In the frame

Sunday, 01 December 2013
Lawrence M Shindell and Filippo Petteni on how passion assets have come to play an essential – but troubling – part in wealth planning.

Passion assets of high-wealth clients have become an increasingly significant part of clients’ net worth. While once this asset class represented simply a number – proportionately small at that – at the bottom of a client’s balance sheet, today trust and estate practitioners must understand the field’s nuanced issues to create effective estate settlement, succession and related philanthropic plans.

In this article, we focus on collectibles as a broad category of tangible personal property (TPP) – from fine art, vintage motorcars, rare stringed instruments, and important books and manuscripts to museum-quality jewellery. Practitioners can encounter single objects in estates that alone are potentially worth millions of dollars (or pounds or euros), yet unexpectedly find that it is challenging to anchor the value of these assets and the integrity of the trust and estate plan built around them.

Two issues have growing importance and complexity for practitioners. First, what constitutes a legally compliant appraisal of these passion assets for tax-valuation purposes? Second, why are fiduciaries (who are retained to take custody and control of these assets and to transfer them as part of trust and estate plans) becoming less inclined to manage precious TPP assets?

Enhanced paradigms for TPP valuation

The answer to the first question rests in the regimes for valuing TPP in the US, by quasi-government regulation, and in the UK and other EU countries, by industry adoption of best practice standards.

In the US, the Uniform Standards of Professional Appraisal Practice (USPAP) are the Internal Revenue Service (IRS)-mandated standard for all valuation appraisals of TPP (as well as non-TPP assets) when used for estate tax or charitable gift income tax deduction purposes.1

For an appraisal to constitute a ‘credible’ (legally compliant) appraisal under USPAP, in addition to other requirements that are not germane here, the appraiser must explicitly state the ‘extraordinary assumptions’ and ‘hypothetical conditions’ on which they based the value.2 At the heart of every TPP valuation are two seminal assumptions or conditions (identified by USPAP): authenticity and clear legal title.

Authenticity is well-known, well-understood and well-managed in the market through authenticity experts, including connoisseur scholarship and scientific testing. Legal title is less understood, is arguably more important and widespread, and represents an equal or greater exposure in the art and collectibles market and in its impact on valuation.

The impact of legal title was dramatically illustrated in the recent US case involving Robert Rauschenberg’s famous assemblage Canyon – to which a bald eagle was affixed. It is illegal to sell, trade, gift or even possess bald eagles in the US (the national emblem and a protected endangered species; Rauschenberg originally acquired the Canyon bald eagle from an heir of a member of then-Colonel (later US President) Theodore Roosevelt’s Rough Riders Cavalry before enactment of this proscriptive law),3 so the value of this work was questioned in the context of assessing estate tax.

After first rather curiously advocating that the work had a value of USD65 million, even if it was a reduced fair market value on the black market, in November 2012 the IRS reached a settlement with the owners of Canyon. The IRS agreed that the value of the work was USD0 and dropped all estate tax assessment of the work; in return, the owners accepted the same USD0 value premise and agreed not to claim any tax deduction for donating the work to the Museum of Modern Art in New York.

The Canyon case confirms the relationship between legal title and value. Without clear, substantiated legal title, TPP has its fair market value reduced to zero, or at least significantly discounted (to account for high-risk-appetite buyers who might take a hedge on the marketability and purchase a work that has unconfirmed legal title).

The extension of this title-value principle has serious repercussions under USPAP and similar international regimes. Appraisers are not equipped – and generally are not permitted under their professional indemnity insurance policies – to render opinions on legal title when they appraise works. Furthermore (or but), USPAP-like standards require appraisers to identify assumptions and hypothetical conditions that support the valuation.

For the practitioner, this means a trust or estate plan will be built on either a non-compliant appraisal (one that does not state the necessary assumptions or hypothetical conditions and ignores legal title) or a compliant appraisal – one that contains these mandatory qualifications (e.g. ‘This appraisal assumes, and I have not independently vetted, that the owner has clear legal title to this work’) but that becomes the effective equivalent of a ‘qualified audit report’: untenable and lacking adequate meaning in the financial world.

The requirement to identify assumptions and hypothetical conditions underlying the valuation of TPP also exists, at least impliedly, in the RICS Appraisal and Valuation Standards (RICS Red Book) in use in the UK and other EU and non-EU countries.4

What, then, does the practitioner do with a USPAP-styled compliant appraisal? Suppose the carefully crafted trust or estate plan intends to sell a multimillion-dollar object to pay estate taxes and thereby preserve real estate holdings and defer or extinguish related taxes. What happens if the work unexpectedly proves to be unsalable and of no value because of defective legal title?

