Assurance Policies: Third-Party Guarantees May Reduce Risk and Yield Rewards

Assurance Policies: Third-Party Guarantees May Reduce Risk and Yield Rewards
An auction at Sotheby's
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It wasn't long ago that financial guarantees, or minimum amounts promised to sellers regardless of how their artworks performed in the salesroom, were a crucial part of the auction business. Houses were willing to put up their own funds to secure stellar consignments, especially when the market was strong. In 2006, for example, the major New York spring sales at Christie's and Sotheby's together involved approximately $500 million worth of guarantees. Then came the economic crisis of 2008. That fall Sotheby's incurred losses amounting to $52 million because of guarantees, many of them made months before the credit meltdown, on property that failed to sell. As a private company, Christie's is not obligated to report such figures, but top management confirms that the house suffered similar losses.

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Having experienced the pain of the downside of this practice all too keenly, the houses have developed a variation on it: the third-party guarantee, a hybrid that shifts the risk to an outside backer. Third-party guarantors, also called irrevocable bidders, are a select and mostly anonymous group of deep-pocketed collectors and dealers who, approached by the auction houses, agree to bid for specified works up to a minimum price. If bidding stops there, they acquire the lot; if they are outbid, they split any profit from its sale with the consignor and, if this is part of the agreement, with the auction house, the percentage going to each party varying with the deal.

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Every third-party negotiation is separate. In this respect, these arrangements differ from the house-backed ones. For the latter, says a New York–based art attorney familiar with deals done in the late 1990s, "you never guaranteed a single piece of property; you only guaranteed a group of properties. You spread the risk out that way, and the auction house would generally get a fairly sizable amount of the upside. As the market became hotter and more competitive, the auction house retained lower and lower portions of the upside and made more complicated deals."

Where third-party guarantees do resemble the earlier ones is in complexity. Each house has its own criteria for such transactions, the details of which are strictly confidential. "I've done deals [where the third party] gets from 50 to 80 percent of the upside," says one New York private dealer, who insists on anonymity, noting that the arrangements have become a primary part of his business. He also points out that a more generous guarantee can result in a bigger payback for the third-party once the bottom line is met.

Although traditional guarantees are still used, third-party arrangements have largely replaced them. Since November 2008, Christie's has forged third-party guarantees for 20 Impressionist/modern lots and for 56 postwar and contemporary ones in its London and New York sales. Sotheby's breaks down its statistics differently. According to a spokesperson for the house, the total amount of all auction guarantees issued by Sotheby's amounted to $626 million in 2008 and $7 million in 2009.

Third-party deals free the houses of the burden of off-loading bought-in property. But they have an even more important advantage, which adheres to the sellers as well: "Someone is committed to bidding," says Philippe Ségalot, of the New York and Paris dealer Giraud Pissarro Ségalot. "The auction-house guarantee only goes up to the level of the guarantee, but the third-party guarantor might surpass the level of the guarantee he gave, so it helps the work in the end." For his November 2010 Carte Blanche auction at Phillips de Pury & Co. in New York, Ségalot arranged a handful of third-party bids that accounted for $82 million of the $117 million sale total.

The New York trader and collector Alberto Mugrabi and his art-dealing family have participated in third-party deals as both backers and as consignors. They took the latter role, for example, with their 1962 Andy Warhol silkscreen "Men in Her Life" (est. $40–50 million), which was the top lot of Ségalot’s Carte Blanche sale. The painting, featuring Elizabeth Taylor, exceeded expectations to bring $63,362,500. Mugrabi declines to discuss other such deals he's participated in, but points out their benefits for all parties involved, including the market. "Usually the people doing third-party guarantees want to own the piece," he explains, "so it's a chance for them to buy it for a better price. And the consignor still has hope that he'll make more money beyond the guarantee. The person selling wants the security, and without it some great things don’t come on the market."

Among the blockbusters that third-party guarantees might have helped bring to auction are several from the trove of 20th-century art that the estate of the Los Angeles collector Mrs. Sidney F. Brody, consigned to Christie's for its May 2010 sale. A private New York dealer backed Picasso's "Nude, Green Leaves, and Bust" (1932), which sold for an auction-record $106,482,500 (est. on request), and Giacometti's "Grande tête mince" (1955), which brought $53,282,500 (est. $25–35 million). According to trade sources, the dealer made in excess of $10 million on the two works.

