Summarize

Many of the seasoned art professionals are worried, or at least cautious, about the growing popularity of auction guarantees. What are the guarantees at auction, how are they different from an irrevocable bid or a reserve price and who wins from the opportunities offered by guarantees - all these questions are answered in the article below.

*intro by ArtLaw.club

 

Maria Boicova-Wynants,

Mediator, Business Writer, Trademark and Patent Attorney

There are no guarantees in this life, but at an auction.

The CNBC article “The two mystery paintings that sunk Sotheby’s stock” (Aug.6, 2018) starts with the statement: “The art market is not always what it seems.” This quote pretty much sums up what’s going on in the high end of the art market when it comes to blockbuster sales and jaw-dropping numbers. It is not always what it seems. One of the reasons for such a statement is the widespread practice of guarantees, which basically transform auctions into either a type of a speculative financial forum or a theatrical play where more than often the buyer and the price are defined in advance and the rest is a show with “chandeliers”^[1]. Art market guarantees: what are they? How are they working? And if they have the potential to be “the next art-market scandal” as Harry Smith (from Gurr Johns) coined them, why is it so?

The Art Collector’s Handbook (Rozell, M., 2014) defines a guarantee as “an agreement to pay a specified amount for a work, regardless of whether or not the work actually sells”. It can be either in-house guarantee provided by the auction house, or a third-party guarantee (or in some cases a combination thereof). If a guarantee is accepted, the consignor can be sure s/he gets at least the guaranteed amount, or more. Even if an artwork fails to sell at an auction, the consignor will still receive this guaranteed amount. Worth noting that the consignor is not always interested in the guarantee, that is in situations when s/he believes that the artwork will be hammered down high over its estimate. The guarantee is such circumstances means that the consignor would need to split the upside with the auction house, which in the absence of the guarantee would not be the case. Another remark is that the guarantee is usually issued only for the top lots of the auction; for the desired consignments that can cause the halo effect and enhance the competitive edge for the auction house.

There are two other related terms: a reserve price and an irrevocable bid. According to the Sotheby’s Glossary, a reserve price is the confidential minimum price agreed upon between the consignor and the auction house, set at or below the low estimate. The consequence of not reaching the reserve is that the artwork will not be sold and will, thus, become a bought-in.^[2] This is the main difference with the guarantee, as the latter ensures that there is no bought-in situation (Thompson, D., 2014). An irrevocable bid, on the other hand, is in a sense equal to a guarantee. According to the Art Radar article (“Sotheby’s irrevocable bid explained”, Nov. 12, 2008), it is an undisclosed agreement for a bid, wherein if no one bids any higher, then the buyer gets the work and pays the buyer’s premium. While if the work sells for more, the bidder who placed an irrevocable bid gets a part of the upside.^[3] The explanation of the difference with the third party guarantees went that the third party guarantor doesn’t bid, while the irrevocable bidder does. Nevertheless, as the mentioned article also acknowledged this difference is not cast in stone, because third-party guarantors are known to have been bidding as well.

Historically, guarantees are a fairly recent phenomenon. Sotheby’s started routinely issuing guarantees as of the sale of forty-seven Kandinsky paintings from the Guggenheim Museum in 1971 (“Guggenheim Will Auction 47 Works by Kandinsky”, The New York Times, Aug. 16, 1971). Its major competitor, Christie’s, seemed to be hesitant at first, though from the 1990s caught up on this trend as well. However, the most significant increase of the number of guaranteed lots occurred after the rise of the third major auction house — Phillips — in the early 2000s^[4]. Provided that guarantees allow the auction houses to secure commissions of high valued artworks, the increased competition between the auction houses significantly contributed to the number of guaranteed lots. In the beginning, they were all auction house secured guarantees (in-house guarantees), but soon the auction houses introduced another variation, which rapidly became the prevalent one — third-party guarantees.

An incentive for the third party guarantor is buying the desired artwork at a usually lower estimate plus, in the best case scenario, getting a part of an upside (which is the difference between the guaranteed amount and the ultimate sales price). An additional, and frequently more important incentive for the guarantor is relationship building with the auction house. Worth noting that for certain guarantors this is not about getting a bargain. For them, it is yet another (and a very risky way) to earn money. Such guarantors might be less (or even not) interested in an artwork, but in the potential upside split.

