It usually takes years of experience to acquire the knowledge needed to be an effective fine art collector. Sophisticated art collectors are usually sensitive to factors establishing an artwork’s value, such as authenticity, condition, provenance, subject matter, rarity, as well as broader market trends. Occasionally, art collectors use their knowledge to identify and acquire grossly undervalued art which they then resell for windfall profits. However, many people believe that a sophisticated collector has a duty to inform an art seller when he has grossly undervalued his art. Such people often believe that the buyer’s failure to disclose the fact that she is buying the piece for a proverbial “steal” renders its purchase illegal as an unconscionable, predatory, or fraudulent scheme. This article addresses the ethics and legality of such a practice.[1]
Consider the following hypothetical situation: An art historian specializing in 19th century French Impressionism has acquired a fine collection of Impressionist paintings over the course of twenty-five years. Not only does he purchase art, but he also periodically resells acquired pieces for profit, and he has become independently wealthy doing so. One day, he is driving through a neighborhood where he spots a garage sale. Its inventory is strewn along the driveway. Most of it is items are of modest value, used plastics, metal knickknacks and the like. In addition, a framed painting has been placed on the asphalt with an attached $10.00 price tag. The painting has been abused, its canvas being ripped and dirtied, and its frame severely damaged. Nevertheless, the professor knows absolutely that it is an authentic oil painting by a famous 19th century French Impressionist. As a result, the professor is sure that this painting is extremely valuable even in its present condition. He then obtains confirmation from the garage sale operator that the price is just $10.00. After receiving said confirmation and handing a $10 bill over to the seller, he places the painting in his car. Instead of going home, the professor immediately drives to an internationally renowned auction house, which agrees to sell the painting on his behalf. After the auction, the professor receives mail from the auctioneer containing a check in the amount of $750,000.00.
Has the professor stepped over any legal lines? May he keep the money? Does the garage sale operator have a cause of action against him?
Many people would instinctively respond to the above hypothetical and insist that the professor, a sophisticated buyer, took advantage of an uninformed seller. Accordingly, many people would insist that the professor’s so-called “obscene” profit must be disgorged. As is discussed below, such a view is, we believe, legally incorrect.
In order to fully understand why our hypothetical art purchaser need not disgorge his profits, it is useful to consider other real world commercial situations in which one would normally expect the buyer to keep secret valuable information about the transaction. For example, oil and mining operators who scout for productive property, often pay many hundreds of thousands of dollars and expend hundreds of hours in geological research as to each targeted parcel. Prospectors frequently invest such sums only to find that the targeted land is likely devoid of oil, thereby losing 100% of their investment. Suppose, however, an oil prospector, who had spent over one-half million dollars in geological surveys and analysis, discovered a tract of targeted ranchland above probable massive oil reserves. Would any reasonable person expect the prospector to approach the rancher as follows:
“Hello! Wildcat Drillers, here! Our company has invested over one-half million dollars in research, and we’ve determined that an enormous oil reserve probably lies beneath your cattle ranch. We will, therefore, offer to buy it from you for its fair market value as grazing land.”
Of course, that scenario is patently ridiculous. If Wildcat believed that the rancher did not already know that oil lay beneath his pastureland, it would not recklessly disclose its prospecting analysis that it had procured at considerable effort and expense.
Not only is it legally permissible for a buyer to remain silent as to facts in her possession that are material to the asset’s value, but she is also permitted under limited circumstances to employ certain deceptive tactics to preserve the secrecy and value of that information. Again, turning to the example of the oil and gas industry, petroleum producing businesses guard their proprietary information from opportunistic exploitation by forming subsidiary corporations or utilizing individual nominees as agents. Human or corporate nominees are routinely employed to disguise their undisclosed principals by posing as the purchaser. Turning to the Wildcat Drillers example, Wildcat might hire a genuine cattleman to pose as the purchaser for the grazing land that floats above a petroleum reserve, thereby intentionally leading the seller to assume incorrectly that his tract’s value lay in is use as mere grazing land. Alternatively, Wildcat might form a subsidiary corporation with a name purposefully denoting an enterprise in the beef industry, such as “Longhorn Ranchers, Inc.”, so that the land owner/seller would not be tempted to probe the buyer’s real motivation for contracting. For this reason, the law expressly permits a person making an offer to conceal the identity of her principal, i.e., the real-party-in-interest. See generally, Restatement (Third) of the Law of Agency § 6, et seq.[2] The law has always recognized that such deceptive tactics are both necessary and fair. Why? Wildcat simply protected its enormous investment in geological research from opportunistic exploitation by a seller who had invested no effort, time, or money in determining whether or not his grazing land was floating atop oil reserves.
