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Auction house guarantees: friend or foe?

Auction house and third-party guarantees remain a hot topic in the art market. At the 2015 Autumn sales in New York, Bloomberg reported that $1 billion - approximately half - of the $2 billion total value of lots were already sold before the "paddles are even raised".

Only a few years later in 2018, the Arts Newspaper reported that "auction sales worth $3.47bn worldwide in 2018 will have been covered by a guarantee, $2.5bn of those offset to a third party." Despite their increased prevalence, auction house guarantees remain a controversial topic in the art market, with some experts claiming that they could potentially be the cause of a future crisis in the market.

What is an auction house guarantee?

An auction house guarantee is an agreement by which the seller agrees to consign their work or collection to an auction house. The auction house agrees to guarantee to the seller that, whatever the outcome of the auction, the seller will receive a minimum sale price for the work or collection.

How do auction house guarantees work in practice?

The exact way in which an auction house guarantee will operate will depend on the terms and conditions that have been negotiated between the auction house and the seller in advance of the sale. However, the usual potential outcomes of an auction house guarantee are as follows:

  • The lot fails to sell at all: the auction house becomes the owner of the lot and pays the seller the full guarantee amount.
  • The lot sells for less than the guarantee amount: the winning bidder becomes the owner of the lot, and the auction house pays the seller the hammer price plus the difference between the hammer price and the guarantee amount.
  • The lot sells for more than the guarantee amount: the winning bidder becomes the owner of the lot and the auction house receives a proportion of the excess of the guarantee amount from the seller.

Does the auction house take on all of this risk itself?

In giving guarantees, auction houses are taking a financial risk. This risk could be substantial, especially if the auction house is guaranteeing a number of high value works in the same period. In the autumn of 2008 Sotheby's reportedly lost $52 million in one season, all from guarantees. In the immediate years following the financial crisis in 2008, auction houses virtually stopped giving guarantees.

However, guarantees came into use again when the auction houses started to off-set their risk to third parties. Whilst auction houses can take on the entire risk themselves, they can also choose to share the risk with a third party and that is where matters become more complicated.

Typically, this works by the third-party agreeing, for a fee, to place an irrevocable written bid, for an undisclosed amount, on the lot, before the auction (known as a third-party guarantee).
The amount of the bid can be up to or exceeding the guarantee amount. As a result, the third-party guarantor takes on all or part of the risk of the lot not being sold. For example, if an auction house gave a minimum price guarantee to the seller of £100 million for an artwork, but a third-party guarantor places an irrevocable written bid for, say, £80 million, the auction house's risk is reduced by that sum. Third-party guarantors may then also participate in the auction themselves and choose to bid on the lot over and above their irrevocable written bid.

If the lot sells for more than the guaranteed amount, the third party will receive a percentage of the upside. If there are not any bids over the irrevocable bid, the third party will obtain the work (essentially at a discount due to the fee owed to them). It may be that they are happy with this result. However, in certain circumstances, it may be considered a bet that has not paid off. In order to recover the situation, such works can return to the market relatively quickly, which, in turn, can have a negative effect on their resale value.

The use of third-party guarantees is now particularly prevalent in respect of high-value, modern, impressionist and contemporary auction sales.

Why do auction houses offer guarantees?

There are three primary reasons to offer an auction house guarantee: profits, certainty, and securing works for auction. If a lot sells for more than the guaranteed amount, this can provide a good source of profits for the auction house. The guarantee provides certainty that the item will "sell" and therefore commission will be received. If an auction house offers a seller a guarantee as an incentive, they may secure the consignment of works that would otherwise have gone to their rival.

If you are a buyer at auction, how do you know if an item is subject to a guarantee?

Lots which are subject to a guarantee are marked in the catalogue with a symbol and the symbol key in the auction house's conditions of sale provides an explanation. Different symbols are used for auction house guarantees (e.g. º) and third-party guarantees (e.g. º ♦). The auctioneer may also disclose at the start of a sale that some works will be sold with guarantees. However, the amount of the guarantee is not disclosed.

Art Seller Advantages

Certainty: one of the biggest risks at auction is that an item will fail to sell. This can have a significant impact on the reputation of the item, as some would then consider it "burnt" in respect of the market. A seller may have to wait years before feeling confident enough to offer the item to the market again. A guarantee eliminates this risk, as a seller will have the certainty that their item will be sold.

Using the auction process to obtain a minimum price: normally in an auction if a work fails to reach its reserve price, the work goes unsold, and the seller receives no money. A guarantee eliminates this outcome for works that risk not hitting a reserve.

