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March 21st, 2017
Court Holds Art Advisor Must Pay Collector $1.05MM for Fraud
A New York court has ruled that an art advisor who brokered the sale of a collector's painting and secretly pocketed $1 million will have to pay the money back. Because the dispute turned on the advisor's agreement with the collector and what kind of legal duty the advisor owed to the collector, the case offers valuable lessons for people structuring art transactions. Here's what you need to know.
For over a decade, Lisa Jacobs served as independent curator for collector Hannelore B. Schulhof. During that time, Ms. Jacobs also ran her own independent art advisory firm. In 2011, Mrs. Schulhof asked Ms. Jacobs to help locate a buyer for a painting by Jean-Michael Basquiat. On October 11, 2011, Ms. Jacobs signed an agreement with Mrs. Schulhof's son (the "October Agreement"). The October Agreement provided that, in return for a fee of $50,000, Ms. Jacobs would (i) not offer the work for less than $6 million without prior written approval and (ii) "not accept any fee from the purchaser, in cash or in kind."
About a week later, Ms. Jacobs offered the work to an art dealer for $6.5 million, who accepted. Ms. Jacobs never told the Schulhofs the actual accepted offer; instead she falsely reported to Mr. Schulhof that she "was able to get the [buyer] up to [$]5.5 million." Based on her representation, Mr. Schulhof agreed to sell the work for $5.5 million, and went along with Ms. Jacobs' suggestion to structure the sale as a two-step process to protect the buyer's anonymity. Thus, on November 7, 2011, Mr. Schulhof, as his mother's attorney-in-fact, signed an agreement selling the work to Ms. Jacobs for $5.45 million, and by agreement dated November 11, 2011, Ms. Jacobs, as "agent for an undisclosed principal" signed an agreement with the purchaser to sell the work for $6.5 million. After the purchaser wired $6.5 million into Ms. Jacobs' account, Ms. Jacobs wired the Schulhofs $5.45 million, and kept $1.05 million (her $50,000 fee, and unbeknownst to the Schulhofs, an additional $1 million).
In 2013, after Mrs. Schulhof died, Mr. Schulhof learned that Ms. Jacobs sold the work for $6.5 million, not $5.5 million. Mr. Schulhof, as executor of his mother's estate, sued Ms. Jacobs in New York state court for breach of contract, breach of fiduciary duty, fraud, unjust enrichment and restitution. He asked the court to order the return of the $1.05 million Ms. Jacobs retained from the sale proceeds, plus punitive damages and attorneys' fees.
In defense, Ms. Jacobs claimed she did not have a fiduciary relationship with the Schulhofs, and that her statements about the value of the work were insufficient to support a fraud claim, relying on two recent decisions where New York courts ruled under different circumstances that art merchants were not liable for overcharging their longtime clients. See MAFG Art Fund, LLC v. Gagosian and McKenzie v. Fishko, discussed here and here.
Ms. Jacobs also claimed that the October Agreement was unenforceable because Mr. Schulhof signed it personally, rather than in his capacity as an attorney-in-fact for his mother. She also argued she had reached an oral agreement with Mrs. Schulhof to sell the painting on a "net" basis, meaning that she would sell the work for an agreed-to amount and Ms. Jacobs could keep as her commission the incremental amount between the agreed-to price and the actual purchase price. She claimed that a commission of $1.05 million (or 16% of the purchase price) was reasonable and consistent with market standards. (In response, Mr. Schulhof argued that everyone knew he was acting for his mother, that there was no evidence of another agreement with his mother, and while he was aware that many art transactions are completed on a "net" basis, he specifically drafted the October Agreement to clarify that this was not a net sale arrangement and that Ms. Jacobs' total compensation was $50,000.)
The Court's Decision
On February 27, 2017, the court ruled that Ms. Jacobs was liable for fraud, as she misrepresented that the buyer was only willing to pay $5.5 million. She also mispresented that she had gotten the purchaser "up to" $5.5 million, thereby leading Mr. Schulhof to believe that she had pushed the buyer as high as she could. The court also found that, "[g]iven Jacobs and Mrs. Schulhof's longstanding business relationship combined with the terms of the October Agreement, Jacobs owed a fiduciary duty to Mr. Schulhof as executor, thereby obligating her to disclose the $6.5 million offer prior to entering into the November Agreement." The court characterized Ms. Jacobs as a "faithless servant," and said she must return the $1 million of secret profits, plus forfeit the $50,000 in compensation earned for the sale of the work.
Although there was evidence that Ms. Jacobs breached the terms of the October Agreement which prohibited her from receiving any fees from the purchaser, the court did not rule on the contract claim — thus avoiding a perhaps complicated determination as to whether the contract was properly formed.
Ms. Jacobs has appealed the decision. Mr. Schulhof also filed an appeal, seeking punitive damages and attorneys' fees.
This case provides a compelling example of what can go wrong in art transactions, even when longstanding advisors are involved. Although Ms. Jacobs may have been correct that the net amount she kept for herself (16%) was a reasonable commission, the industry practice on commissions did not matter here, where she had signed an agreement limiting her fee to $50,000. That commission cap and other provisions of the October Agreement were strong evidence of the parties' understanding about their respective expectations and obligations. Persons conducting art transactions should scrutinize the terms of their agreements carefully - particularly where they involve creative financial structuring - to ensure that the agreements reflect the parties' desired intentions and goals. As shown in this case, a court will certainly assume they do.
The Schulhofs' case is also a teachable moment for collectors. The Schulhofs clearly intended to build safeguards into the October Agreement limiting Ms. Jacobs' compensation and obligating her to disclose the purchase price. But they might have avoided an expensive litigation had they also included contract language requiring Ms. Jacobs to share all transaction paperwork, including invoices and agreements, and if they had insisted that funds from the buyer (even an anonymous one) be wired directly into their account or, if necessary, through an escrow agent.
If you have any questions about art purchase agreements or other art-related legal issues, please contact Amelia Brankov at (212) 826 5574 or email@example.com, Lily Landsman-Roos at (212) 705 4894 or firstname.lastname@example.org or any other member of the Frankfurt Kurnit Art Law Group.
Other Art Law Alerts
Recent NYS Sales Tax Law Change Affects Art Sales Between Related Entities
On August 14, 2017, the New York State Department of Taxation & Finance issued a Technical Memorandum, TSB-M-17(4)S, which will be of interest to many New York-area art dealers and collectors.
August 23 2017
Appraisal Relied on by Estate Undervalued Paintings by $1.77 Million
Recently, in Estate of Kollsman v. Commissioner the U.S. Tax Court held that an art collector's estate significantly underreported the value of two artworks for estate tax purposes. The problem: the estate relied on appraisals by an auction house specialist who had an incentive to "lowball" the appraisals to win the right to later auction the works. In addition to this conflict of interest, the court found that the values reported by the estate were unpersuasive because the auction house specialist exaggerated the dirtiness of the paintings and failed to adjust his appraisals after one of the works sold at auction for approximately five times more than the reported value. Here's what you need to know about the case.
April 4 2017
New Federal Law Clarifies Foreign Governments’ Immunity in Connection with Art Loans to US Museums
President Obama signed the Foreign Cultural Exchange Jurisdictional Immunity Clarification Act into law on December 16, 2016. This new law clarifies when foreign states and fine art carriers can avoid a lawsuit in the US arising from loans of culturally significant artwork to US museums. The new law is important to museums and fine art carriers, and is expected to encourage art loans by foreign states. Here's what you need to know.
January 10 2017