This article is authored by Phoebe Kouvelas LL.M. and has been first published at Private Art Investor. Access here.
A common risk for selling an artwork at auction is failure to sell. In fact, it is a dreaded scenario, as the artwork becomes less attractive to the market and consequently loses value, since - seemingly - there is no demand for it. Prestige being one of the key drivers of collecting, who would want a piece rejected by their art collecting peers?
Auction houses have long offered a solution to this problem. With competition being fierce between houses at the top end of the market, they need to offer incentives to sellers in order to persuade them to consign blue chip works. A strong such incentive hedges the seller’s risk of failure to sell at auction. The name: auction house and third-party guarantees.
Auction House Guarantee
An auction house guarantee is an agreement between the seller and the auction house by which the seller agrees to consign an artwork at auction on the condition that the auction house guarantees a minimum price to be paid to the seller, regardless of whether the lot sells at auction or not. Clearly, the auction house assumes a financial risk; if the lot fails to sell, it has to pay the full guarantee amount to the seller and in return obtains legal title and possession of the (arguably, not so attractive) work. This assumption of risk does not come for free to the seller. If the artwork sells for more than the guaranteed amount, the auction house will capitalize on the upside of the sale by receiving a proportion of the difference between the guaranteed price and the price achieved at the auction.
Third-Party Guarantee
It is increasingly the case, however, that auction houses choose to reduce their financial exposure by paying a third party a fee for guaranteeing a lot before the auction. This third party guarantee is an arrangement whereby a third party would either share with the house or fully bankroll the risk of the amount of the guarantee. Although the fact that a lot is subject to a guarantee is marked in the catalogue, the amount guaranteed is undisclosed to the public and so is the identity of the guarantor (in most cases, even to the seller). This creates a few issues which both sellers and bidders, as potential buyers, must be aware of.
Seller Considerations
On the seller side, the auction estimate will tend to be set lower than would otherwise be. The reason is that the guarantee amount is up to the pre-sale low estimate and it is natural that the guarantor will push for a lower guarantee amount to reduce their exposure. The auction house, in turn, will also want the lot estimate to be close to the guarantee amount. Therefore, the house will have a direct interest in lowering the auction estimate, although this may not always be to the seller’s advantage.
Further, guaranteed lots can depress bidding in the room. It is notable that two of the most expensive paintings (Modigliani’s Nu Couche and Picasso’s Fillette à la corbeille fleurie) sold to their guarantors for $157,2 millions and $115,1 millions respectively with no other bids in the room. Clearly, sellers with exceptional artworks may not be getting the best from the auction process by missing out on a potential bidding war which could drive the price upwards the pre-sale estimate.
Finally, sellers will need to weigh how much they wish to pay for the certainty provided by the guarantee. With their profits significantly reduced (mainly due to waiving part of the upside from the sale) it may not be worth putting the work up for auction, but instead opt for a private sale, with significantly reduced expenses.
Buyer Considerations
On the buyer side, potential bidders must be very careful not to reveal their intention to bid for an artwork prior to the auction. This is because the very knowledge that someone is going to bid may prompt the not so scrupulous dealer to place a guarantee on that same lot, knowing that they will make a good profit without having to eventually buy the artwork. This scenario becomes even more problematic when a potential buyer asks an advisor to bid for a specific lot on their behalf (which is often the case). Here, a breach of fiduciary duty from the advisor’s side may give rise to legal action against the dealer. A written agreement between principal and agent (in this case, bidder and advisor) guaranteeing that the advisor will not put himself in such a conflict of interest situation would be necessary in such case.
Whether on the seller or guarantor side, the auction house or third-party guarantee is an agreement, the terms of which are the outcome of sophisticated, case-by-case negotiation between the parties. It must be noted that Christie’s and Sotheby’s have different rules and terminology when it comes to guarantees and one must be aware of these differences before starting a negotiation with either. It is therefore wise to always seek expert legal advice before venturing out to bid on, sell or guarantee an artwork at auction.
