There is an old legal adage that you should never ask a question in court if you don’t know what the answer will be. That adage can perhaps be applied to a recent lawsuit that could lead to the demise of the California Resale Royalties Act.

In October 2011, identical complaints were filed against Sotheby’s and Christie’s in federal court in California. The complaints alleged that the auction houses had deliberately failed to comply with the California Resale Royalties Act by failing to pay royalties when due – either to the appropriate artists or to the California Arts Council, the state entity charged with collecting and distributing the funds when the artist cannot be located. The complaints also alleged that the auction houses had deliberately concealed whether a seller at auction was a resident of California, a fact which would trigger the royalty no matter where in the United States the auction was held. This act of concealment was alleged to have prevented artists from knowing when a royalty should have been paid on the sale of their works.

As we noted in the Winter 2010-2011 issue of the Legal Canvas, the California Resale Royalties Act was a statute that generally went unenforced, in large part because its enforcement relied on actions brought by the artists themselves. Artists were reluctant to bring those actions, both for fear of alienating a collector or gallery, and because the amount of any given royalty rarely justified the cost of litigation. The complaints filed last October, however, were filed as “class actions,” that is, they purported to be brought not only on behalf of the named plaintiffs, but also on behalf of any artist or artist’s estate that was not paid a resale royalty that was due to be paid by one of the auction houses during the three years prior to the filing of the complaints. The class action mechanism shifts the calculus of litigation: the aggregation of the individual claims makes the case worth litigating, the costs are shared, and all but the named plaintiffs remain anonymous.

While providing a way for the artists’ rights under the statute to be enforced, the lawsuits proved to be a risky venture. The dearth of prior litigation under the statute meant that there was little opportunity to challenge the validity of the law itself. The auction houses took the opportunity here to do so, and on May 17, 2012, the District Court for the Central District of California declared that the statute violated the Commerce Clause of the Constitution of the United States, and was therefore unconstitutional. Under the Commerce Clause, a state may not purport to regulate commerce outside its own boundaries, and the court held that the California Resale Royalties Act did just that. The court illustrated the point by noting that the statute would require an auction house or dealer located in New York to pay a royalty to an artist living in New York on a work sold in New York as long as the consignor of the work lived in California.

Having found that the application of the statute to transactions outside the state was unconstitutional, the court had the option of invalidating only that portion of the statute. Nevertheless, it chose to strike down the statute as a whole. The court cited law to the effect that a court should invalidate only a part of a law if it is clear that the legislature would have passed the remaining portion on its own. In the case of the California Resale Royalties Act, the state legislature explicitly rejected a version of the bill that would have applied solely to transactions in California for fear that it would drive business out of the state.

The court’s decision was not unforeseeable. In fact, the court referred to a letter written by California’s Legislative Counsel in 1976 when the bill was being considered. In the letter, the Legislative Counsel advised that the state had no interest in the fiscal welfare of artists living outside California and that the application of the statute to transactions outside California would be unconstitutional.

The plaintiffs have announced their intention to appeal the judge’s ruling. If they do, there is reason to believe that it will be upheld by the Ninth Circuit Court of Appeals. The appellate court faced an analogous issue in 2009 when it struck down a special statute of limitations for Holocaust-related claims. Although the constitutional provision at issue in that case related to the exclusive rights of the federal government in the realm of foreign affairs, the flaw in the statute arguably lay in the fact that it was deliberately drafted to apply to museums and galleries both inside and outside the state. (As described in our article on page 24, a federal district court has since ruled that a revised version of that statute is also unconstitutional.)

A Proposal for federal legislation.

On December 15, 2011, Senator Herb Kohl and Congressman Jerry Nadler introduced the Equity for Visual Artists Act of 2011. The Act would impose a 7% resale royalty on the sale of a work of art for at least $10,000 – as long as the sale takes place at an auction house that sells in excess of $25,000,000 of property per year in sales that are not conducted over the internet. In other words, the royalty would only apply to sales at major auction houses – Christie’s, Sotheby’s, Phillips, Bonhams, and a handful of others. Sales by private galleries, collectors, or internet auction sites would not be subject to the royalty. Failure on the part of the auction houses to pay royalties would be considered a copyright violation, which means that the copyright holder could, if the failure was intentional, sue for three times the amount of the royalty.

