Grossman LLP | Litigation Highlights Risks of Art Financing
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  • Litigation Highlights Risks of Art Financing
    A recently-filed lawsuit provides insight into some of the risks involved in art transactions given the increased use of creative purchase structures and financing arrangements in the art market.
    The plaintiff in the suit is Artemus, a company that allows collectors, art dealers and other professionals to leverage and monetize artworks through sale-leaseback arrangements and art-secured loans (generally speaking, in a sale-leaseback, a client would sell artwork to Artemus, and Artemus would then lease the art, either back to the client or to another party).  The defendant is the Paul Kasmin Gallery (PKG), a Manhattan-based art dealer.  Another important player in this story is art dealer Anatole Shagalov and his company, Nature Morte; Shagalov, who has been involved in other lawsuits involving debts in recent years, is not actually a party to this particular suit, but his dealings are central to the events giving rise to this case between Artemus and PKG.  See Case No. 156295/2018 (Sup. Ct. N.Y. Co.).
    According to Artemus’s complaint, the story begins in 2014, when PKG sold Shagalov a 60% interest in a Frank Stella artwork for $430,000; the deal provided that if the work didn’t sell by 2016, Shagalov would have an option to buy it outright for an additional $168,000.  Then, in the spring of 2016, Shagalov entered into a deal with Artemus, who agreed to a sale-leaseback of four of Shagalov’s artworks, including the Stella work.  As part of its due diligence in connection with this transaction, Artemus asked Shagalov, among other things, for evidence of full ownership of the Stella.  In response, Shagalov provided documentation from PKG, dated 2014, purporting to show that Shagalov purchased the work from PKG for $430,000; neither the invoice nor Shagalov disclosed to Artemus that he had not acquired full title, but rather only a partial interest in the work. 
    Artemus alleges that PKG created this documentation in 2016, knowing that it was misleading and did not reflect the “true state of affairs,” which was that Shagalov would not have full title to the work unless he paid the additional $168,000—which had not happened.  Artemus further alleges that the parties’ dealings in 2016—including communications related to a resale certificate—make it clear that PKG must have known it was creating this documentation “for presentation by Shagalov to a prospective third-party purchaser,” and chose to create the misleading paperwork so as not to impede Shagalov’s attempt to sell the Stella to a third party.  Thus, Artemus claims, it entered its deal with Shagalov (in which Artemus bought the Stella and leased it back to Shagalov) in reliance on the misleading invoices PKG created.  The Complaint says that the fraud came to light when PKG began seeking to collect the additional $168,000 from Shagalov, and filed a UCC-1 financing statement on the Stella work.  At that point, Artemus discovered that Shagalov actually had only partial ownership of the Stella. 
    The dispute between Artemus and Shagalov is now the subject of a separate litigation, initiated by Shagalov in 2017.  (See Case No. 655576/2017, Sup. Ct. N.Y. Co.; the Complaint in that action is available here.)  But Artemus’s case against PKG represents a way for Artemus to seek redress not just from Shagalov, but from the entity that allegedly enabled Shagalov to mislead Artemus.  Artemus’s claim against PKG is based on the theory that, due to PKG’s invoices, Artemus was fraudulently induced into purchasing something less valuable than what Artemus had bargained for.  Artemus is seeking from PKG compensatory damages, including amounts Artemus has incurred in its litigation with Shagalov, as well as punitive damages. 
    PKG has filed a motion to dismiss Artemus’s case, arguing first, that Artemus has not adequately alleged that PKG intended to defraud Artemus (or any third-party entity contemplating a deal regarding the Stella).  PKG’s motion seeks to capitalize on the fact that there were no direct dealings between PKG and Artemus, so Artemus’s claim must be a tort claim for fraud, not a contract claim.  PKG also seeks to exploit a facet of New York law requiring fraud plaintiffs to meet a higher pleading standard, by making more specific allegations than might suffice for other types of claims.  Thus, PKG argues, “Artemus has failed to allege any facts indicating that PKG knew or even had any reason to expect that the Shagalov Parties would supply the [purportedly fraudulent] Invoices to a financier . . . to induce a financier to loan” Shagalov money in exchange for rights to the artworks.  Artemus, for its part, will need to convince the court that, based on the communications between Shagalov and PKG, PKG must have known that the invoices—which PKG allegedly created many months after its initial transaction with Shagalov—were intended to be communicated to someone who would rely on them.  PKG downplays Artemus’s allegations that the communications between PKG and Shagalov include discussions about a resale certificate, arguing that this signifies only that PKG didn’t have to collect sales tax in its transaction with Shagalov for the Stella, and nothing more.
    PKG urges that Artemus has not adequately alleged that it would not have entered into the deal with Shagalov but for the invoices.  Rather, PKG speculates that Artemus might have proceeded with the transaction even without the invoices, particularly because the Stella represented only a part of the deal (there were three other works involved).  PKG also argues that it did not cause all Artemus’s damages; rather, PKG says, some of Artemus’s legal fees in the Shagalov litigation were incurred in connection with Shagalov’s allegations that Artemus mishandled Shagalov’s artwork after learning of the title problem with the Stella, and that that conduct is not PKG’s fault. 
    Artemus has not yet responded to the motion to dismiss, but Artemus may seek to argue that many of the issues PKG raises actually represent disputes of fact that the court should not decide on a motion to dismiss; for example, at this early phase, Artemus need not have a smoking gun proving PKG’s fraudulent intent, but it must only allege facts that could reasonably give rise to an inference that PKG intended to defraud Artemus or someone in its position.  Depending how the court rules on this motion, Artemus may also have an opportunity to amend its complaint. 
    This case highlights some of the potential pitfalls inherent in an art market where many transactions are no longer straightforward purchases of a work by a buyer from a seller, but rather represent more creative purchase structures or financing arrangements.  The initial transaction between Shagalov and PKG was only a purchase of a partial interest, with an option for Shagalov to obtain full title at a later date.  Likewise, the very nature of the transaction between Artemus and Shagalov is disputed (as shown in a ruling by an intermediate appellate court in that case, available here); Shagalov’s claims in his suit against Artemus are grounded in part on a theory that his transaction with Artemus was not a sale-leaseback at all, but rather was a loan in which the art served as collateral.  And the case has been further complicated by the fact that Shagalov now argues that the way Artemus dealt with the artwork after learning the truth about the Stella was improper.  The case further demonstrates the reality that, even when a party attempts to perform due diligence (as Artemus did here), problems can arise; and moreover, that when these more complex art transactions go sour or do not proceed as planned, the problems can have a ripple effect, as claims may arise between a variety of parties up and down the chains of title and possession.