The Disney Corporation’s method of acquiring enormous tracts of land in central Florida is probably the most famous example of the use of nominees posing as an undisclosed buyer/real party in interest. Disney decided to build his theme park in a swampy area near Orlando where real estate values were extremely low, e.g., $180 per acre. Only by acquiring cheap land could enough contiguous property be acquired for the size of the park he had planned. The targeted land was predominantly owned by orange and walnut grove operators, so Disney formed shell companies whose names were suggestive of enterprises engaged in the orange and walnut producing industries. In this way, orange and walnut grove operators where intentionally discouraged from probing into the real motivation behind the acquisition of large tracts of contiguous land.
It is important to note that Disney’s use of subsidiary nominee purchasers to pose as orange and walnut grove operators was eventually discovered before Disney had purchased all the land it required. The result? Swamp land whose fair market value had been only $180 per acre skyrocketed to $80,000—a price Disney was actually forced to pay See Richard Folgelsong, The Mouse that Roared: How Disney Secretly Acquired Vast Plots of Land to Create Walt Disney World. Disney’s cover story, which involved (a) inventing motivations for acquiring the land and (b) concealing the identity of the real-party-in-interest, was not fraudulent, but rather, it constituted an equitable, lawful strategy to prevent a seller from opportunistically (and unfairly) exploiting the buyer’s information acquired at the cost of many millions of dollars.
Turning back to the example of the art historian, his knowledge and expertise concerning French Impressionism and its market required years of higher education, decades of practical experience, and the expenditure of substantial monetary sums on (1) tuition, (2) collected paintings, (3) books, treatises, publications, and catalogs, (4) extensive travel to museums, exhibitions, galleries, and auctions and (5) consultations with art advisors. The point to be made is that the professor’s investment of time and money to develop the skill and knowledge needed to spot an abused masterpiece lying on asphalt was very substantial, indeed.[3]
The right of a buyer not to disclose material, proprietary information to a seller in an arms-length transaction was first addressed by Chief Justice Marshall in the seminal case, Laidlaw v. Organ, 15 U.S. (2 Wheat.) 178 (1817). Laidlaw concerned a seller’s claim that the buyer had a duty to disclose to him material facts which, had they been disclosed, would have caused the seller to demand a much higher sales price. Organ, a tobacco dealer, learned before others that the Treaty of Ghent had been signed ending the War of 1812, which meant that the British blockade would be lifted and that American tobacco could be sold overseas again causing prices to soar. Organ promptly negotiated to purchase a large quantity of tobacco from Laidlaw at low, wartime prices, purposefully choosing not to disclose his proprietary information, namely, that the blockade’s end would cause tobacco prices to skyrocket. Laidlaw claimed that Organ had defrauded him by not disclosing the end of the blockade. In his opinion, Chief Justice Marshall held:
The question in this case is, whether the intelligence or extrinsic circumstances, which might influence the price of the commodity, and which was exclusively with the knowledge of the vendee, ought to have been communicated by him to the vendor? The court is of the opinion that he was not bound to communicate it. It would be difficult to circumscribe the contrary doctrine within proper limits, where the means of intelligence are accessible to both parties.
Laidlaw, 2 U.S. (2 Wheat.) at 93.
Laidlaw has been the law of the land as to a buyer’s right of non-disclosure for over 200 years. Scholars have since analyzed Laidlaw, its holding and underlying rationale. In so doing, each asks this question: “Why is it fair and equitable to permit a buyer’s nondisclosure of material information about the transaction to a seller?” The answer is simply this: A buyer’s right of nondisclosure is often commercially essential. It has been observed that the right to trade without disclosure provides an incentive to buyers and sellers to acquire valuable information. In other words, individuals will not incur the cost of obtaining information if they must subsequently disclose that information without compensation to potential trading partners who have not incurred such costs. Such a practice would, therefore, impede public policy in favor of promoting knowledgeable exchanges. In this regard, the Laidlaw precedent implicitly recognizes that information is itself a commodity. Requiring its distribution without compensation is likely to deter its production, just as a duty to share any other commodity would deter production.
