The right of first refusal in art sales in New York

A recent decision by the District Court of the Southern District of New York suggests that a resale restriction in the sale contract between A and B could violate the warranty of good title in the sale contract between B and C.  Before we turn to that decision, we shall consider briefly how rights of first refusal are dealt with by the New York Courts.

Understanding the right of first refusal

Typically, the right of first refusal is a contractual commitment by the buyer to give the seller, should the buyer decide to re-sell the property, the right to re-purchase the property, or to sell the property as agent for the buyer, subject to pre-agreed conditions.  Rights of first refusal have become standard practice in the primary market sales.  There is an ongoing debate as to whether they are enforceable against the buyer who resells the artwork in breach of his or her commitment to give the selling primary market gallery the right to exercise the right to buy back the artwork on the terms set out in the right of first refusal clause.   There is not a great deal of case law in this area, hence the debate.  We would suggest that enforceability depends on the terms of the right of first refusal clause: are they sufficiently clear, certain and fair?  If the answer is affirmative, it is more likely than not that the right is enforceable, in the UK and in the USA.

Case law on the right of first refusal: Wildenstein & Co. v. Wallis

The main decision in the public domain involving artworks in the New York Courts is known as Wildenstein & Co. v. Wallis.  The case was decided in June 1992.  Movie producer Hal Wallis had agreed to grant art dealer Wildenstein the right of first refusal and exclusive consignment over Wallis’s collection of paintings.  Wallis granted the rights to Wildenstein in exchange for Wildenstein’s return of certain paintings to Wallis in settlement of a dispute that arose out of Wildenstein’s acquisition of the paintings from a third party that, unbeknown to Wildenstein, lacked authority to sell them.

Wildenstein started legal proceedings in the New York Courts to enforce its first refusal and exclusive consignment rights when it learned that Wallis’s foundation (the successor to Hal Wallis who, in the meantime, had passed away) intended to consign paintings from his collection to Christie’s.  The right of first refusal required the foundation to give Wildenstein at least 30 days prior notice of the terms of any proposed sale of a painting and granted Wildenstein the option to purchase it within 20 days on the same terms as the triggering purchase offer.  The exclusive consignment right required Wallis, if he wished to sell any painting at auction, to first consign it exclusively to Wildenstein for six months.

New York’s highest court found that the resale restrictions to which Wallis agreed were not unreasonable restraints, and therefore upheld them. In doing so, the Court found that the 30-day first refusal period and six-month exclusive consignment period were reasonable in duration, noting an expert’s evidence that the six-month exclusive consignment right was unusually short. Further, the Court found that the method of price-setting was reasonable, as the first refusal right was conditioned on payment equal to a third party’s offer, and the exclusive consignment right called for Wallis’s input on the price, which, if the parties could not agree a price, would be set by a major international auction house representative. The purpose was also reasonable: in exchange for helping Wallis recover a valued part of his collection, Wallis assured Wildenstein that, in the event of sale of one or more of the paintings, Wildenstein would have the opportunity to realize the profit or commission it hoped to earn when it originally acquired them.

A real estate parallel: Metropolitan Trans. Auth. v. Bruken Realty Corp

Wildenstein & Co. v. Wallis echoed an earlier case involving a right of first refusal in a real estate transaction (cited by the Court in Wildenstein & Co. v. Wallis).  In Metropolitan Trans. Auth. v. Bruken Realty Corp (1986), in an appeal from the Appellate Division of the Supreme Court in the First Judicial Department, the Court considered the following situation.  The State of New York, acting through the Metropolitan Transportation Authority (“MTA”) had sold to Delbay Corporation (“Delbay”) air rights above a freight yard it acquired.  The State also executed an "option agreement" granting Delbay the right to purchase 12 lots in the freight yard (the land itself) at market value if the State subsequently determined that those lots were "no longer necessary for [its] transportation operations".

In 1982, MTA notified Delbay that it no longer required six of the lots and that Delbay could acquire them. Delbay thereafter assigned its right to two of the lots to a real estate developer, defendant Bruken Realty Corporation (“Bruken”), and Bruken notified MTA of its election to purchase them. Although the original agreement provided for arbitration of the market value, the parties agreed to attempt to negotiate the price after obtaining separate appraisals. When the parties were unable to reach agreement, MTA sought from the Court a declaration that the “option agreement” was void because it violated the general policy against unreasonable restraints.

The right acquired by Delbay, noted the Court, “though called an option by the parties, was a pre-emptive right to buy the freight yard property. An option grants to the holder the power to compel the owner of property to sell it whether the owner is willing to part with ownership or not. A pre-emptive right, or right of first refusal (our emphasis), does not give its holder the power to compel an unwilling owner to sell; it merely requires the owner, when and if he decides to sell, to offer the property first to the party holding the pre-emptive right so that he may meet a third-party offer or buy the property at some other price set by a previously stipulated method.   Once the owner decides to sell the property, the holder of the pre-emptive right may choose to buy it or not, but the choice exists only after he receives an offer from the owner. If the holder decides not to buy, then the owner may sell to anyone”.