Why fiduciaries are troubled by passion assets

If a practitioner does not address these issues, the independent fiduciary will (or should, if it is performing its fiduciary duties effectively) – and here the issue gets thornier.

When banks or trust companies sell trust or estate assets, purchase assets with trust resources or publicly exhibit trust assets at museums, they must certify (as fiduciaries) to the demand side of the market (auction house, buyer, museum, etc) that its client (the trust, estate and putative owner of the asset) has clear legal title to the offered work.

Fiduciaries, which know they must eventually represent and warrant their clients’ clear legal title to TPP, putting themselves at risk of liability, are increasingly requiring reliable assurance of clear legal title of TPP before accepting it into a trust or other entity on behalf of which (and its beneficiaries) they are willing to act as fiduciary.

This asset-integrity benchmark requirement affects everything from executing consignment agreements by which fiduciaries can sell trust assets (for self-directed grantor trusts, the fiduciary cannot ask the grantor to execute this paperwork, as it will nullify the trust) to directing and reporting to beneficiaries the calculation of the total value of the entire trust base. Fiduciaries know or should know that a legally complaint appraisal must be qualified by all relevant assumptions and hypothetical conditions.

A knowledgeable, experienced fiduciary should also know that assurances of clear legal title from the living owner or from the beneficiaries of a deceased owner do not suffice. Similar to what the financial industry knows as ‘management assertions’ under the Generally Accepted Accounting Principles,5 and parallel EU accounting rules for asset ownership in the preparation of financial audit reports,6 owner assurances of clear legal title to assets that are traded in opaque and unregulated markets (as is the case with collectible TPP) are, on their own, insufficient to provide the necessary, independent factual and legal support.

If the fiduciary seeks outside legal advice to avoid the risk of liability for title-related losses incurred by trust beneficiaries, this too is problematic. The trust and estate community learned this in a closely watched 2011 case, US v Jicarilla Apache Nation, 564 US _, 131 S Ct 2313 (2011), which highlighted the general validity – though inconsistent treatment, at both US state and federal levels – of the long-standing and partly forgotten rule under US common-law jurisprudence (premised on English common law) that there is a ‘fiduciary exception’ to the attorney-client privilege.

As a result, if and when a fiduciary seeks legal advice on the status of legal title (or value) of TPP in executing their duties to the beneficiaries of a trust or other tax-driven entity, the obtained advice is likely to be discoverable – and ‘Exhibit A’ – in litigation over resulting loss. Moreover, because the fiduciary-sought legal opinion will be discoverable, the advice is likely to be watered down, making it of limited or no use.

Conclusion

The intertwined relationship between (i) enhanced appraisal requirements for TPP, (ii) legal precedent on the relationship between legal title and the valuation of TPP and (iii) the opaque and unregulated nature of the markets in which TPP assets trade creates new and challenging issues both for practitioners who are developing and executing trust and estate plans for such assets and for the fiduciaries who are entrusted to manage these assets.

Practitioners should seek to educate themselves about the unique risks surrounding TPP and how best to serve their clients and simultaneously reduce their own liability when transacting around and managing high-valued, precious collectible objects. As a starting point, practitioners should try to find ways to buttress appraisals of passion TPP to assure the integrity of trust, estate and philanthropic plans built around these assets, which represent a growing portion of the value of trusts and estates.

  • 1. USPAP broadly governs and provides standards for real and personal property appraisals, and consulting and business valuations
  • 2. USPAP Standard 7, r7-1 and r7-2, subsections (f) and (g), and comments to r7-2. See also r7-1, b and r7-2(e)(iii)
  • 3. For more, read Barbara Rose’s account in her book An interview with Robert Rauschenberg (Vintage Books, 1987)
  • 4. www.rics.org
  • 5. And the related Generally Accepted Auditing Standards and Financial Statements Assertions. The International Financial Reporting Standards used outside the US have comparable provisions on management assertions; see International Standards on Auditing r315 and r200
  • 6. For fiduciary liability when, for example, a fiduciary might provide representations and warranties about clear legal title of TPP (and on valuation) but knows or suspects the information is incomplete, inaccurate or untruthful, see Varity Corp v Howe (1996) 516 US 489; Cristallina SA v Christie, Manson & Woods International, 117 AD2d 284 (NY App Div, 13 May 1986); Keach v US Trust Co, NA, 256 F Supp 2d 840, 842 (CD Ill 2003) and Smith v Van Gorkom, 488 A2d 858, 870, 975 (Del 1985)
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Lawrence M Shindell and Filippo Petteni

Lawrence M Shindell is Chair of New-York-headquartered ARIS Title Insurance Corporation, and Filippo Petteni is Managing Director of Asterion Advisors, Art Industry Consultants.

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