Auction house and third party guarantees are a hot topic at the moment, with Bloomberg reporting that, for the 2015 New York autumn sales, $1 billion – approximately half – of the $2 billion total value of lots were already sold before the “paddles are even raised” (Bloomberg, 29 October 2015). On 9 September 2015, Sotheby’s filed a Form 8-K with the US Securities and Exchange Commission confirming that they had entered into an arrangement with the Estate of A. Alfred Taubman, their former chairman, to sell art from his collection, which was estimated to be worth in excess of $500 million. The arrangement provided that “Sotheby’s agreed to provide an auction guarantee for the collection at approximately that level”.
An auction house guarantee is an agreement by which the seller (in this case the Estate of A. Alfred Taubman) agrees to consign their work or collection to an auction house (in this case Sotheby’s) and the auction house agrees to guarantee to the seller that, whatever the outcome of the auction, the seller will receive a minimum sale price for the work or collection (in this case approximately $500 million).
In recent news, it has emerged as a result of the leak of the Panama papers, that an early version of a third party guarantee lay behind the Christie’s landmark sale in 1997 of the collection of Victor and Sally Ganz. The sale was said to have been “an icon of estate sales, a milestone in pricing. Bidders were buying the Ganz provenance” (New York Times, 11 April 2016). However, the Panama papers have now revealed what was not known to those in the auction room at the time; a significant proportion of the works were not actually being sold by the Ganz family.
Six months prior to the auction a deal had been done between an offshore company, Simsbury International Corporation, (revealed to have been controlled by billionaire currency trader – and at the time the single largest shareholder in Christie’s – Joe Lewis) and a subsidiary company of Christie’s, Spink & Son, by which Simsbury purchased from Spink more than 100 of the Ganz paintings. A secondary agreement provided that Simsbury then agreed to place the paintings into the Christie’s auction. The agreement provided that Simsbury’s owner could not bid at the auction. The Guardian reported that “experts who have seen the papers believe Spink was acting as a broker – buying from the Ganz family and selling on to Simsbury” (Guardian, 7 April 2016). There was nothing illegal about these arrangements but the New York Times described the deal as “all a massive “flip”, a quick resale that was early, if undisclosed evidence of just how much art was being treated like a commodity” (New York Times, 11 April 2016). The gamble paid off for Simsbury and Spink, as the Guardian reported: “Should the final bid prices on all sold paintings have exceeded $168m, the documents suggest Simsbury and Spink would split the difference. The event broke all previous records for a private collection, fetching $206m” (Guardian, 7 April 2016).
How do they work in practice?
The exact way in which a guarantee will operate will depend on the terms and conditions that have been negotiated between the auction house and the seller in advance of the sale. However, the usual potential outcomes of an auction house guarantee are as follows:
- The lot fails to sell at all: the auction house becomes the owner of the lot and pays the seller the full guarantee amount.
- The lot sells for less than the guarantee amount: the winning bidder becomes the owner of the lot, and the auction house pays the seller the hammer price plus the difference between the hammer price and the guarantee amount.
- The lot sells for more than the guarantee amount: the winning bidder becomes the owner of the lot and the auction house receives a proportion of the excess of the guarantee amount from the seller.
Does the auction house take on all of this risk itself?
In giving guarantees auction houses are taking a financial risk. This risk could be substantial, especially if the auction house is guaranteeing a number of high value works in the same period. In the autumn of 2008 Sotheby’s reportedly lost $52 million in one season, all from guarantees (New York Times, 7 January 2015). It has been reported that the Taubman guarantee resulted in a loss for Sotheby’s and the auction house had to take possession of $33m of unsold artworks last year (Bloomberg, 10 June 2016).
Whilst auction houses can take on the entire risk themselves, they can also choose to share the risk with a third party and that is where matters become more complicated. In their filing relating to the Taubman guarantee, Sotheby’s stated that it “may reduce its financial exposure under auction guarantees through contractual risk and reward sharing arrangements.” Typically this works by the third party agreeing, for a fee, to place an irrevocable written bid for an undisclosed amount on the lot before the auction (known as a third party guarantee). The amount of the bid can be up to or exceeding the guarantee amount. As a result the third party guarantor takes on all or part of the risk of the lot not being sold. For example, if an auction house have given a minimum price guarantee to the seller of £100 million for an artwork, but a third party guarantor places an irrevocable written bid for, say, £80 million, the auction house’s risk is reduced by that sum.
Third party guarantors may then also participate in the auction themselves and choose to bid on the lot over and above their irrevocable written bid. If the lot sells for less than the irrevocable bid the third party pays the bid amount, less the fee, and secures the work. If the lot sells for more than the irrevocable written bid, and the irrevocable written bidder was not the winning bidder, they receive their fee and a share of the profits above the guarantee amount.
Why do auction houses offer guarantees?
There are three primary reasons: profits, certainty and securing works for auction. If a lot sells for more than the guarantee amount, this can provide a good source of profits for the auction house. The guarantee provides certainty that the item will “sell” and therefore commission will be received.
If an auction house offers a seller a guarantee as an incentive, they may secure the consignment of works that would otherwise have gone to their rival. Reports suggest that sellers are becoming more demanding in what they require from auction houses, such as guarantees, reductions in seller’s commissions and splitting buyer’s commissions. In relation to the Ganz auction, the Guardian suggests that information which emerged from the Panama papers regarding the underlying deal “may finally lay to rest rumours about how Christie’s snatched the Ganz commission from under the noses of rival auction houses… Christie’s would have been in fierce competition with rivals, including Sotheby’s, to win the prized commission. Offering to buy the work in advance of the auction for such a large sum may have helped swing the deal” (Guardian, 7 April 2016).