In New York, observed the Court, an owner's power to dispose of property is limited by three rules.  The first two rules apply to real estate, not works of art – we shall not describe them here.  The third rule is established by common law and invalidates transfers of property imposing unreasonable restraints on resale. The rule against unreasonable restraints on resale does so directly by forbidding owners to impose conditions on resale which block the buyer from freely disposing of the property. The common-law rule is applied flexibly, by considering the reasonableness of the restraint.

Whether a restraint on the disposition of property is unreasonable is a question of fact depending upon its purpose, duration and price.  Usually, a right of first refusal will not be unlawful when conditioned on payment of market value or a sum equal to a third-party offer.  In this case, Delbay had the right to purchase the lots at a price fixed by arbitration, stating "'a market value fixed by arbitrators compelled to consider the price a willing seller would accept from a willing buyer at the time of sale can hardly be unreasonable, as a matter of law".  The Court opined that “the market value, in some instances, may be less than sale price, but a market value fixed by arbitrators compelled to consider the price a willing seller would accept from a willing buyer at the time of sale can hardly be unreasonable, as a matter of law, notwithstanding the separate ownership of air and ground rights”.  Thus, the Court found that “the pre-emptive right granted [to] Delbay by [MTA] was under all the circumstances a reasonable restriction on the alienability of the freight yard lots”, and Delbay/Bruken could enforce it.

Reasonableness as a key factor

These cases illustrate the New York Courts' approach to evaluating rights of first refusal, emphasizing the importance of reasonableness. The Courts generally enforce these rights when they are well-defined and fair. However, if the terms of the right of first refusal are ambiguous or lack detail, or they excessively restrict the rights of the buyer as owner to resell the property, the right may be unenforceable.

Recent case: DW Properties v. Live Art Market

In a recent case (DW Properties v. Live Art Market, Inc., No. 1:2023cv07004 - Document 24 (S.D.N.Y. 2024) 22 April 2024), the District Court for the Southern District of New York considered a somewhat different issue.  Did the buyer of an artwork have a claim for breach of contract against the seller who sold him the artwork without notice of a right of first refusal?

Live Art, a global art trading platform, served as art advisor to DW Properties (“DW”) (a Belgian company) and its principal, Sacha Daskal, an art collector.  In November 2021, Live Art informed Daskal of the opportunity to purchase a painting by Cornelis Annor known as ya tena ase.  Before purchasing the painting, Daskal told Live Art that he intended to own the painting for a limited period before reselling it.  For that reason, he asked Live Art a series of questions about the painting’s estimated resale price. Live Art responded that Daskal could likely resell the painting for USD120,000.  During those conversations, Live Art did not mention that a resale restriction encumbered the painting.  Instead, Live Art represented to Daskal that, on receipt of the purchase price, Live Art would deliver good title to the painting.  DW purchased the painting for USD80,000.  The sale invoice’s terms and conditions stated that Live Art “warrants that good title to the Work shall pass upon payment of the Purchase Price and that the Work was created by the artist.”

In the months following DW’s purchase of the painting, Daskal kept in touch with Live Art, asking multiple times whether it would be a good time to resell the painting. In February 2023, Live Art recommended that Daskal sell the painting at Phillips, assuring Daskal that he would at least break even, if not profit, from the sale. Daskal consigned the painting to Phillips. However, in April 2023, Phillips informed Daskal that they would withdraw the painting from auction because a third-party art studio called Good Lamp (the “Studio”) had informed Phillips that they sold the painting to Live Art subject to resale restrictions.  The contract between Live Art and Good Lamp stated that “Buyer [Live Art] agrees to include the following resale restrictions when reselling these artworks”.  The first restriction was that “Buyer agrees it will not, any under circumstances offer the Artwork through an art fair or public auction for a three (3) year period (the “Non-Resale Period”) starting from the date of this invoice.”  The second provided: “The Artwork is also sold on condition that, during the Non-Resale Period, the Buyer will not offer the Artwork for a private sale to a third party other than by offering GOOD LAMP a first right of refusal to carry out this sale.”  The Studio claimed that Live Art violated the resale restriction when selling the painting to DW. Daskal, who had no prior knowledge of the resale restriction, was stuck with a painting that DW could not resell.

On 28 June 2023, DW sued Live Art in the New York state court for breach of contract and other claims. Live Art moved the action to the U.S. District Court for the Southern District of New York, then moved to dismiss the complaint for failure to state a claim. On 22 April 2024, the District Court denied Live Art’s application to dismiss DW’s claim for breach of contract arising out of Live Art’s failure to comply with resale restrictions set out in the contract between Live Art and the Studio. The Court found that, although DW was not a party to the contract with the resale restrictions, Live Art’s failure to comply with those requirements could undermine the title that Live Art passed to the DW, giving rise Live Art’s potential liability to DW for breach of warranty of good title.

