UK: Goods Mortgages – Revolutionising The Business Of Lending Against Art?

The Law Commission has published its long-awaited draft of the Goods Mortgages Bill. Put simply, this will better enable individuals to use goods they currently own, such as artwork, as collateral for their debts.

This Bill has the potential to revolutionise art financing and lending over other high-value assets. With the uncertainty that Brexit brings, the Goods Mortgages Bill could be a saviour and provide a new avenue to the market of financing art.

Why is there a need for reform?

The Bill will replace the Victorian era Bills of Sale Act 1878 and Bills of Sale Amendment Act 1882, which are archaic and inadequate in the modern world. The Bills of Sale Acts allow individuals to grant security over personal chattels, but work within rigidly-defined boundaries, including onerous requirements that documents, and subsequent amendments to documents, be registered at the High Court. Such "chattel mortgages" will be null and void if they do not meet the prescribed form and registration requirements, leaving a lender with no right of redress against a defaulting borrower. Unsurprisingly, they are unattractive to lenders and therefore stifle the ability of individuals to raise finance secured on chattels such as artwork.

These limitations meant that lenders have traditionally favoured the use of a pledge instead of a bill of sale. The pledge is a form of possessory security interest. It therefore does not provide the benefit of enabling borrowers to grant security whilst still keeping the artwork on their walls.

"With the uncertainty that Brexit brings, the Goods Mortgages Bill could be a saviour and provide a new avenue to the market of financing art."

The Bills of Sale Acts came under scrutiny due to the rise in "logbook loans". These loans enabled borrowers to raise finance by granting a lender security over their vehicle whilst still retaining possession of the vehicle. The financial crisis in 2008 and the rise of sub-prime lending meant that the use of "logbook loans" became increasingly popular.

The sudden increase in registering bills of sale in relation to "logbook loans" highlighted the shortcomings of the registration system at the High Court which was not designed to deal with the volume of registrations being made. Not only was it costly to register but it was also an untimely and cumbersome process to search for security interests. This led to vehicles acquired by innocent third parties being seized and sold to pay the debt of the fraudster.

In 2014, the Law Commission launched a consultation with a view to reforming the Bills of Sale Acts. The consultation culminated in the draft Goods Mortgages Bill.

Changes proposed by the Goods Mortgages Bill

The Bill is primarily targeted at addressing the legal deficiencies in vehicle "logbook lending". However, it also provides a more flexible framework for individuals to grant security over other high-value assets including artwork, fine wine and jewellery. The legislation will better enable individuals to raise finance against art they already own and keep the art for their enjoyment, which is an appealing proposition for borrowers.

In order to make this an attractive proposition for lenders and mitigate the risks involved, the Bill proposes an electronic register for security over chattels. This will provide transparency for the art finance market and will operate in much the same way as Companies House does in respect of security created by companies. It will enable third parties to discover whether security exists over the artwork or other asset.

A similar approach is currently taken in the US under the Uniform Commercial Code. The register (which is readily accessible by the public) has provided lenders with sufficient comfort to allow borrowers to keep art work for their enjoyment. It also protects third party purchasers who may unwittingly purchase artwork that is subject to a security interest. According to Deloitte's Art and Finance Report 2016, this system has helped the US art finance market expand to between $15 and $19 billion (value of average loans outstanding).

"...legislation will better enable individuals to raise finance against art they already own and keep the art for their enjoyment..."

Will the Goods Mortgages Bill revolutionise the art world?

Unlike other tangible assets, the value of art can appreciate over time making it an appealing asset over which to take security. Borrowers are becoming increasingly aware of the value of monetising their art collection in order to raise capital or to exploit investment opportunities. The Bill has the potential to stimulate the growth of a large asset-backed lending market for individual borrowers.

However, will lenders be willing to explore the potential of this undeveloped market? Art financing carries a substantial number of risks, making it precarious for lenders when compared to established asset classes such as commercial real estate. Will it truly be able to address concerns of authenticity, provenance and value? While an alluring opportunity for borrowers, the risks involved may still be too much for lenders such that they continue to prefer the relative safety of security over art in storage.

The potential impact of this new legislation on the art world is unknown. Will it revolutionise the art world? Or, will the risks associated with art remaining on the borrower's wall mean that non-possessory financing of art remains rare? With the uncertainty of Brexit ever pressing, the new Bill could provide a unique opportunity to attract new lenders and borrowers to the UK art finance market.

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