to an undisclosed level, either winning the lot—and paying the full buyer’s premium—or getting a pre-agreed compensation if someone else buys the lot.

Ownership interest (triangle): a result of a failed guarantee is that the auction house now has to sell the unsold lot. The work may reappear at auction, as happened in London last month, when Feininger’s The Proposal, 1907, unsold at Christie’s New York in 2007 (est $4m-$6m) sold for £1.27m ($2.048m, est £1m-£1.5m). Ownership interest may also arise if the auction house has made an advance to the consignor to secure the property.

Interested party: Sotheby’s has a symbol (underlined v) to indicate that parties with a direct or indirect interest may be bidding on a lot. Christie’s does not have a symbol, but makes a public announcement at the beginning of the auction.

Originally appeared in The Art Newspaper as 'Guaranteed outcome'