A person objecting to the windfall profit made by our posited art historian might also reflexively conclude that the buyer had a duty of disclosure because it is well known that sellers must disclose information that is material to the transaction. That person might raise the hypothetical situation in which a seller of artwork fails to reveal the fact that the painting is a clever, intentionally deceptive reproduction. He would be correct in insisting that the seller’s nondisclosure constitutes a fraud, i.e., the seller is duty-bound to reveal to the buyer that the painting is a reproduction. Nevertheless, he would be legally wrong to conclude that the buyer, would, therefore, be saddled with a similar duty in a case in which the seller wrongfully believed the painting was a reproduction whereas the buyer in fact knew it to be an original masterpiece. However, no principal of logic or reason compels the conclusion that the duty of disclosure is a reciprocal obligation. In fact, it has long been recognized that disclosure duties viz a viz a buyer and seller are legally and properly asymmetrical.
As discussed above, an imposed reciprocal duty of disclosure impedes the public’s interest in acquiring vital extrinsic facts affecting the transaction. In addition, disclosure duties viz a viz buyers and sellers is properly asymmetrical because each stand in a different relationship as to the property being alienated. For example, sellers often know information about the property being sold casually or fortuitously as a result of having owned it for a period of time. Consider, for example, a seller of a home who became aware that it was invested with hidden termites because he lived there. His awareness of the existence of that latent defect was not obtained as a result of a costly, time-consuming investigation, but rather, his knowledge about the infestation naturally resulted as a byproduct of his having lived there. On the other hand, where the buyer incurs time and expense to acquire knowledge or expertise required to facilitate the transaction, he does not obtain that knowledge as a free byproduct of his association with the property. If the law were to impose upon a buyer the duty to disclose his acquired information or share his expertise, then the acquisition of commercially valuable information or expertise is discouraged. Such a result runs counter to the public policy in promoting a free market.
The asymmetry viz a viz buyers and sellers with respect to disclosure duties is justified on other economic grounds. For example, no gain or efficiency comes from a seller’s nondisclosure of the existence of termites because that nondisclosure severs information from the economic resource, i.e., the property. From a social point of view, gain and efficiency result from the merger, not severance, of information and the resource being transferred, and it is almost always the buyer, not the seller, who is responsible for that merger.[4] When a seller silently parts with his termite-infested house, he profits from the severance of the resource and information relating thereto. This violates public policy because the seller’s nondisclosure under such circumstances serves no social benefit whatsoever. Nothing is beneficially created by the seller’s nondisclosure about the termite infestation since the buyer will not know to take remedial action until the infestation becomes obvious. A seller’s non-disclosure typically results in an even greater social cost associated with the transaction—a cost unfairly borne by the buyer alone.
Efficiency theories of economics also favor a buyer’s nondisclosure for yet another reason. Turning to the hypothetical art historian, suppose the garage sale operator represented to him that the painting was only a print, but the art historian knew that it was, in fact, an original painting. As a print, it would be worth at most $100, but as a painting, it was really worth hundreds of thousands of dollars—an amount far beyond the purchaser’s ability to pay. In such a case, the law would favor the decision made by the art historian/buyer not to disclose his information. Why? If the buyer does not successfully acquire the painting by means of his nondisclosure, the economic resource will remain in the hands of a person who does not know important facts about it. The ramifications for efficient resource use are evident. A party who does not know that a painting is an original work of art may not care for it properly, secure it, or use it to advance the common good by, for example, exhibiting or donating it. In general, a party who is unaware of the material properties of a resource will not be motivated to make proper use of that resource or to acquire appropriate resources complementary to its conservation, restoration, protection and use.
Our hypothetical art historian, by not informing the seller that the painting was a masterpiece, merged his knowledge with the painting. Because of his efforts, the masterwork, which for all intents and purposes, had been abandoned, would now be conserved or restored. By acquiring the property, the painting could be properly safeguarded against casualty or theft, thereby assuring that an important piece of our heritage and culture will be preserved for future generations. The purchaser at the auction would have had to pay sales tax on the painting, and the art historian would be liable to pay income taxes on his enormous gain, and the interests of the commonwealth would, therefore, be financially advanced.