If you are a buyer, how do you know if an item is subject to a guarantee?
Lots which are subject to a guarantee are marked in the catalogue with a symbol and the symbol key in the auction house’s conditions of sale provides an explanation. The auctioneer may also disclose at the start of a sale that some works will be sold with guarantees. Christie’s state that if third party guarantors choose to bid on the lot over and above their irrevocable written bid, “they are required to inform us, and the auctioneer will, before offering the lot for sale, make a saleroom announcement that the third party will be bidding so that other bidders are aware that someone with a financial interest may be bidding on the lot.” However, the amount of the guarantee is not disclosed.
If you are a seller, should you sign up to a guarantee?
Advantages
- Certainty: One of the biggest risks at auction is that an item will fail to sell. This can have a significant impact on the reputation of the item, as some would then consider it “burnt” in respect of the market. A seller may have to wait years before feeling confident enough to offer the item to the market again. A guarantee eliminates this risk, as a seller will have the certainty that their item will be sold. Whilst it may be possible to find out that the auction house was in fact the buyer by way of a guarantee, which could also be damaging to the reputation of a work, that would then be a problem for the auction house who then owned the work, rather than the seller.
- Using the auction process to obtain a minimum price: Normally in an auction if a work fails to reach its reserve price (the confidential minimum price agreed upon between the seller and the auction house which is kept secret from the buyer, but which must be set at or below the low estimate), the work goes unsold, and the seller receives no money. A guarantee eliminates this outcome for works that risk not hitting a reserve.
- Getting the best of both worlds: In the above circumstance, not only has a seller used the auction process to guarantee a minimum price, but they also have the benefit of the chance the item will exceed expectations and sell for an amount in excess of that at auction.
- Better promotion of the work?: According to a New York Times article (7 January 2015) critics suggest that an auction house may put more effort into marketing an item in which it has an increased financial interest. However, this should not be the case, as legally the arrangement should not change the duty that the auction house owes to their client, the seller.
Disadvantages
- It could reduce your profits: Art Market Monitor suggests that in the current market sellers are “too smart” to sign up to guarantees. They raise the valid question: “If you know you have something really good … why take the auction house’s insurance policy at the cost of your own profits?” (Art Market Monitor, 29 October 2015).
- It could reduce the price made at auction: Guarantee prices are not disclosed but they are often close to the pre-sale low estimate. Naturally the guarantor will always want to set the guarantee price as low as possible to reduce their risk. As a consequence, the auction estimate may also be set lower. The fact an auction house has estimated an item’s value at a lower amount could have the knock-on effect of reducing the amount that buyers are willing to bid to auction.
- It could deter bidding: a potential buyer will be aware that another buyer has already put his hat in the ring in respect of an item and will have done so at a potentially discounted price. This may dissuade a potential buyer from bidding as they know this is an item that has already been spotted and therefore there is less chance of obtaining the item at a ‘bargain’ price.
- It could sell for less than would be received in the private market: The most important question for a seller to ask is ‘if it is necessary for me to sign up to an auction house guarantee, should I really be selling at auction?’ The very fact that such guarantees exist is an indicator of the risk of selling at auction.
Are guarantees ethical?
Auction house guarantees are legal but they remain a controversial topic as some consider that they serve to distort the market and inflate prices.
It is noted in the auction house catalogue that a lot is subject to a minimum price guarantee but the guarantee amount is not made public and the guarantor knows the amount. Therefore, arguably they have information that puts them in a better position than their rival bidders. Normally, the reserve price is not disclosed to anyone else. This arguably threatens the idea that those participating in the auction process are doing so on a level playing field.
There have also been concerns raised over the fact that due to the existence of guarantees and risk-sharing the published price of an item sold at auction may not be the actual price paid. Bloomberg highlight that in response to such transparency concerns, Sotheby’s lists their prices net of fees paid to buyers, which enables the market to estimate the fee paid to the irrevocable bidder (based on Sotheby’s standard sales commission). However, Bloomberg reports that “Christie’s does not adjust for such fees in its reporting of final prices.”
It has been suggested, that collectors, agents and dealers may attempt to maintain high market values for an artist that they have a financial interest in, by acting as a guarantor and putting in a guaranteed bid (see for example comments in the article “Art turns ugly” (10 June 2016)). If the winning bid is higher than the guaranteed price, then the guarantor receives their fee and a share of the profits above the guarantee amount. Of course there is a risk that the guarantor may end up with the work if they place the highest bid. However, assuming they can afford it, they have both added to their collection of the artist’s work, supported the market of the artist in whose value they hold a stake, and paid a ‘discount’ price as their fee has been deducted.
If you do sign up to a guarantee, should you take legal advice?
The short answer is yes. The terms of the guarantee are negotiable and in light of the effect it can have on the sums that a seller may end up receiving as a result of the guarantee, they need to ensure that it is legally watertight and reflects the terms that have been agreed.
Further reading:
http://www.ft.com/cms/s/2/1d20e4b6-d47c-11e3-bf4e-00144feabdc0.html#axzz3pImi3mnB
http://www.brandeis.edu/departments/economics/RePEc/brd/doc/Brandeis_WP71.pdf
http://www.christies.com/features/guides/buying-guide/related-information/financial-information/
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