If you have tried to borrow monies and use artwork as collateral, or if you have determined to loan money and take a piece of art as security, you may have encountered some interesting challenges.
In order to take a security interest in works of art, it is necessary to identify and classify not only the artwork, but also the nature of the borrower. Is the artwork consumer goods, inventory or equipment? Is the borrower a business, an individual or a corporation? How does a lender using art as collateral “perfect” this interest in the collateral pursuant to the provisions of the Personal Property Security Act of Ontario (the “PPSA”) so as to ensure that if the loan goes into default, the lender can realize upon the art?
The nature of the borrower and the nature of the collateral
(a) An art gallery
If you own an art gallery, the paintings, sculptures and other objets d’art, which are displayed in the gallery and available for lease or purchase, are inventory to the gallery. The gallery is in the business of selling or renting its art. As a result, a lender to a gallery would be seeking either a general security agreement (“GSA”) or an inventory security agreement (“ISA”). A GSA is a broader type of security and would normally include all of the assets of the gallery, including its inventory of works, the equipment used to run the gallery, its accounts receivable and any intangibles, like trademarks, chattel paper (leases) or royalty payments. An ISA would generally encompass the inventory of art as well as any proceeds derived directly or indirectly from the sale or lease of the art. In addition, it is possible for a lender to obtain a “purchase-money security interest” (“PMSI”) in some or all of the inventory of the gallery if the seller of the art work is owed monies for their purchase price and takes a security interest to ensure payment, or if monies are being loaned to enable the gallery owner to purchase the art. A PMSI is a priority security interest and generally provides the lender with a security interest in the assets covered by the PMSI, ahead of the security interest of other lenders, provided the purchase-money security interest holder complies with certain specified provisions of the PPSA.
Even if the gallery is owned and run by an individual, partnership or corporation, the analysis of the borrower and the type of security interest that a lender could obtain by providing a loan to the gallery is the same. The gallery is a business; the loan is primarily against the inventory of the gallery and the proceeds or accounts receivable from the sale or lease of the artwork.
(b) An individual
For an individual, if you wish to use the art which you personally own as collateral for a loan, there is a need to first identify the nature of this collateral. In most instances, it is consumer goods. Under the PPSA, “consumer goods” are goods that are used or acquired for use primarily for personal, family or household purposes. There will be a need to ascertain from the borrower the reason behind the borrower purchasing the artwork and the rationale for the borrowing.
What if the borrower advises that the artwork was purchased not for personal or household purposes, but for investment? In this instance, the nature of the collateral may not be consumer goods. The PPSA defines “goods” as tangible personal property other than chattel paper, documents of title, instruments, money and investment property. “Inventory” is defined as goods that are held for sale or lease or that have been leased or that are to be furnished or have been furnished under a contract of service, or that are raw materials, work in process or materials used or consumed in a business or profession. The PPSA defines “equipment” as goods that are not inventory or consumer goods. So the artwork purchased for investment purposes, if not consumer goods, is likely equipment. The definition of “investment property” is not broad enough to include art.
A lender to an individual may request that the individual sign a GSA which would include all assets owned by the individual. Since this would include the individual’s bank accounts and all other personal property including vehicles and furnishings, most individuals prefer not to sign a GSA. As a result, the borrower would have to provide the lender with a security agreement that describes the artwork being used as collateral for the loan. This security agreement would also likely include the proceeds derived from dealing with the collateral.
(c) A corporation
If an individual through a corporation or a corporation that has invested in artwork wishes to borrow money and use the art as collateral, the corporation, which is not in the business of leasing or selling the artwork, would have to provide the lender to the corporation with a security interest in the artwork. If the corporation holds no other assets than the artwork, or if the borrower is an investment vehicle, then the lender should request a GSA. Alternatively, the borrower could sign in favour of the lender a security agreement that covers the artwork being used as collateral for the loan and any proceeds therefrom.
The nature of the security interest and the nature of the perfection
In Ontario, to perfect a security interest in collateral requires attachment and perfection. A security interest is not enforceable against a third party unless it has attached. Attachment essentially requires that (i) value has been given, (ii) the debtor or borrower has rights in the collateral and (iii) the debtor or borrower has signed a security agreement that contains a description of the collateral sufficient to enable it to be identified.
Perfection may be achieved by registration or possession. Although the PPSA provides that registration perfects a security interest in any type of collateral, possession or repossession of collateral by the secured party or on the secured party’s behalf by a person other than the debtor or the debtor’s agent is limited to certain categories of collateral. These include goods, chattel paper, money, instruments and negotiable documents of title, but only while it is actually held as collateral.
Registration is effected by the filing of a financing statement. The Ontario PPSA system is the only system in Canada that has a “check the box” system. In effecting a registration pursuant to the provisions of the PPSA a lender when completing the financing statement must determine into what category or classification the collateral falls. Is it “consumer goods”, “inventory”, “equipment”, “accounts” and/or “other”? Although there is an ability to provide more detailed information in respect of the collateral in the general collateral description, the initial step requires that one or more categories of collateral be checked.
