Taking security over art

In recent years, we have seen lenders in the English private banking market increasingly showing an appetite for taking security over artworks.  

Once it has been established that English law is applicable (see below), there are several legal and practical issues which should be considered before entering into security over artworks, including those set out below. This article covers the key points to consider when taking such security. We note, however, that we would typically include specific provisions and conditions within a loan agreement when acting for a lender on an art finance transaction in order to ensure that the value of the security can be preserved and monitored throughout the life of the loan.

Consider what security interest to take

Under English law, the principal forms of security that can be granted over an artwork are a legal mortgage, a charge, a pledge, or a security bill of sale. The type of security interest that is taken by a lender will largely depend on the identity of the security provider.

Legal mortgage

Under a legal mortgage the legal title in an artwork is transferred to the mortgagee, subject to the mortgagor’s right to have that legal title transferred back to them when the mortgage is discharged. The mortgagee does not need to have possession of the artwork in order for the mortgage to be effective and because of the transfer of title, taking a mortgage over artwork is the most legally secure form of security interest (although of course as art is moveable, actually taking possession of the artwork may often be more physically secure). Note, however, that under English law, if an individual is granting security over an artwork it will most likely be effected by way of a pledge, for the reasons set out below, rather than by way of a legal mortgage or charge.

Charge

As with a legal mortgage, for a charge to be effective a chargee does not need to take possession of the charged artwork (although the chargee does need to have a sufficient degree of control over the art in question in order to ensure that the charge is a fixed and not a floating one). Unlike a legal mortgage, a charge over an artwork doesn’t transfer legal title in that artwork to the chargee, but it does give a chargee an equitable proprietary interest in the charged artwork. This includes the right to appropriate that artwork if the charge becomes enforceable and to use the proceeds of any sale of the artwork to discharge any debt which is secured by the charge.

Security Bills of Sale

If an individual or a partnership (although not a limited liability partnership) creates a mortgage or charge over personal chattels (which would include artworks) such mortgage or charge will be subject to the Bills of Sale Act 1878 and the Bills of Sale Act (1878) Amendment Act 1882 (collectively referred to as the Bills of Sale Acts). These require the security to be documented, registered and renewed every five years in a specific form as set out in the Bills of Sale Acts (unless the security falls within one of the extremely narrow statutory exemptions), or the security will be deemed void.

For this reason, coupled with the fact that the Bills of Sale register is not comprehensive and is difficult to search (and searches take a long time to be returned), security bills of sale are often perceived by lenders as being cumbersome and unappealing. Bills of sale also cannot be used to secure certain forms of credit, such as revolving loan facilities or overdrafts, because a bill of sale must state the exact amount of the loan, the rate of interest that will applied and the amounts and dates of any repayment instalments. It is therefore rare for lenders to take English law governed mortgages or charges from individuals in respect of artwork, given the level of formalities that are required to comply with the Bills of Sale Acts, the risk of the security being held to be invalid if there is any such failure to comply, the inadequacy of the register and unsuitability of bills of sale for modern financing structures.

Pledge

Taking a pledge from an individual avoids the challenges of taking security under the antiquated Bills of Sale Acts and is therefore generally seen by lenders as a preferred method of obtaining robust English law security over artwork.

A pledge also deals with practical security issues, the key feature of a pledge being that the pledgee takes possession of the secured asset (the artwork) and has control over it, although the title to the asset remains with the pledgor. Helpfully, possession can be either actual or constructive, meaning that a lender can establish constructive possession in situations where a third party specialist storage provider or custodian agrees to hold the pledged artwork in a suitable environment to the exclusive order of a lender.

A Note on Consumer Credit

In addition to considering the type of security interest being granted, consumer credit issues should also be at the forefront of a lender’s mind if security is being granted by or securing a loan made to an individual. In this case the lender must carefully consider whether the related loan agreement would constitute a regulated credit agreement and be subject to the regime governing such agreements, which is outside the scope of this article.

Check title and provenance in relation to the artworks

As when taking security over any other asset, it is crucial to establish title to the artwork that is being charged. The lender will need to obtain confirmation, most likely from a specialist valuer or adviser (who may themselves also be able to provide a valuation to the lender of the artwork in question), of the security provider’s title to the work of art.