It is important to note that the painting’s former owner, the garage sale operator, has no equitable claim to the professor’s profits from reselling the painting. As one scholar has observed,
[T]he value of property is a function of the creative insights that human beings bring to the physical objects they control. The owner of the land was paid a fair price for every use to which the owner was able to put the land. There is no compelling normative reason that entitles the owner [seller] to the profits derived from the creative insights of the buyer regarding additional uses for the parcel of land.
Wonnell, 41 Case W. Res. at 344.
The economic rationale for permitting nondisclosure is nicely illustrated by several cases involving the purchase of real estate where the buyer had reason to believe in the existence of a subsurface oil or mineral deposit unknown to the seller. For example, in Neill v. Shamburg, [158 Pa. 263, 27 Atl. 992 (1893)] the parties were cotenants of an oil lease on a 200-acre tract. The buyer (Shamburg) bought the cotenant’s interest in the tract for $550.00 (with a provision for an additional $100 in case a well producing six or more barrels of oil a day should be found). At the time of the sale, Shamburg was operating several wells on an adjacent tract of land. One of the wells was quite valuable. Shamburg “directed his employees not to give information on this subject” and said nothing to his cotenant regarding the well when he purchased her interest in the 200-acre tract. The court held that Shamburg did not owe Neill any duty of disclosure and refused to set aside the sale of her half interest in the oil lease. The court reported its conclusion with the following argument:
The plaintiff [the seller] had no interest in the 50-acre lease, but we may concede that, when she was about to sell her part of the other lease to her co-tenant, she became entitled to know such facts with regards to its production as would bear upon the value of the other. But unless there is some exceptional circumstance to put on him the duty to speak, it is the right of every man to keep his business to himself. Possibly, Shamburg was unduly suspicious on this point, but the nature and position of his business suggested caution: Fogle testifies that Shamburg was the only person operating in that neighborhood, and James says that Shamburg told him he had spent nearly $150,000 in developing that territory, “and now all these fellows are anxious to pry into my business”. We do not find in the acts of Shamburg, under the circumstances, anything more than a positive intention and effort to reap the benefit of his enterprise by keeping the knowledge of its results to himself, and we agree with the master that this “falls far short of establishing fraud”.
Shamburg, 27 Atl. at 993 (1893) (emphasis supplied).
Cases holding that a buyer’s deliberately-procured proprietary information is privileged from disclosure are legion and usually appear in the context of the purchase of land by oil or mineral prospectors. Because this issue has been settled law since the days of Chief Justice Marshall, there are relatively few recent cases re-addressing this law to which our hypothetical garage sale operator would object. See generally Furman v. Brown, 227 Mich. 629, 199 N.W. 703 (1924) (disagreement as to the value of land during negotiations is not evidence of fraudulent inducement); Stuart v. Dorow, 216 Mich. 591, 185 N.W. 662 (1921) (no duty to disclose the purpose for which land was being purchased); Zaschak v. Traverse Corp., 123 Mich. App. 126, 129, 333 N.W.2d 191, 193 (1983) ("Michigan courts have not yet recognized a duty on the part of a vendee to disclose facts relevant to the value of the real estate in question even when specifically asked."); Smith v. Beatty, 2 Ired. Eq. 456 (N.C. 1843); Harris v. Tyson, 24 Pa 347 (1855); Stackpole v. Hancock, 40 Fla. 362, 24 So. 914 (1898); Holly Hill Lumber Co. v. McCoy, 201 S.C. 427, 23 S.E.2nd 372 (1942).
The following cases establish some circumstances under which a prospective purchaser who knows that land contains valuable resources is under no duty to disclose this information to the seller: Storthz v. Arnold, 74 Ark. 68, 84 S.W. 1036 (1905) (purchaser of land from two "ignorant girls" not obligated to disclose the presence of valuable bauxite deposits); Zaschak v. Traverse Corp., 123 Mich. App. 126, 333 N.W.2d 191 (1983) (denial of motion for summary judgment by plaintiff affirmed because plaintiff failed to support the assertion that the defendant had a duty to disclose the potential presence of oil and gas on the property); Crowley v. C.N. Nelson Lumber Co., 66 Minn. 400, 69 N.W. 321 (1896) (lumber company was not required to tell seller of the presence of valuable iron ore on land used to grow timber); Caples v. Steel, 4 Or. 491 (1879) (purchaser did not have a duty to disclose the presence of a valuable coal mine on the seller's property).