A guarantee is essentially a financial instrument, thus the third party guarantor might also be entitled to a financing fee. The latter is auction house specific. According to the Economist (“Financial machinations at auctions”, Nov.18, 2011), at Christie’s third-party guarantors receive a financing fee irrespective of whether they end up buying the artwork or not, while at Sotheby’s a financing fee is paid only in case the guarantor fails to become the ultimate buyer.

The very simplified math behind a guarantee is as follows. For example, a collector wants to sell his Magritte painting, yet wants to be sure that 1) it sells, 2) it sells for a good price. The auction house, interested in such a consignment will most likely offer a guarantee, which it will afterward sell to the third party investor (most of the times there would already be an investor in mind before the auction house issues a guarantee). Let’s assume the guaranteed sum is €10 million and the negotiated upside split with the third party is 50/50 (and the same 50/50 with the consignor). If Magritte sells for a hammer price of over the guaranteed sum, say for €15 million, the third party guarantor will receive €1,250,000, but the painting will go to the successful bidder.^[5] If Magritte fails to sell, the third party guarantor will be forced to buy the painting for €10 million.^[6] Thus, a guarantee is surely a high risk — high return undertaking.

It all seems to look pretty good: there is an insurance for the consignor, so that he can be sure that he gets his money irrespective of an outcome of the auction. Also the guarantor seems tobenefit: be it by getting a great artwork at its lower estimate or a monetary compensation for his willingness to risk. Finally, there is also some sort of an insurance for the auction house that they will not be left with an inventory and will cash in at least some proceeds. So everybody wins, right? Seemingly. Yet, coming back to what I have started with: “The art market is not always what it seems”.

Firstly, are guarantees actually profitable for the auction houses, or are they the reason the auction houses are losing money? That was exactly the question raised in Lee Rosenbaum’s article in the Arts Journal (Nov.10, 2014). It was answered by the then-CEO of Sotheby’s William Ruprecht, who said that guarantees were “meaningfully profitable to the company”. That was of course 5 years ago. Since then the number of guaranteed lots increased even more substantially, as has the competition for the big and flashy consignments between the major auction houses. In light of the above, the statement of “meaningfully profitable” might not entirely hold anymore. The example I have used in one of my previous articles at Artlaw.club (“Is the art market bubbling or just casually simmering?”) illustrates this point. In May 2018 Amedeo Modigliani’s Nu couché (sur le côte gauche) (1917) was hammered down by Sotheby’s at $139 million ($157,2 million with the buyer’s premium). This painting despite the pre-sale auction estimate of $150 million and a lot of hype around the sale, did not trigger much interest from the collectors. The Nude ended up being sold on a single, prearranged bid, with no upside to split. One may stress that the guarantee ensured the sale actually happened, which would otherwise be the question mark. That is true, however, is this really what auctions are supposed to be: a private sale made in public? To add that given the fierce competition between the major auction houses, consignors and guarantors have a strong negotiating power to adjust split percentages and other conditions. The auction houses frequently get themselves into very tight margins just to ensure top lots go to them and not to the competitor. Plus, there are significant expenses related to organizing an auction: transportation, cataloging, insurance, private events, press, and other publicity costs, to name a few. All that deducted, there is, in fact, not that much commission to still keep for the auction house. Hence, is it still really so “meaningfully profitable”?

Secondly, the obscurity of the whole backroom arrangements raises a question as to how ethical it all is. Balancing on the verge of legal it might still be, but the ethics question is truly up in the air. For example, the neutrality which is normally expected from the auction house is heavily compromised by guarantees. This set-up contributes extensively to the information asymmetry; while if some bidders are given much more information than the auction catalogue shows, can the auction house still pretend to be a neutral intermediary? To put it simply, guarantees support insider trading, which is illegal in most of the countries when it comes to financial markets. One might argue that the art market is significantly different from the financial market, but in the context of the third-party guarantees, that are, as mentioned, in the essence a financial instrument, this statement becomes highly dubious.

Finally, the roles of the art market players are corrupted by the guarantees. There are several aspects to it. The auction houses engaging in “pre-arranged private sales” are basically tapping into the domain prior belonging to galleries. Furthermore, as already mentioned above, cut throat competition between the auction houses makes them rather settle for losses than miss a chance to hit the headlines. Is that healthy, sustainable and how will that affect the power balances in the market in the long run remains to be seen.