A New Goods Mortgages Act - Refining the art of lending, or just a comfortable disturbance?

According to Banksy, "Art should comfort the disturbed and disturb the comfortable," and in this article, we consider whether the new Goods Mortgages Bill might be about to disturb the historically uncomfortable English law position relating to secured lending on art that remains "on the Borrower's walls".

As the recent $450,000,000 sale of the Salvator Mundi has shown, art can have extraordinary value as an asset, not only in terms of its aesthetic (or historical) worth, but because (unlike some other tangible assets), the value of art can actually appreciate over time. As the dynamics of the art market in the UK and Europe are changing, so is the business of lending against art. A swathe of new capital is currently infiltrating the art finance market through both the private banking groups of some of the largest traditional lenders and via a growing number of new alternative art finance providers. Sophisticated borrowers are becoming increasingly alive to the ability to monetise their art collection by using it as collateral, whilst retaining the flexibility to choose when (or if) to sell and liquidate their assets.

The discomfort

The discomfort starts when lenders consider the type of security available to them. Credit committees at most traditional UK bank lenders still struggle to find a satisfactory English law mechanism of securing art in a way that provides them with sufficient practical and legal security to ensure ultimate repayment, whilst also allowing the client flexibility of location and treatment of the asset. Some alternative art finance providers, with higher risk tolerance and greater flexibility, can however offer more creative structures, which allow the artwork to remain on display or on the borrower's walls throughout the financing period, a solution clearly appealing to some clients, but stifling for some bank lenders.

Whilst currently English "chattel mortgages" do allow lenders to take possession of secured art if a loan defaults, these are easier to enforce against companies than individuals. Where an individual grants security over a "personal chattel", (including a work of art), the security will be subject to the Bills of Sale Acts (the "Existing Acts"), four antiquated statutes (1878, 1882, 1890 and 1891) which deal with securing personal chattels by handing over ownership of an asset whilst remaining in the borrower's possession.

Unless however, it is in the form required by and is registered under the Existing Acts, the security is void and the lender has no recourse to the borrower or the asset. In practice, these formalities are cumbersome, unattractive to lenders and frankly, unfit for purpose. For example, the original and a copy of each bill of sale must be filed with the registrar at the High Court together with a sworn affidavit within seven clear days of its execution, and registration must be renewed every five years. The bill of sale itself must state the loan amount, interest rate and repayment instalments, including the repayment date (extremely difficult if the bill of sale is to secure an overdraft or a revolving credit facility). Any amendments must also be registered with the court, and the register is only searchable manually by the name and postcode of the borrower, therefore trying to establish whether there is existing security over the asset becomes almost impossible.

Unsurprisingly, the use by UK banks of bills of sale to take a mortgage or charge from individuals over artworks is to say the least, uncommon, and even when it is used, lenders often resort to physically tagging the art and relying on a search of the Art Loss Register (a register designed to track lost and stolen art, but helpfully where lenders can also voluntarily register their own interests in the art and conduct searches on others' interests) to bolster protection. Contrast this to the US position where, thanks to The Uniform Commercial Code (adopted by all 50 states), creditors may give notice of their interest in the personal property of a debtor (e.g. a piece of art) on a public register. This more accessible and transparent registration format not only means that US borrowers are more likely to be able to borrow against their art while keeping up appearances (and the art on the wall), but also (according to Deloitte's Art & Finance Report 2016), has helped the US art finance market to expand to between $15 and $18 billion (value of average loans outstanding).

But comfort for UK lenders may be on its way from the most unexpected of sources...

The comfort

The financial crisis in the UK saw the sudden rise of "logbook lending" by which borrowers raise finance against their vehicle whilst retaining possession of the asset. With this came an increase in the use of bills of sale, despite clear difficulties with the Existing Acts. Such unexpected growth, predominantly in the consumer sector, highlighted the need for reform to the Law Commission (the "Commission"), who in September 2014 launched a consultation into a reform of the Existing Acts. Predominantly targeted at improved consumer protection in logbook lending, the Commission's subsequent proposals could also potentially provide a significant legal mechanism by which individuals and unincorporated businesses may secure loans on their other assets including art, fine wines and watches.

In its final report and recommendations for reform (published in September 2016), the Commission concluded that the Existing Acts should be repealed and replaced by a new Goods Mortgages Act (the "Goods Mortgage Act") allowing individuals to create and register charges over goods. A draft bill (the "Bill") has now been published, which proposes a single simplified regime for registering all goods mortgages, with no time limit and re-registration required every ten years. The Bill also proposes to exempt goods mortgages granted by high net worth individuals from the additional consumer protections enshrined by other parts of the proposed legislation.

The outcome

Rather like Chekhov's description of the role of the artist being "to ask questions and not to answer them", the new proposals seem (at least in the context of goods mortgages that will be secured on assets other than vehicles) to raise at least as many questions as they provide answers. Crucially, the Bill leaves the key question of the approach to registration as a largely blank canvas to be determined by regulation rather than the Bill itself. Whilst the Commission appears to have listened to consultations and moved away from the "do nothing" option relating to the registration of the new goods mortgages (which we hope will lead to a new, reliable, comprehensive and user-friendly register), until we have further clarity on ministers' intentions, the impact of the new Goods Mortgages Act on the art, and indeed any other luxury asset, finance market will remain unclear.

The other more fundamental question that remains is whether the disturbance will be sufficient. Will the new law be fulsome enough to surmount the practical problems that may subsist in respect of this particular type of asset security? Will the Goods Mortgages Act be sufficiently far-reaching and robust to provide a lender with the necessary comfort that a secured valuable painting or sculpture can remain in a domestic home despite risks that it could simply be removed and taken out of the country or sold?

Can this new legislation help to overcome (or at least allow lenders to feel more comfortable with) the age old problems of value, title, provenance and authenticity that lending on art creates? It is clear that no matter how uncomfortable the disturbance to the statute books, the veil of opacity of the art market and art world is not about to be lifted. But, a new law supported by sensible regulation which allows for quicker and more flexible registration together with an easier and more comprehensive search procedure could provide traditional lenders with the comfort that they need to compete with the alternative finance providers. The Goods Mortgages Act might also pave the way for a more widespread financing of less commonly secured luxury assets, such as fine wine, cars, books or watches, allowing lenders to leverage off those parts of their clients' wealth and investment portfolios thus far unattributed with lending values.

To revert to Banksy, whilst the Goods Mortgages Act may not completely comfort those disturbed by the current risks of art lending, the much loathed and incomprehensible Existing Acts will be removed from the statute book. This could then also potentially allow the first small steps to be taken along the road towards the zenith (for some) of a universal electronic register of security interests which, while some way off, seems now at least to be emerging on the distant horizon.

If you require further information on anything covered in this briefing please contact Suzanne Conticelli, Bethan Waters, Anisha Birk or your usual contact at the firm on 020 3375 7000.

This publication is a general summary. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, November 2017