Given that there is no single title document that can be used to establish the ownership of an artwork, and often no certificate to prove its authenticity or provenance, establishing ownership can be complex. If the title to such artwork is no longer owned by the artist who created it, the lender will need to verify a chain of title. This verification usually involves going back to the original artist through auction records, sales receipts, and invoices. It will also be vital that the borrower gives a representation in the relevant loan agreement that it (or the relevant third party security provider) is the sole legal and beneficial owner of the artwork that is being charged.

Depending on the jurisdiction where the relevant artwork is located, it might also be helpful to a lender to carry out further searches in that jurisdiction. Very few of these searches will be entirely comprehensive, but they may be a useful further check for a lender. We, or local counsel, should be able to advise as to which searches should be conducted prior to making any loan facility available to a borrower.

Obtain a valuation of the artwork

The valuation of the artwork will be of fundamental importance to the lender, given that this will be essential to determining how much the lender will be prepared to lend against the value of the artwork. As would be the case when lending against any other asset, the loan agreement should include provisions that would allow the lender to request an updated valuation of the artwork at any time during the lifetime of the facility.

Loan to value levels (being the proportion, usually expressed as a percentage, that a loan bears to the value of the asset that is being used as security for such loan) are often lower for art financing than in relation to lending against other assets, due to the type of security involved, so a borrower should typically expect to provide more security when borrowing against art than most other forms of property.

Consider the storage location of the artwork

Is the artwork located in England and Wales? If not, it is essential to check with local counsel in the jurisdictions where any artwork is located or is likely to be moved to during the life of the loan, that any English law security would be effective and whether there are any local law security, perfection or registration requirements.

If possession needs to be established, lenders will need to think carefully about where the artwork is to be stored. Lenders may store works themselves, but typically the artwork would be correctly stored with a third party professional storage provider, providing a secure environment where issues such as temperature and humidity levels can be safely monitored in order to preserve the works.

Any third party custodian should enter into a tripartite agreement with the borrower (or security provider, if this is not the borrower) and the lender, pursuant to which the custodian agrees to hold the artwork to the order of the lender and to the exclusion of the security provider, subject to the terms of the tripartite agreement. Constructive possession to the charged artworks could also sometimes be established by providing the lender with the keys to any room in which the artworks are being stored. A lender will need to consider the potential conflict with any liens that a storage provider may have over the artworks if their fees aren’t paid.

Lenders should also always consider the tax position of the secured artwork (particularly from a VAT perspective) and take tax advice regarding the location and storage of any artworks which are to be used as security for a loan. Careful consideration should be given to the potential impact from a tax perspective of the charged artwork being stored under temporary admission or in a bonded warehouse and subsequently needing to be sold as part of an enforcement.

Should the security provider have access to the secured artwork?

The lender should be extremely cautious about allowing the borrower or security provider to have access to the secured artworks, even if they are stored with a third party storage provider. If the artworks are pledged, the lender must always maintain actual or constructive possession of the secured asset. Allowing a borrower or security provider unfettered access to the artwork could threaten such possession.

If artworks are mortgaged or charged or not stored in a specialist warehouse with controlled access, lenders must of course also consider the physical security and portability of the artworks. They should take steps from the outset to prevent any theft of, interference with or damage to the secured artwork and will need to ensure that they can establish and maintain control over the secured work and preserve its value.

Key insurance points to consider

As with all assets intended as security, but specifically with unique, irreplaceable assets such as artworks, the lender will need to ensure that it has seen sufficient evidence that the artwork is adequately insured for the agreed value. They should potentially also take composite insurance with the borrower, security over the insurance policy itself, or alternatively insure the artworks in its own name.

Depending on the circumstances, lenders may also require other provisions to be included in the policy which would prevent the insurance from suddenly being withdrawn in the event of a breach of the policy or non-payment of premium by the borrower or security provider.

Summary

When taking security over art, there are a number of considerations that need to be made in order to ascertain the title and value of the artworks in question and to ensure the enforceability of the security and the preservation of the assets which are being charged. However, with assistance from lawyers who have expertise in taking security over such assets, such considerations should be relatively straightforward to navigate.  

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

© Farrer & Co LLP, April 2024