The Court noted that it was “far from clear” that the resale restrictions contained in Live Art’s contract with the Studio applied directly to Live Art because that contract stated only that Live Art “agrees to include the following resale restrictions when reselling these artworks,” and “then goes on to describe the two restrictions that Live Art is obligated to include in any future resale contract”: the buyer will not, for a three-year period, offer the painting (i) for sale at an art fair or public auction or (ii) for private sale other than by offering the Studio a right of first refusal. The Court observed that the “most natural reading of that contract language is that it requires Live Art to include those two restrictions in any contracts with a future buyer, and not necessarily that Live Art itself must comply with those restrictions.” Even so, the Court determined that, regardless of whether the contract required Live Art to give the Studio a right of first refusal when reselling the painting or, under the “more natural reading”, it merely required Live Art to include the restrictions in any resale contract with a future buyer, DW sufficiently pled a breach of contract claim. The Court reasoned that, in either scenario, Live Art’s sale of the painting to DW failed to comply with the terms of its purchase contract with the Studio, potentially encumbering the painting’s title.

The Court made it clear that the resale restrictions imposed a contractual duty on Live Art to the Studio, not to DW. Privity of contract meant that DW could not sue Live Art directly for violation of those restrictions. However, the Court found that Live Art could be liable to DW as a result of Live Art’s failure to include the restrictions in the sale contract with DW, or to inform DW of them. Any such liability to DW would be through the “good title” warranty that Live Art gave to DW.

The Court relied on a previous decision known as Jeanneret v. Vichey (2d Cir. 1982) which, it said, broadly supported DW’s position that an encumbrance that may undermine the resale value of a painting can constitute failure to deliver good title.  Jeanneret v. Vichey involved an action by a buyer against the seller for having sold a painting that was allegedly illegally exported from Italy.  According to the buyer, the work’s status as having been illegally exported from Italy rendered it more difficult to resell, and the buyer brought various claims, including a claim for breach of contract.  After the seller appealed a jury verdict against them, the Second Circuit determined that the jury instructions were erroneous because they failed to focus on whether the painting was more than fifty years old at the time of its exportation, which was the relevant fact that determined whether the painting was exported in violation of Italian law.  In remanding the case, the Court suggested that if the painting had indeed been sold and exported in violation of that law, such violation could “create an encumbrance sufficient to invoke a provision of the N.Y. Uniform Commercial Code that requires all sales contracts to include a warranty by the seller that . . . the goods shall be delivered free from any security interest or other lien or encumbrance of which the buyer at the time of contracting has no knowledge” (N.Y. U.C.C. § 2-312(1)(b)).

The Court continued: “Here, too, there is a question as to whether Live Art’s failure to honor the terms of its contract with Good Lamp “create[s] an encumbrance sufficient to invoke [N.Y. U.C.C.] § 2-312(1)(b)” and suggests that Live Art did not pass good title to DW Properties, in violation of the sales contract.  Works that have been sold without honoring certain contractual restrictions can result in litigation that functions as a cloud over good title.  See, e.g., Wildenstein & Co., Inc. v. Wallis, 79 N.Y.2d 641, 646-67, 651 (1992)”.

The decision is unusual in that the Court does not (yet) opine on the enforceability of a right of first refusal, or the 3-year restriction for selling the work at auction or at an art fair.  The Court considered a situation where there is no right of first refusal in the sale contract between B and C, however the fact that there is a right of first refusal in the contract between A and B could mean that C’s title is not as good as it would have been had the contract between A and B not included a right of first refusal (assuming, as in this case, that B failed to disclose the existence of the right of first refusal to C).  The fact that C’s title is not as good is illustrated by the fact that Phillips withdrew the painting from the auction when notified by the Studio of the existence of the right of first refusal. 

Conclusion: Legal considerations for sellers and buyers

While the validity of resale restrictions on the sale of an artwork is ultimately a fact-specific question of reasonableness depending on their duration, price and purpose, Wildenstein & Co. v. Wallis and Metropolitan Trans. Auth. v. Bruken Realty Corp provide useful guidance.  As for the right of first refusal binding on Live Art in the case of DW Properties v. Live Art Market (which is still in its early stages), it remains to be seen if the New York District Court will have the opportunity to determine whether the rule against unreasonable restraints on resale invalidates that right.  Equally interesting is the question of whether an undisclosed right of first refusal can amount to a breach of the warranty of good title (which, in the UK like in New York, is implied by law).  Sellers of art who fail to abide by the right of first refusal should think twice before reselling the artwork without disclosing the existence and terms of the right to the buyer.