Another anonymous New York dealer was the guarantor of Felix Gonzalez- Torres's "Untitled (Portrait of Marcel Brient)" (1992) (est. $4–6 million), which brought an artist-record $4,562,500 in the Carte Blanche sale, and of Juan Gris's "Violon et guitare" (1913) (est. $18–25 million), which fetched an artist-record $28,642,500 at Christie’s in November 2010. "I was actually the underbidder on that one," he says of the Gris. "I walked away with more than $3 million. It's a win-win if you do it right."

Another successful player is the Taiwanese collector Pierre T.M. Chen, CEO of the computer-chip maker Yageo Corporation. According to a source close to Chen, he was the third-party backer for at least two enormously successful artworks: Amedeo Modigliani's "Nu assis sur un divan (La belle Romaine)" (1917) (est. in excess of $40 million), which an Asian bidder on the telephone bought for an artist-record $68,962,500 at Sotheby's New York in November 2010, and Picasso's "La lecture" (1932) (est. £12–18 million; $19.3–29 million), won by an anonymous telephone bidder at Sotheby's London last February for £25,241,250 ($40 million).

Of course, not all third-party guarantors profit — in fact, they can lose millions if they agree on a price that is higher than anyone in the salesroom is willing to pay. And even a guarantee can't restore the luster to a piece that's been shopped around too aggressively. Take the much-hyped Jeff Koons "Pink Panther" (1988) (est. $20–30 million), a deliciously naughty porcelain sculpture that came up last May at Sotheby's New York and sold on a single telephone bid, presumably by the third party, for a disappointing $16,882,500. It is unknown how much of a guarantee the consignor, the publishing magnate Benedikt Taschen, received for the work, but speculation in the trade is that the number was close to the low estimate. Sotheby's declines to make an official comment on the performance of the Koons, but one specialist there admits that the work's value was "probably overestimated."

According to Brett Gorvy, international head of postwar and contemporary art at Christie's, which was also offered the Koons, "The seller didn't limit who he went to and went to dealers as well, so by the time the object came up for sale, all the fire had been taken out of the market. In this case, all of the houses as well as [some] dealers were trying to find backers, and no matter how good the object was, people stayed away. The seller got his guarantee, but there was no upside."

One drawback to these deals is that they can drive away bidders, who are alerted to their presence in the salesrooms by the auctioneers and in cata- logues by a symbol. These bidders perceive an unfair advantage for guarantors and auction houses, which effectively presell the works, precluding anyone else from getting a better deal. "I just feel there are opportunities for doing slightly underhanded things when you are a third-party guarantor," says one New York dealer and former auction house specialist. "It's like you've got an inside edge."

Guarantors doing business at Christie's have another advantage: a "financing fee," which rewards them for the risk they take and which may be in the form of a reduction in the buyer's premium on lots they back and purchase. Christie's spokesperson Toby Usnik explains that the fee "is processed separately from any purchases. As disclosed in our notices section [in the catalogue], the third party may, for convenience, choose to use the financing fee to offset any amounts the third party may owe Christie's, but the third party can also simply take the payment."

This remuneration deal gives Christie's an edge in attracting backers over Sotheby's, which disclaims such practices. "I can assure clients they are bidding in a fair, transparent, and level playing field," says Sotheby’s CEO William Ruprecht. "I could not offer those assurances elsewhere."The house's legal counsel, Jonathan Olsoff, is even clearer on this point. "Our disclosures about irrevocable bidders say that if successful, the irrevocable bidder will be required to pay the full buyer's premium and will not be otherwise compensated."

What if Sotheby's were to provide such a discount in the future? "We would have to report the price net of the compensation paid to the irrevocable bidder," says Olsoff. "However, we would not, in any event, discount the buyer's premium."

Another aspect of third-party guarantees is perhaps less obvious: The fact that consignors need such incentives suggests that confidence in the art market may not have recovered completely. And that means this special form of insurance will not likely disappear anytime soon.  

"Assurance Policies" originally appeared in the September 2011 issue of Art+Auction. For a complete list of articles from this issue available on ARTINFO, see Art+Auction's September 2011 Table of Contents.