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Let's take a moment to talk about the price-guarantee mechanisms at auctions

Updated: Nov 24, 2023




After the huge disappointment of the October sales in Hong Kong, which confirmed the current crisis of supply and demand that we have been experiencing for the past year, the November sales in New York could either reassure the art market or instigate fears we were finally entering a recession. Fortunately, as explained in our most recent article on these sales, the former ended being true. Whereas only 11 of the 73 lots sold at the three major evening sales were guaranteed during the recent Hong Kong sales, this time around the auction houses made extensive use of the guarantees system in order to limit the damage. For the Triton sale on November 14, for example, Phillips reportedly fully guaranteed the lots. And, apart from one sale by Christie’s, the guaranteed portion of the total sum of low estimates presale ranged from 56% to 79.9% across the major evening sales.


But what how do these price guarantees even work? Under this system, auction houses (or, as we will later see, a third-party) undertake to guarantee the seller that, whatever the outcome of the auction, they will receive a minimum sale price for the work or the full collection consigned. The amount of the guarantee is known only to the guarantor (the auction house or a third party) and the seller. In the case of in-house guarantees, should no one bid on the lot, the auction house that guaranteed it becomes the owner of the lot and pays the seller the full amount of the guarantee. The lot thus never actually sells for less than the guaranteed amount. If on the other hand the lot is sold at a higher price than the guaranteed amount—and this is where this system benefits the auction house —the winning bidder becomes the owner of the lot, and the auction house receives part of the amount exceeding the guarantee from the seller. The usual distribution is 80/20 or 70/30 in favor of the seller. For instance, if a lot guaranteed at $100,000 is sold $150,000, the auction house recovers a profit of $10,000 and the seller $40,000 (in a 80/20 case).


Although auction houses have been offering guarantees since the early 1970s, the system of guarantees has been gaining ground for some years now : it has become very common to see the words "lots guaranteed" on sales documents. In November 2015 during the New York evening sales, there was already more than $1 billion worth of paintings and sculptures had guarantees before being auctioned (about half of the $2 billion total value of art proposed during that auction season). More recently, in May 2023, at the nine evening sales in New York, 87 of the 332 lots offered were guaranteed, and the sum of low estimates for these guaranteed lots represented 57.1% of the overall sum of low estimates of the 332 lots auctioned off. Additionally, in the context of the art market slowdown of these past few months, art owners were increasingly reluctant to sell their works via auction houses. However, this season, the three main auction houses (Christie’s, Sotheby’s and Phillips) were able to offer top-level works by great modern and contemporary masters. To obtain these lots, they had to compete to offer favorable conditions to the owners, compensating for the financial risk linked to sales, notably through the system of guarantees. The dangers associated with the absence of guarantees are also regularly illustrated (including the Hong Kong sale, where there were ultimately few guarantees, and at rather low prices). Picasso's Femme assise au chapeau de paille (1938) is a case in point: estimated $20-30 million before the sale, the work went unsold. The sale of the Gerald Fineberg Collection (which we profusely talked about in a previous article) is another example of a bad outcome for Christie’s that could have been avoided had the collection been guaranteed.


Some owners even negotiate a guarantee on all the lots in their collection, and most major collections are now close to fully guaranteed : this was the case for the S.I. Newhouse Collection sale on May 11, 2023, the impressive Macklowe or Paul Allen sales, and more recently the Emily Fisher Landau sale—the largest collection of the New York November sales season in 2023. This system of guarantees even gives rise to competitions between auction houses to acquire the sale of collections, with the auction house giving the highest amount of guarantee on the lots winning over the sale. In order to secure the lots for the Emily Fisher Landau sale, Sotheby's had to match it with aggressive guarantees, despite the unstable economic and geopolitical context. But, once the warranty has been accepted by the seller, the real work begins for the auction houses: re-selling as much as possible of price guarantees to third parties, in order to minimize risk associated with keeping these guarantees « in-house »…


Indeed, the risk that « in-house » guarantees represent for auction houses is considerable, especially in times of crisis. In 2008, Sotheby's reportedly lost $60.2 million due to guarantees alone. Losses occurred when an artwork either sold for less than the minimum price the auction house had guaranteed or did not sell at all. In these cases, Sotheby’s was thus not able to avoid the deficit created by the reimbursement to the seller with the buyer premium fees and ended up as the owner of the work of art—hence taking the auction house away from its original purpose as a sales platform. But Sotheby’s was not the only auction house affected by the crisis, as in 2008, Christie’s and Sotheby's together had to pay out at least $200 million on works for which they had guaranteed a minimum price but which failed to sell. They were then forced to use the channels of private or even public sales to resell them (as a gallery would), thus straying away from their core business model.


Initially, in the years following the financial crisis, auction houses virtually stopped granting guarantees. Then, as the market recovered, auction houses had to find a way to remain competitive in the eyes of sellers, whilst limiting their financial liability. They hence decided to transfer the risk of guarantees to new intermediaries, by reselling them to third parties—a pre-existing trend that took on a new dimension in the wake of the crisis. These intermediaries are investors or collectors. According to The Economist, the first guarantee funded by a third party is believed to date back to November 1999. But the phenomenon gained momentum after the 2008 crisis. For example, Leonardo da Vinci's Salvator Mundi, sold in November 2017 for $400 million hammer at Christie's, was guaranteed for a total of $100 million with a third-party investor, offering the latter a huge return on investment (i.e. around $300,000 million). In recent years, some investment funds have even specialized in these guarantees, such as London's The Fine Art Group, which has been investing via two dedicated funds in the past 5 years. According to The Art Newspaper, some third parties even resell fractions of their guarantees to anonymous partners, thus sharing risks and profits (which, of course, generally goes against auction house rules and clauses in third-party guarantee agreements).


Nowadays, with the difficulties associated with a bearish art market, the auction houses have made the resale of their in-house guarantees a real policy. The guarantees are resold to third parties as much as possible, thus prophesying the outcome of the sale even before it even takes place. It should be said here that price guarantees by a third party take the form of an irrevocable bid placed by said party on a lot. In the event of the irrevocable bid winning the sale, the irrevocable bidder becomes the owner of the lot for the price of that bid plus the buyer’s premium on that bid, but minus a discount on the final sale price (the buyer’s premium fees hence make it possible for the auction house to avoid creating a deficit). On the other hand, if this irrevocable bid is surpassed by another bid during the sale, the auction house typically pays the irrevocable bidder a percentage of the difference between their irrevocable bid and the sale price. So, it makes sense for many art market players and investors to sometimes place an irrevocable bid on a given lot in the hope that they will either acquire a good work (at what they deem to be a reasonable price) or profit off of someone else’s acquisition.


But according to analysts ArtTactic, the risk for third parties is growing: the estimated average return on guarantees has fallen from its peak at 21.8% in 2021 to a low of 11.1% in 2022. The guarantee system, while attractive to sales companies and investors, could represent an increasing risk in an already financially unstable period. Although it artificially alters sales results, this system could cause auction houses, already dealing with a difficult business model (article), to plunge even further, and provide investors with a low or even negative return on their investment. It doeshowever make it possible to buy great masterpieces at correct prices.

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