Returning to the example of the art historian, suppose the garage sale operator directly asked him if the painting had been done by the hand of a master? Should the buyer be compelled to answer that question? Although the law is less well-settled on this point, the answer is probably, “No.” For example, University of Virginia law professor, Saul Levmore, has observed within the familiar context of oil and mineral exploration, buyers/prospectors spend huge sums of money researching whether or not a prospective oil field or mine would likely be productive, and land sellers should not be allowed to steal that information by asking the question, “Do you have reason to believe that there is a valuable ore deposit on my land?” The real purpose of the question is not to promote fairness, but rather, to place the buyer under duress and fear of a possible prosecution for fraud if he does not answer honestly. The seller, who has invested nothing of his own resources in investigating his land’s full potential, is in effect extorting from the buyer his entire investment on pain of being accused of fraud. Levmore concludes:
[B]oth nondisclosure and dishonesty will prevent free riding [by the seller] and encourage the socially-beneficial quest for information. . . . The unfairness and inefficiencies of the buyer-explorer’s dilemma suggest that the law ought to allow dishonest disclosure in cases in which the misinformation would only cause the misinformed party to behave as he would have without the information, and in which it would be unfair--because of the cost and risk of extortion--to require disclosure by the informed party.
Saul Levmore, Securities and Secrets, Insider Trading and the Law of Contracts, 68 Va. Law Rev. 117, 140 (1982). See also, Christopher Wonnell, The Structure of a General Theory of Nondisclosure, 41 Case W. Res. 329, 361 (1991):
[N]ondisclosure is an alternative means of preventing [a seller’s] opportunism. A railroad lacking the power of eminent domain will attempt to purchase land needed for construction without disclosing its plans to the land owners. . . . [I]f the railroad does not disclose its plans to its agent, the agent if asked specifically whether the land is being acquired for purposes of building a railroad, should be able to say that no such plans exist. The theory is that the land owner is only seeking information for an improper strategy or monopolistic purpose and has no to right to demand the information. . . . [F]alse answers which only neutralize questions that should not be asked are not immoral.
See also Randy Barnett, Rational Bargaining Theory and Contract: Default Rules, Hypothetical Consent, the Duty to Disclose and Fraud, 15 Harv. J. L. & Public Policy 783, 796 (1992) (arguing that the lack of disclosure in contracts is not fraudulent when the information relates to the supply and demand for the resources that are the subject of the contract).
If we apply these principles to the garage sale scenario in the beginning of this article, the art historian should not be compelled to answer candidly or honestly the garage sale operator’s question as to whether or not his $10.00 painting is really an original masterwork. This writer concurs with the authorities cited above that by answering this question in the negative, the art historian’s misrepresentation cannot be a fraud, since its purpose was to defeat a greater wrong, i.e., the seller’s use of duress through an implied action in fraud to coerce the free disclosure of information to which the seller is neither ethically nor legally entitled. It ought to be clear to everyone in the 21st Century that we live in an information age in which acquired knowledge and expertise is guarded and treasured. Art sellers are, therefore, duty-bound to be knowledgeable about intrinsic and extrinsic facts affecting the value of their art offered for sale.
[1] The legal principles and analyses addressed by this article also apply to the collection and investing of decorative arts, antiques, jewelry, timepieces and virtually all luxury assets.
[2] But see, Restatement (Third) of the Law of Agency § 6 (4):
When an agent who makes a contract or conveyance on behalf of an undisclosed principal falsely represents to the third party that the agent does not act on behalf of a principal, the third party may avoid the contract or conveyance if the principal or agent had notice that the third party would not have dealt with the principal.
In most transactions, the identity of the buyer, though relevant, is not material since the amount of monetary consideration is nearly always the essential term of fee simple absolute purchases where deed restrictions and easements are not at play.
[3] Some dicta exists to the effect that a buyer who casually or accidentally obtains valuable information about a chattel offered for sale must disclose it, such as when an uneducated person fortuitously obtains valuable information as a result of her eavesdropping on the conversations of experts. In such cases, more than the “free” nature of the information falling into the buyer’s lap comes into play, there usually being implicated some additional overstepping of social propriety or fairness.
[4] For an excellent discussion as to why there is asymmetry in the law permitting nondisclosure for buyers but not sellers, see Christopher Wonnell, The Structure of a General Theory of Nondisclosure, 41 Case W. Res 329, 340-46 (1991) (Discussion Point III, “The Asymmetry of Buyer and Seller Disclosure”).