(a) An art gallery
A GSA or an ISA signed by the borrower in favour of the lender that contains a description of the artwork that allows the art to be identified and differentiated from other pieces of art, usually meets the requirement for attachment. As noted, the PPSA provides that a security interest may be perfected by either registration or possession. In some instances a lender will both register against the borrower and take possession of the art. The form of ISA or GSA would not be significantly different from that of any other business borrowing money; the collateral would just be or include the artwork and if the borrower failed to make payments in accordance with the terms of the loan documentation, the lender would realize on the assets of the gallery secured under the agreement.
If the borrower owes money to the seller of the artwork or is using the monies loaned by the lender to acquire the art, then the security interest of the seller or lender may be a PMSI and the lender would have to comply with the provisions of the PPSA to effect registration and provide notices to prior registered secured creditors with an interest in inventory or accounts.
A lender with a GSA to a gallery would usually check all boxes, except consumer goods. A lender with only an ISA covering the inventory of the gallery and proceeds from the sale of the art would usually check only two boxes: “inventory” and “other.” It is possible, depending on the nature of the security interest set out in the loan documentation that the lender would also check the “accounts” box. A careful lender would register against the gallery before the funds were advanced or the documentation in respect of the sale of the artwork to the gallery completed. It is harder for a lender to a gallery to “possess” the collateral, as the gallery wants its inventory to be in its premises.
(b) An individual
If the art constitutes consumer goods, the lender could enter into a security agreement with the borrower which describes the art in a manner sufficient for it to be identified and sets out the terms of the loan, the repayment and the nature of any default that may entitle the lender to take the art in satisfaction of the debt. If the art is already owned by the borrower, the lender will not be able to obtain a PMSI. So the lender will need to ascertain what other loans have been obtained by the borrower and what security has the borrower given in respect of these prior loans. Have there been registrations against the lender pursuant to the PPSA? If the borrower is obtaining the loan to enable it to purchase the art for the borrower’s personal use, the newly acquired art could be the subject of a PMSI. The lender would have to comply with the provisions of the PPSA in respect of a PMSI when the collateral is other than inventory or its proceeds.
As consumer goods, there are special provisions in the PPSA which set out how the lender can “perfect” its security interest in the art. Firstly, the lender has to decide whether to perfect its security interest by possession, by registration or both. The PPSA provides that possession of the collateral by the secured party or the agent of the secured party perfects a security interest in goods, but only while the goods are actually held as collateral. The definition of “goods” includes consumer goods. So the lender, or its agent, could hold the art in its possession. As noted, registration perfects a security interest in any type of collateral. With recent changes to the PPSA, a registration in respect of consumer goods may be made for longer than five years. However, the PPSA still has special provisions that are only in respect of consumer goods. The amount of the loan needs to be set out, as does the maturity date if there is one. If there is no maturity date, it needs to be specified as such. The registration still may not be made in advance of the loan being made. Finally, if the borrower goes into default, there are special provisions for realizing on the collateral.
To effect the PPSA registration against the individual or natural person, the lender would need to obtain specific information in respect of the borrower, including the borrower’s first given name, the initial of the second given name and the surname. As well, the date of birth of the natural person is required. The collateral classification or “box” would be consumer goods, and, a prudent lender would also likely check the box “other”. This would be for any proceeds from the sale of the artwork.
(c) A corporation
As noted above, since the art cannot be consumer goods, and it is not inventory, it likely falls under the classification of equipment. This is an unusual categorization for works of art, but is the only category available for a PPSA registration in Ontario. As noted, the lender could also “perfect” its security interest in the art by possession, as an alternative or in addition to effecting a registration. If the corporation owes the seller of the art monies in respect of the balance of the purchase price or has borrowed the monies to acquire the art, the lender — who has obtained either a GSA or security agreement only covering the art and its proceeds — could obtain a PMSI if it complies with the requisite provisions of the PPSA to do so. These provisions are different than those which are set out in respect of inventory or its proceeds.
The seller or lender would normally effect the registration against the borrower corporation before the sale or loan transaction is concluded. As noted, the collateral classifications on the registration being made would note the boxes “equipment” and “other.”
The general collateral description
In Ontario it is not a requirement that a secured party complete the general collateral description, describing the collateral in further detail than the boxes selected. Part of the reason for this reticence is a provision in the PPSA specifying that when a financing statement sets out a classification of collateral and also contains words that appear to limit the scope of classification, then unless otherwise indicated in the financing statement, the secured party may claim a security interest perfected by registration only in the class as limited. For a gallery, a security interest in all the artworks of the gallery, as described in the security agreement would usually encompass any existing works and those subsequently acquired, so no limitation or further description would be required. In other instances, if the security interest is in only specified works of art, then the borrower would likely want these itemized or described, so as to limit the security interest of the seller or lender to those items. But, as noted, the security interest would be limited to those works of art described and, without amendment to the agreement and registration, could not extend to further items purchased.
Taking a security interest in art is perhaps a little more unusual than taking a security interest in a motor vehicle. However the analysis required is not dissimilar. The seller or lender needs to ascertain the identity of the borrower and the nature of the collateral. Getting the correct information about the purpose of the loan and the identity of the borrower will allow the seller or lender to ascertain the type of security agreement to be obtained and if a registration is to be effected for perfection, how best to undertake the registration.