Getting the best of both worlds: in the above circumstances, not only has a seller used the auction process to guarantee a minimum price, but they also have the benefit of the chance the item will exceed expectations and sell for an amount in excess of that at auction.

Better promotion of the work? Some have queried whether an auction house would put more effort into marketing an item in which it has an increased financial interest, as opposed to one where it does not. This should not be the case, as legally the arrangement should not change the duty that the auction house owes to their client, the seller, but it may be an added incentive.

Art Seller Disadvantages

It could reduce your profits: whilst it is the case that you will receive the certainty of a guaranteed sum for a work, you will, in turn, be giving away a slice of your profits. If the work is really something special, a seller should consider whether it is necessary to use a guarantee.

It could reduce the price made at auction: Guarantee prices are not disclosed but they are often close to the pre-sale low estimate. Naturally, the guarantor will always want to set the guarantee price as low as possible to reduce their risk. As a consequence, the auction estimate may also be set lower. The fact an auction house has estimated an item's value at a lower amount could have the knock-on effect of reducing the amount that buyers are willing to bid to auction.

It could deter bidding: a potential buyer will be aware that another buyer has already put his hat in the ring in respect of an item and will have done so at an essentially discounted price, as they will still get their fee if their bid is successful. They also have more information than other potential buyers as they know the guarantee amount. This may dissuade a potential buyer from bidding as they know this is an item that has already been spotted and therefore there is less chance of obtaining the item at a 'bargain' price. There have been reports of recent sales where, as a result of so many lots being guaranteed – and everything being viewed as essentially pre-sold – the sale lacked any 'spark'. It is this 'spark' at auction that can lead to fantastic and unexpected results for a seller.

It could sell for less than it would have in the private market: the most important question for a seller to ask is 'if it is necessary for me to sign up to an auction house guarantee, should I really be selling at auction?' The very fact that such guarantees exist is an indicator of the risk of selling at auction. Further, if the work is simply going to end up in the hands of the guarantor who offered an irrevocable bid, the seller may ask themselves if they could just have sold the work privately and directly to the guarantor, without the publicity and costs involved in taking it to auction?

Are auction house guarantees ethical?

Auction house guarantees are legal, but they remain a controversial topic as some consider that they serve to distort the market and inflate prices.

There is undoubtedly a lack of transparency in respect of these deals. It is noted in the auction house catalogue that a lot is subject to a minimum price guarantee, but the guarantee amount is not made public and the guarantor knows the amount. Therefore, arguably they have information that puts them in a better position than their rival bidders. Normally, the reserve price is not disclosed to anyone else. This arguably threatens the idea that those participating in the auction process are doing so on a level playing field.

A further potential conflict of interest is that the guarantors are frequently the auction house's top clients. It is arguable that these client-guarantors are being offered preferential treatment by the auction house; they are giving them access to these 'fee deals', and the ability to pre-purchase a work, in advance of the sale. The auction house is also pitching two clients' interests against one another – that of the seller and that of the guarantor.

There have also been concerns raised over the fact that due to the existence of guarantees, and risk sharing, the published price of an item sold at auction may not be the actual price paid, which distorts the market.

It has been suggested that collectors, agents and dealers may attempt to maintain high market values for an artist that they have a financial interest in, by acting as a guarantor and putting in a guaranteed bid. If the winning bid is higher than the guaranteed price, then the guarantor receives their fee and a share of the profits above the guarantee amount. Of course, there is a risk that the guarantor may end up with the work if they place the highest bid.

However, assuming they can afford it, they have both added to their collection of the artist's work, supported the market of the artist in whose value they hold a stake, and paid a 'discount' price as their fee has been deducted. Conversely, it has been pointed out, that in practice, this would be a potentially expensive and risky way of trying to support an artist's value in the market.

How can I protect myself from the potential pitfalls of auction house guarantees?

The terms of the guarantee are negotiable, and in light of the effect it can have on the sums that a seller may end up receiving as a result of the guarantee, legal and expert advice should be sought before entering into a guarantee.

In a less obvious scenario, buyers may also benefit from obtaining legal advice relating to guarantees. A situation may arise whereby a buyer asks a dealer or advisor to bid for a lot on their behalf. The unscrupulous dealer or advisor, armed with this information, could hypothetically then offer the auction house to guarantee the work, knowing it is going to be bid on. The buyer would have no way of knowing that their dealer or advisor has a separate financial interest in the lot they are also bidding on for them. This risk can be addressed by way of a formal agreement between client and dealer or advisor, providing for disclosure of such an interest, or an agreement not to enter into such an arrangement, when acting on the buyer's behalf.

Speak to our art law team for more information on auction law and the impact of auction house guarantees, or find out more about Boodle Hatfield's art law services.

 

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