Lending against art is on the rise. In a survey conducted by Deloitte and ArtTactic for their Art and Finance Report 2014, 48% of collectors said that they would be interested in using their art collection as collateral for a loan, which according to the report, is an increase from 41% in 2012. Skate’s Global Art-Loans Market Report, whilst wildly optimistically predicting that “the 2015 art loans book [is] scheduled to grow above $10 billion this year, which is at least twice the level of the art-lending market last reviewed by Skate’s in 2011”, perhaps more accurately described the United States “as the world’s largest, most transparent, and most efficient market for art lending”. To suggest that the US art lending market is transparent is wishful thinking, but it is the world’s largest, and probably the most efficient. Its success can largely be attributed to its Uniform Commercial Code (the “UCC”) system. A lender can perfect its security interest in moveable property without taking possession, and gain priority over subsequent charges filed by other creditors, by filing a UCC financing statement which has the effect of putting the public on notice that the lender has a charge over the property. Once filed, the security interest is searchable by anyone, making it more difficult for the borrower to defraud creditors. The UCC presents a practical solution for the art-lending community, allowing lenders to publicly record their financial interest in the borrower’s artworks, while allowing borrowers to retain possession of their prized collections.
In England, there is no modern registration system such as the UCC. Lenders against art typically fall back on the traditional pledge. A pledge is a form of security interest. It is perfected by physical delivery of the moveable property to the lender or someone acting for the lender. In practice, this means that in England, lenders against art insist on taking possession of the art given as security for the loan. Generally, this is done by requiring the borrower to hand over the art to a specialist storage facility, although art on loan to museums can equally be pledged if the museum agrees to hold the art as collateral to the lender’s order.
In the second half of the 19th century, a registration system was introduced in England. The borrower would grant the lender a ‘bill of sale’ which the lender would register, thus giving it priority over other lenders. To protect the borrower from sharp lending practices, the form of bill of sale was strictly regulated and formalistic, thus limiting the circumstances in which a loan secured by a bill of sale could be made. The Bills of Sale Acts (1878 and 1882) require all bills of sale to be registered at the High Court. Bills of sale have been heavily criticized as “archaic” and “cumbersome”. In fact, they are more likely to confuse borrowers than to protect them, and for lenders, the sanction for non-compliance can be unduly severe. Most troubling is the fact that the High Court is used as a repository of the bills of sale register, which is still paper-based, reliant on manual processes, not necessarily up to date and searches are difficult to conduct. This is a stark contract to the UCC system in the United States, which is reasonably efficient and practical.
In 2014, HM Treasury asked the Law Commission to consider the current bills of sale laws and make recommendations for reform*. As a result, the Law Commission published a Consultation Paper and sought responses on its proposal to reform the bills of sale regime. Constantine Cannon LLP submitted a response to the Law Commission in support of a much-needed reform. (*The Bills of Sale Acts do not apply to Scotland. Accordingly, any reform made would apply to England and Wales only.)
In its Consultation Paper, the Law Commission described bills of sale as being “far too complex”, “impenetrable for the modern reader”, and “seriously out-of-date”. It seems that banks, auction houses and specialist lenders making art-backed loans in England agree with the Law Commission, as bills of sale are rarely used for loans against art. In 2014, of the 260 bills of sale registered to secure loans on goods other than vehicles, only one pertained to art and antiques, while six others pertained to wine. These numbers do not accurately reflect the number of loans against art and collectible items in England in 2014, because lenders rely on pledges instead of bills of sale to protect their interest in art collateral. Pledges are not favoured by borrowers, because a condition of the pledge is physical delivery of the art or collectible items to the lender for the duration of the loan. In fact, many borrowers shy away from borrowing against their art for that very reason. There can be little debate that England’s art lending industry would benefit from a reform to the bills of sale regime.
The Law Commission has proposed a new legislative framework. Specifically, the Law Commission has proposed to abolish the Bills of Sale Acts altogether and replace them with another act, known as the “Goods Mortgages Act”. In broad terms, the new legislation would apply where (i) an individual, (ii) uses goods, (iii) which the individual already owns, (iv) as security for a loan or other non-monetary obligation, and (v) retains possession of the goods. See, Consultation Paper. Under the proposed framework, the current archaic standard form will be replaced by a short, simple document which makes clear to borrowers what a goods mortgage entails and the potential consequences of default. The proposal allows the parties flexibility in deciding whether a goods mortgage should take effect by transferring ownership to the lender or as a charge only. The Law Commission proposes that the statutory form of document will contain warnings designed to inform consumers, although these warnings will not apply to loans to high-net-worth individuals or for business purposes above a certain value.
The Law Commission acknowledges that the sanction for failure to comply with the document requirements in the 1882 Act is harsh and disproportionate. The lender not only loses any right to the secured goods but also loses the right to sue the borrower for repayment of the loan. A different sanction is proposed: the lender would still be entitled to repayment of the loan, but the goods mortgage itself would be void. In other words, the lender would lose its rights to the secured goods, both as against the borrower and as against third parties. In its response to the consultation, Constantine Cannon observed that this approach may or may not be appropriate depending on the wording of the proposed statutory document and the flexibility afforded to the lender to adapt the statutory wording to the circumstances of each individual loan.
In its response, Constantine Cannon argued that the proposed reform does not go far enough. For example, the Law Commission is of the view that registration of the goods mortgage under the new framework must continue to be made with the High Court, and that there is no need for a more modern public register. The Consultation Paper states, “[g]iven the small volume of security bills currently registered over goods other than vehicles, we do not think that the costs of establishing such a register would be justified.” In our view, the Law Commission’s rationale for not investing in a public register is flawed. In our response, we explained that the fact that few bills of sale have been registered in relation to art loans is a reflection of the fact that bills of sale, including the current form of register, are unsuitable to modern lending. Unless the register is fit for purpose, the proposed reform will not have the desired effect of opening up the market for non-possessory art-backed loans in England. The High Court is not equipped to run an online, reliable and efficient goods mortgage register. A new register should be established that is akin to the UCC register in the United States.
In our response, we encouraged the Law Commission to adopt a new framework that is forward looking. For example, we suggested that the requirement of a physical signature in the presence of a witness is no longer appropriate in the 21st century given that most contracts are concluded at a distance through use of modern distance communications. Formalities such as original signature and witnesses are outdated. If there is doubt as to whether the borrower agreed to be bound by the goods mortgage, the burden of proof should fall on the lender.
The consultation is a positive step forward. The proposals formulated by the Law Commission strike a reasonable balance between the interest of lenders and borrowers, although there is scope for improvement. The importance of a modern, efficient and up-to-date goods mortgage register cannot be overstated. Without it, assessing risk when buying art, borrowing art or lending against art will remain hazardous, and transparency will continue to be an issue. Unless reformed, the bills of sale regime will continue to be a major impediment to the growth of England’s art-lending market, placing the UK at a competitive disadvantage when compared to the United States where the UCC system has worked well for many years.
It is not possible at this stage to predict if and when the Law Commission proposals will make their way to the statute-book. It could take a couple of years before we know whether they may become law.
Pierre Valentin and Azmina Jasani