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California Resale Royalty Act Ruled Unconstitutional as to Out of State Sales, What Effect on the Market?

Posted by Nicholas O'Donnell on May 6, 2015 at 6:53 AM

In a decision long awaited by artists and auction houses in particular, the Ninth Circuit Court of Appeals has ruled that the California Resale Royalty Act of 1976 (CRA)—America’s only droit de suite—is unconstitutional top regulate any sales of art outside of California. The court concluded, however, that that portion of the law is severable from the rest, and let the regulation of in-California sales stand for further interpretation by a subsidiary panel of the appeals court. There are two likely aftereffects of this decision. Galleries and auction houses can put any concerns to rest about sales in New York in particular, but one has to wonder about the effect it will have on putting items for sale in California, which will effectively have a premium not present in other states. It also raises the possibility that the resulting piecemeal framework will motivate movement on the pending federal bill (the American Royalties Too (ART) Act of 2015) concerning resale royalties. Could this be the development that prompts movement in Congress?

Cal. Civ. Code § 986(a) was enacted in 1976. It provides that a seller of fine art must pay 5% of the sales price to the artist “if the seller resides in California or the sale takes place in California.” The plaintiffs, artist Chuck Close among them, sued on behalf of a class of plaintiffs, alleging that Christie’s, Sotheby’s, and eBay had not paid the royalties due under the act. The defendants responded by moving to dismiss, arguing that the act was unconstitutional because it regulated interstate commerce, and thus violated the Commerce Clause of the United States Constitution.

As we have discussed before, there is no actual “Dormant Commerce Clause.” Rather, the negative implication of the provision in Article I of the Constitution that Congress can regulate interstate commerce has been termed the “dormant” aspect, that is, because Congress can regulate interstate commerce, the states may not. That in turn takes various forms: the explicit regulation of interstate commerce is forbidden, but so are laws that either substantially burden interstate commerce, or favor their own states’ citizens over others.

The U.S. District Court allowed the motion and dismissed the case in its entirety in 2012. The District Court held that the Act’s regulation of sales outside California is an impermissible regulation of wholly out-of state conduct, in violation of the dormant Commerce Clause. The court next held that the entire law was unconstitutional because the remaining portions could not be severed from the offending provision. The full Ninth Circuit last year to year the case en banc.

The Ninth Circuit “easily” reached the same conclusion as the District Court with respect to out of state sales:

Those sales have no necessary connection with the state other than the residency of the seller. For example, if a California resident has a part time apartment in New York, buys a sculpture in New York from a North Dakota artist to furnish her apartment, and later sells the sculpture to a friend in New York, the Act requires the payment of a royalty to the North Dakota artist—even if the sculpture, the artist, and the buyer never traveled to, or had any connection with, California. We easily conclude that the royalty requirement, as applied to out-of-state sales by California residents, violates the dormant Commerce Clause.

The court distinguished the CRA from use taxes that can be imposed on residents and which have repeatedly been held constitutional (if I buy a car in New Hampshire where there is no sales tax and bring it to Massachusetts, I have to pay a use tax equivalent to the sales tax had I bought it in Boston). The CRA is not a tax, it regulates payments between private parties.

The most contested portion of the opinion concerned sales of art outside of California but by California residents, sales that now are not regulated by the CRA under this opinion. The opinion concludes that regulation of any out of state sales is unconstitutional. There were dissents and partial concurrences by judges on the panel who thought the majority opinion went too far. As one put it:

It decides a question entirely unnecessary to the resolution of this case when it holds the Act unconstitutional as applied to California art owners who ultimately receive proceeds from out-of-state sales and are then responsible for the payments to the artists. The majority does so despite the fact that no California art owners are a party to the case, and despite the fact that we could and should affirm the district court’s grant of the auction-house defendants’ motion to dismiss on far narrower constitutional grounds.

This is a fair point insofar as California defendants are not parties to the case, but the question was certainly ripe for consideration because the defendants challenged the statute on its face, and they are consignees. An owner/consignor who is from California is certainly within the facial reach of the statute. This opinion proposed a different perspective: that the entire dismissal should be affirmed because the auction house are out of state entities, but that did not carry the day.

The severability question, however, went the other way. To determine if some portion of a law should remain in force even if another aspect is unconstitutional, California law requires that the court consider whether the “invalid provision [is] grammatically, functionally, and volitionally separable.” Cal. Redev. Ass’n v. Matosantos, 267 P.3d 580, 607 (Cal. 2011). In plain English, is the unconstitutional part an essential part of the law, or does the remaining law not make sense either grammatically or substantively?

Without the out of state sales, the law now reads: ““Whenever a work of fine art is sold and . . . the sale takes place in California, the seller or the seller’s agent shall pay to the artist of such work of fine art or to such artist’s agent 5 percent of the amount of such sale.” The Ninth Circuit concluded that this still addresses the substantive goal and has “coherent functionality.”

There is an even shorter route to the severability conclusion, namely, the law itself. Elsewhere in § 986, the legislature provided:

If any provision of this section or the application thereof to any person or circumstance is held invalid for any reason, such invalidity shall not affect any other provisions or applications of this section which can be effected, without the invalid provision or application, and to this end the provisions of this section are severable.

The court concluded that the unconstitutional portion was severable, and remanded to the three-judge panel of the Ninth Circuit to address the remaining issues in in the case. Presumably that will result in a mandate to the District Court concerning litigation of the disputed royalties on in-state sales. There, the first question will likely be class certification. The plaintiffs claim to represent a class, but they will have to demonstrate now that the class of plaintiffs is so numerous, and its issues sufficiently common, that a class action is the appropriate way to proceed. That will no doubt be a pitched battle.

Don’t rule out a successful petition to have the Supreme Court hear the case, either (which is not to say who would be successful once they got there). There has been a significant trend in narrowing Dormant Commerce Clause jurisprudence, and this may be the sort of case that one or more justices see as appropriate to clarify the doctrine further.

The implications go beyond these plaintiffs, of course. The question will be whether the resolution of this law (which had essentially been ignored) will affect the art market significantly. In a mobile market, it certainly disincentives holding sales in California. That may end up affecting the auction houses that have presences elsewhere less than it does galleries and art fairs, who are tied to the location either as a brick and mortar establishment or as an event. It will bear watching what market monitors have to say about those effects going forward.

Topics: Legislation, Resale Royalties, Chuck Close, Supreme Court, Christie's, Cal. Civ. Code § 986(a), Dormant Commerce Clause, droit de suite, sales tax, Cal. Redev. Ass’n v. Matosantos, use tax, American Royalties Too (ART) Act of 2015, California Resale Royalty Act, Copyright, Ninth Circuit Court of Appeals, Sotheby's, eBay

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The Art Law Report provides timely updates and commentary on legal issues in the museum and visual arts communities. It is authored by Nicholas M. O'Donnell, partner in our Art & Museum Law Practice.

The material on this site is for general information only and is not legal advice. No liability is accepted for any loss or damage which may result from reliance on it. Always consult a qualified lawyer about a specific legal problem.

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