Co-authored by Doron P. Kenter and Cristine Pirro
You may recall our earlier article here discussing the Southern District of New York’s affirmation of the United States Bankruptcy Court for the Southern District of New York’s denial of a motion for relief from the automatic stay to proceed with arbitration regarding proper ownership of a painting, Madonna and Child, by Sandro Botticelli. Well, in yet another case in the Botticelli saga, the bankruptcy court considered (i) whether a perfected blanket lien on the debtor’s inventory attached to Botticelli’s Madonna and Child while it was on consignment to the debtor’s art gallery and (ii) if so, whether that lien had priority over the consignor’s interest in the return of the painting.
Picture it: Salander-O’Reilly commences a chapter 11 case while it is in possession of over 4,000 works of art, including Botticelli’s Madonna and Child, listed for sale at $9.5 million. The Botticelli, however, doesn’t belong to the gallery – instead, it is owned by Kraken Investments Limited, which consigned the Botticelli to the art gallery. Unfortunately for Kraken, it did not file a UCC-1 financing statement with respect to the consignment of the Botticelli.
To complicate matters further, under a prepetition loan agreement, the debtor had granted Bank of America a continuing security interest in all of the debtor’s “personal and fixture property of every kind and nature including without limitation all goods (including inventory, equipment, and any accessions thereto)… and all products and proceeds of the foregoing.” Bank of America successfully perfected its blanket security interest in substantially all of the debtor’s assets by, among other things, filing a UCC-1 financing statement stating that the collateral securing the loan agreement included “all works of art.” In connection with settling and allowing Bank of America’s claim pursuant to the debtor’s liquidating plan, the debtor was assigned Bank of America’s lien on all of its assets, including its lien pursuant to the prepetition loan agreement.
Seeing an opportunity to generate value for the estate, the liquidating trustee objected to Kraken’s claim in the gallery’s bankruptcy case and argued that the trustee had a superior right to the Botticelli either pursuant to section 544(a) of the Bankruptcy Code, which allows the trustee to avoid certain unperfected interests in the debtor’s property, or, alternatively, as assignee of the bank’s perfected lien in the Botticelli. In response, Kraken argued that (i) the debtor did not have an interest in the Botticelli as of its petition date, which precluded avoidance pursuant to section 544(a), and (ii) under the terms of the loan agreement covering the debtor’s inventory, the bank’s lien did not extend to goods that the debtor held on consignment (such as the Botticelli). The parties filed cross-motions for summary judgment.
Who, then, has the right to the Botticelli?
First, Chief Judge Morris turned to the trustee’s arguments pursuant to section 544(a). The trustee’s claim that it had a superior right to the Botticelli is based on provisions of the UCC that allow the creditors of a consignee (like the debtor) to obtain rights in consigned goods that are superior to those of the actual owner of the goods if the owner fails to take steps to perfect its interest, as Kraken failed to do in this case. In order for creditors of the debtor (such as the bank) to obtain rights on the Botticelli superior to those of Kraken, the provisions of Article 9 must apply to the consignment of the Botticelli. Judge Morris concluded that she could not decide the issue at the summary judgment stage because the trustee had not yet shown facts to support the application of section 9-102(a)(2) of the Uniform Commercial Code, pursuant to which the gallery could hold superior rights to the Botticelli if it was truly held on “consignment” (as such term is defined in the UCC).
At the same time, however, the court declined to grant summary judgment to Kraken. First, the court concluded that Bank of America’s blanket lien on artwork held by the gallery applied to the Botticelli while it was on consignment in the debtor’s art gallery. In support of its argument that the bank never held a lien on the piece, Kraken pointed to the definition of “eligible inventory” in the loan agreement, which specifically excluded works of art on consignment, and to testimony from various bank executives who did not consider consigned artwork to be included in the stated collateral. On the other hand, the trustee argued that the loan agreement merely referenced “eligible inventory” in connection with the calculation of the amount that the bank would lend to the debtor, but that the provision in the loan agreement regarding collateral contained no such restriction – instead, the loan agreement unambiguously granted the bank a lien on all of the debtor’s inventory, including consigned goods, because it granted the bank a lien on “all personal property… of every kind and nature…” The court agreed with the trustee, concluding that “eligible inventory” in one section of the loan agreement should have no bearing on the clearly stated scope of the bank’s lien on “all” of the debtor’s property – and that extrinsic evidence (such as the bank’s executives’ testimony) was therefore inadmissible and irrelevant.
While we don’t yet know who will ultimately be entitled to the Botticelli (or, more likely, the proceeds from a sale thereof), the court’s decision cautions us to take great care in protecting assets and in clearly setting forth the treatment thereof. For want a lien, the Botticelli may very well be lost.