Grossman LLP | Ninth Circuit En Banc Decision Upholds Parts of California’s Artist Royalties Law
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  • Ninth Circuit En Banc Decision Upholds Parts of California’s Artist Royalties Law
    Earlier this year, this blog covered a case examining the constitutionality of California Civil Code § 986, known as the California Resale Royalties Act (CRRA).  This week, an en banc panel of the Ninth Circuit Court of Appeals struck down part of the CRRA as unconstitutional but severed the objectionable portions from the rest of the statutory regime.  The ruling has potentially complex legal and economic implications for those who buy, sell, and trade in high-end art—and places the spotlight on current efforts in Congress to enact a nationwide resale royalty law.

    The CRRA

    Our earlier post has a full discussion of the case’s background, but in short, American law generally follows the “first sale doctrine,” under which artists usually control only the initial sale of an original artwork, and receive no compensation for subsequent resales of the work.  In 1976, California passed the CRRA, and in doing so became the sole United States jurisdiction to impose a droit de suite system (similar to laws in place in Europe and elsewhere), under which artists and their heirs receive a royalty-type fee every time the artist’s original artwork changes hands.

    As drafted, the CRRA requires the seller of fine art to pay a work’s artist five percent of the resale price of a work, whenever “the seller resides in California or the sale takes place in California.”  Cal. Civ. Code § 986(a) (emphasis added).  The artist may not contractually reduce or waive his or her right to these royalties, although works resold for less than $1,000, or for less than the seller originally paid, are excluded.  Artists’ heirs may assert an artist’s rights for 20 years after the artist’s death.

    The CRRA also requires agents of art sellers, such as dealers and auction houses, to withhold 5% of a sale’s proceeds, and to locate and pay the artist the required royalty.  If the agent cannot locate the artist within 90 days of the sale, then the fee goes to the California Arts Council, which will continue the search for seven years; after that, the Council keeps the funds to “use in acquiring fine art.”  The artist or his heirs can sue the for failing to fulfill his responsibilities under the law.

    The Lawsuit

    In 2011, representatives of a handful of prominent artists (including Chuck Close, Laddie John Dill, and Sam Francis) filed proposed class actions against Christie’s, Sotheby’s, and eBay, alleging that the defendants, in auctioning artworks, had systematically violated their obligations to pay royalties owed to the artists under the CRRA.

    In May 2012, then-U.S. District Judge Jacqueline Nguyen dismissed the artists’ claims, holding that the plaintiffs could not enforce the CRRA because it violated the Commerce Clause of the U.S. Constitution.  The Commerce Clause, which gives Congress the power to regulate interstate commerce, has long been interpreted to have an inverse implication (sometimes called the “Dormant Commerce Clause”) that limits the power of the individual states to ensure that a state cannot unjustifiably burden interstate commerce.  Judge Nguyen concluded that the CRRA, which requires royalties to be paid even where an art sale happens outside California (as long as the seller is a California resident), violated the Dormant Commerce Clause by purporting to regulate commerce occurring wholly outside the state’s boundaries.  See Estate of Graham v. Sotheby’s Inc., 860 F. Supp. 2d 1117 (C.D. Cal. 2012).

    The CRRA’s drafters had included a severability clause in the statute, which specified that if any portion of the law was declared invalid, the rest of the law should still be enforced.  The artist plaintiffs, relying on this clause, argued that even if the CRRA was unconstitutional as applied to certain out-of-state transactions, the courts should preserve the remainder of the law.  Courts generally are willing to honor such severability clauses unless it is clear that the legislature would not have enacted the constitutional provisions independently of the invalid portions.  But Judge Nguyen concluded that the CRRA was not severable, ruling based on legislative history that the state would not have enacted a bill targeting only art sales in California (and noting defendants’ argument that such a result might actually harm California by incentivizing art sellers to leave the state to avoid paying the 5% royalty).  The trial court thus struck down the CRRA in its entirety.

    The Ninth Circuit Appeal

    After their claims were dismissed at the trial level, the plaintiffs appealed to the Ninth Circuit.  At oral arguments held in April 2014, a three-judge appellate panel expressed skepticism about the plaintiffs’ position that even if an artist, a buyer, and a work are all outside of California, the royalty law could permissibly apply as long as the seller was a California resident and the out-of-state company has a presence in California.  But the three-judge panel never issued a decision.  Instead, both sides were ordered to brief the question of whether the case should be reheard en banc to clarify Ninth Circuit Dormant Commerce Clause jurisprudence regarding state statutes with out-of-state impact.  In late October, the Ninth Circuit ordered that the case be reheard en banc.  Sam Francis Found. v. Christie’s, Inc., 769 F.3d 1195 (9th Cir. 2014).  Oral arguments took place in mid-December.

