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Demystifying the Bankruptcy Process – Part Four

The COVID-19 pandemic has created a lot of turmoil in every industry and every company. For the last five months at least 171 companies in the energy, transportation, entertainment, health & personal care, retail, travel, lodging and leisure industries have cited COVID-19 as a factor in decision for bankruptcy.

The risk of dealing with a company in a financial distress is at all times high. Understanding the bankruptcy tools available to a company that is on the path to or already in a court-supervised reorganization can help you in managing and reducing this risk.

Reorganizations in a Nutshell: Chapter 11 of the Bankruptcy Code governs the restructuring of businesses and individuals’ assets and liabilities. It provides financially distressed companies and individuals with protections that are attractive for the debtor and unavailable in many other jurisdictions. Among the key benefits of the US reorganization regime are:

  • the management stays in control of the company and an outside trustee/administrator is not brought in unless there are extraordinary circumstances.
  • the company can cherry pick beneficial contracts and reject burdensome ones.
  • the company can sell its business, selected business lines or individual asses free and clear of any encumbrances or interests.

Chapter 11 filers choose to opt for bankruptcy relief for various reasons: to stop debt collection action, to revise unworkable capital structure, to address overwhelming litigation, to facilitate the sale of major assets to a prospective buyer, and to reject burdensome contracts, to name a few.

Chapter 11 brings all stakeholders to one forum and facilitates global resolution of claims and liabilities. It may have different impact on the different stakeholders and these mini-series will cover the impact of a bankruptcy proceeding on trade creditors, distressed asset buyers, landlords, and the art world. The final summary is intended to help small business owners better understand how valuable a tool chapter 11 can be during a time of crisis by availing themselves of the new restructuring mechanism for businesses (and individuals with business debt) with undisputed liabilities that do not exceed $7.5 million.

What If You Are an Artist Dealing With A Gallery’s Bankruptcy

The Art Dealers Association of America (ADAA), has released a report on how art galleries across the U.S. have been affected by the pandemic. The report shows that galleries have been facing devastating revenue losses, reduction in business activity, and closures of their physical spaces, not only financially impacting their employees and vendors, but artists and creative professionals around the world. Therefore, it is important to be familiar with your rights as an artist

State law dictates the scope and nature of the legal rights and interest that a debtor-gallery has in artwork in its possession even when the gallery is a bankruptcy proceeding in federal court. Applicable state law in New York expressly provides that artwork delivered by an artist to a gallery for sale is trust property, and that any proceeds from the sale of such work are trust funds, in the hands of the gallery for the benefit of the artist. Such artwork and sale proceeds may not be subject to any claims, liens or security interest.

When a bankruptcy proceeding is commenced, property in the possession of the debtor-gallery becomes property of the estate and subject to distribution to all or certain creditors to the extent of the debtor-gallery’s property interest. Such interest is determined by state law. Since under Section 12.01(1)(a)(ii) of the NYACAL, artwork is trust property in the hands of the debtor-gallery for the benefit of the artist, artwork protected by the statute never becomes part of the debtor-gallery estate and should be beyond the reach of the gallery’s creditors.

By its terms, the New York statute applies “[n]otwithstanding any custom, practice or usage of the trade, any provision of the uniform commercial code or any other law, statute, requirement or rule, or any agreement, note, memorandum or writing to the contrary.” Section 12.01 unequivocally provides that no liens or security interest may attach to artwork delivered by an artist to a gallery for sale. Moreover, the statute also expressly provides that an artist cannot waive this provision of the statute, making it impossible for a lien or security interest to attach.

To be protected by the statute, the artwork should fall under the definitions of the statute. Section 11.01 of the NYACAL sets forth the applicable definitions:

  • An “artist” is defined as “the creator of a work of fine art or, in the case of multiples, the person who conceived or created the image which is contained in or which constitutes the master from which the individual print was made.”
  • “Fine art” is defined as “a painting, sculpture, drawing, or work of graphic art, and print, but not multiples.”

Section 12.01(1)(b) expressly prohibits the waiver of the “no lien” provision contained in Section 12.01(1)(a)(v), and no artist whose works are subject to Section 12.01 is able to consent to the granting of a lien or security interest, even if they were inclined to do so. Section 12.01(1)(b) contains one exception to its prohibition on waivers. Subject to certain conditions, Section 12.01(1)(a)(iii), which provides that any proceeds from the sale of work that is trust property are trust funds in the hands of the gallery for the benefit of the artist, may be waived if “such waiver is clear, conspicuous, in writing and subscribed by the consignor. Therefore, when dealing with a gallery an artist has to carefully review any language proposed by the gallery that may suggest relinquishing statutory rights.

Please note that the statutory protections are designed to give an artist a relatively easy exit from the debtor-gallery bankruptcy. It does not necessarily translate into an automatic return of artwork. When a gallery commences a bankruptcy proceeding, there is an automatic stay of any collection activities against the debtor-gallery. Then, as a practical matter, the bankruptcy administrators need certain time to sort out the financial affairs of the gallery and to separate assets held in trust by the gallery from assets in which the gallery has legal title. Therefore, an artist should expect some time lapse between the filing of a bankruptcy proceeding and the return of artwork.

Author: Albena Petrakov, Esq.
Articles have been Reprinted with permission from the charlotte observer and Mike Hunter.

* These articles and related content on this website are provided without warranty of any kind and in no way constitute or provide legal advice. You are advised to contact an attorney specializing in Association Management for legal advice related to your specific issue and community. Some articles are provided by thrid parties and online services. Display of these articles does in no way endorse the products or services of Community Association Management by the author(s).