The royalties would be collected and distributed by “visual artists collecting societies” that satisfy certain criteria set forth in the statute – criteria that are clearly designed to include only the large and preexisting agencies that appear to have been major proponents of the legislation. These agencies would be entitled to retain up to 18% of the funds collected to pay their own operating expenses.

After the deduction of the collecting society’s share of the proceeds, the net amount would be divided, with 50% paid to the artist, and 50% paid into an escrow fund established by the respective collecting society in order to provide grants to non-profit museums in the United States to purchase works by living American artists.

The legislation is striking in a number of ways. First, it is interesting that the purpose of the bill, according to Congressman Nadler, is to create equality between the rights of visual artists and those of “composers, lyricists, playrights and screenwriters” who regularly collect payment when their creations are performed or published. The “starving artist” who has historically provided the impetus for resale royalty legislation is notably absent.

Second, the fact that the royalty would be imposed only on sales by the major auction houses is meant to make the legislation easier to enforce. In our Winter 2010- 2011 issue, we wrote that one of the central difficulties in enforcing the payment of resale royalties is the fact that so much of the art market – particularly for the modern and contemporary artists who are the intended beneficiaries of the royalty – is private and is therefore nearly impossible to track. In that article, we noted that the Australian resale royalties scheme attempted to deal with the enforcement issue by imposing broad-based reporting obligations on all sales of art. The proposed US legislation deals with it by eliminating the “hard part.” This has a number of implications. Very few living artists ever make it to the resale market. Fewer still are ever sold by the major auction houses. So, the number of artists who would benefit from the bill is very limited, as is the percentage of transactions that will be covered. Even without the proposed royalty, private sales make up a huge portion of the resale market for works by living artists – including some of the most important and expensive works. If a royalty is imposed on auction sales, it is likely that the auction houses will pass the fee on to consignors (or, more likely, its buyers). As a result, more sellers are likely to choose to sell privately – as will the auction houses. The royalty will therefore miss a large chunk of the market and chase more sales out of public view.

The shift to private sales may or may not be of general concern, but the prospect of losing 7% of the proceeds of sales at auction may be significant for museums and other entities that have tended to prefer to sell at auction because the transparency of a public sale is less likely to raise questions as to whether museum trustees or estate executors acted appropriately.

Third, while the concept of contributing 50% of the net royalty to non-profit museums is appealing, the true measure of its value will lie in its implementation. One’s comfort level that the funds will be distributed fairly and in a way that promotes the best interests of the museums and the public is only as high as one’s confidence in the collection societies themselves. Under the legislation, each collecting society is charged to work with the Office of Copyright to develop procedures and criteria for determining which museums are allotted how much money to purchase which works of art. The collection societies will then control the distribution of the funds, subject only to annual reporting requirements. The delegation of this sort of official authority to private, profitmaking organizations may be seen by some as troubling.

Indeed, if one were so inclined, there are other reasons to be cynical about the legislation. The Los Angeles Times reported that sales by private dealers were excluded in part to forestall their opposition to the bill and that the grants to museums were included in part to garner their endorsement. The legislation was drafted with the assistance of the “Visual Artists Rights Coalition, a group of artists and two major American organizations that represent artists in copyright matters.” In other words, it was drafted with the help of the likely future collecting societies. And the burden of the legislation falls squarely and solely on the major auction houses – the institutions that everybody loves to hate and few bother to defend.

On its introduction, the bill was referred to the Judiciary Committee of the House. On May 17, Senator Kohl and Congressman Nadler asked the U.S. Copyright Office to conduct a comprehensive review to “assess how existing law affects and supports visual artists and how a federal resale royalty provision would affect copyright law, visual artists and those involved in the sale of artwork.” The letter suggested that as an initial step, the Copyright Office “meet with and solicit comments from stakeholders.” A similar review by the Copyright Office in 1992 recommended against the introduction of federal resale royalty legislation.