    The En Banc Decision

    In a decision authored by Judge Susan Graber, eight members of the panel held that the CRRA’s clause regulating sales outside the state of California violates the Dormant Commerce Clause (Ninth Circuit Docket No. 12-56067).  “We easily conclude that the royalty requirement, as applied to out-of-state sales by California residents, violates the dormant Commerce Clause,” noting that if only the seller’s residency triggers the CRRA, then a California resident with a part-time apartment in New York could buy a work from a North Dakota artist, keep it in New York, and resell it in New York to another New York buyer, and still owe royalties to the North Dakota artist even though neither the work, the artist, or the buyer had any connection with California.  Dormant Commerce Clause case law bars states from regulating commerce that takes place “wholly outside of the State’s borders, whether or not the commerce has effects within the State.”

    The majority also held, however, that the unconstitutional portion of the CRRA can be severed from the rest of the statute.  The law’s severability clause created a presumption in favor of severance, and the court held that the invalid clause was “grammatically, functionally, and volitionally separable”; it could be excised without affecting the coherence of the remaining text, and the remaining statutory scheme is still functional (albeit with a reduced scope).  As to volitional severability, the court said, “we think that the legislature actually foresaw the partial invalidation,” noting legislative history showing that during deliberations over the law, legislative counsel opined that the law would be unconstitutional as applied to sales wholly outside California but would be valid as to sales within the state; yet despite those warnings, the legislature drafted the royalty requirement to apply either when the seller resides in California or when the sale takes place in California, using “easily separable clauses,” with an express severability clause.

    Judge Stephen Reinhardt, in a lengthy partial dissent, characterized the CRRA as “a minor regulation of the proceeds received from art sales by a small number of wealthy Californians,” and emphasized the policy behind the CRRA—providing compensation to artists whose works may not become valuable until many years after their creation and initial sale.  He “reluctantly” agreed with the majority that the Dormant Commerce Clause bars California from requiring out-of-state agents, like New York auction houses, to seek out and pay royalties to artists.  But Judge Reinhardt would have ruled that a California seller can be required to pay the artist royalties, regardless of where the sale takes place.  In his view, the statute simply places a requirement on how a California resident must handle a small portion of the sale proceeds after a profitable art sale, and does not regulate the extraterritorial sale itself.

    The Decision’s Potential Effects

    The case going forward will focus only on royalties for sales within California.  Another issue that may be addressed on remand is eBay’s argument that, unlike the auction houses, eBay is neither a seller nor a seller’s agent and should not be subject to the CRRA at all, even for sales within California.  (Interestingly, the defendants had also argued that the CRRA is unconstitutional for two additional reasons: first, that it effects an impermissible “taking” of private property in violation of the federal and state constitutions; and second, that it is preempted by federal copyright law.  The district court’s decision rested solely on Dormant Commerce Clause grounds, and did not address these additional arguments, but it’s possible that the defendants may now turn toward attacking what’s left of the CRRA on one or both of those other constitutional grounds.)

    For now, the CRRA’s reach has been shortened; the royalty requirement will only apply art sales that take place within California’s borders.  It is not a total defeat for artists, who may still be entitled to royalties when their works change hands in California.  But as a practical matter, this ruling may actually have the undesirable effect of incentivizing players in the art market to take their transactions outside the state, in order to avoid the 5% royalty.

    And in the bigger picture, the decision strikes a blow to those who are concerned with the policy issue Judge Reinhardt raised; should there be a mechanism for artists or their heirs to receive compensation for resales, particularly where a work has skyrocketed in value since its creation and initial entry into the market?  Indeed, the Ninth Circuit’s decision may become fuel in the debate over whether the United States should enact a nationwide droit de suite scheme.  In recent years, federal lawmakers have entertained the possibility; those efforts have so far been unsuccessful (and have faced fierce opposition from, among others, the same auction houses who were defendants in this case).  But this spring, a new version of possible resale royalty legislation was introduced in Congress.  The proposal is in some ways more narrow than the CRRA (for example, it would target only sales at auction and not private sales; would be triggered by sales of over $5,000 as opposed to the CRRA’s threshold of $1,000; and would cap an artist’s royalties at $35,000), but it is motivated by the same policy goals that were behind the CRRA.  While some watchers are skeptical about the bill’s chances of passage, it seems clear that the issue of artist resale royalties is a hot topic in the art law world at the moment.
    ATTORNEY: Kate Lucas
    CATEGORIES: Art MarketAuctionLegal Developments