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Auction house loses 'dual purpose' art litigation privilege case

An auction house has failed to establish litigation privilege over correspondence with experts about whether or not a painting it sold was counterfeit, in a case brought by the seller of that painting.07 Dec 2018

In the view of the High Court, the correspondence failed the 'dominant purpose' test, in that it was not created for the sole or dominant purpose of conducting litigation. The correspondence had instead been created for two purposes: deciding whether the contract for sale should be rescinded on the grounds that the painting was counterfeit, which was a commercial, rather than a litigation, purpose; and preparing for related litigation. Neither of these purposes could be said to be "dominant", according to the court.

Alan Sheeley of Pinsent Masons, the law firm behind Out-Law.com, said that the case was one of two to be handed down within days of each other in which the courts had taken a restrictive approach to litigation privilege.

"Many breathed a sigh of relief following the Court of Appeal's decision in SFO v ENRC, but these latest developments emphasise once again that businesses cannot afford to be complacent about litigation privilege applying," he said.

"It is common for communications to have more than one purpose but this presents particular risks. Determining whether two different purposes are of equal importance, so that privilege will not apply, or the litigation purpose is dominant or overarching, in which case privilege may apply, is highly fact-specific. The case also serves as an important reminder to businesses of all kinds that considering whether rights or remedies under a contract have been triggered is not necessarily a litigation purpose, even where litigation is likely to follow if the decision goes a particular way," he said.

"This, and other privilege cases, clearly demonstrate that advice should be taken from the outset of any review of this nature as to whether litigation at a later date is in reasonable prospect. Thought should be given to why documents are being created and this should be recorded contemporaneously in careful terms. If the dominant purpose is for use in anticipated litigation, this should be made absolutely clear," he said.

The seller, Mark Weiss Ltd, appointed auction house Sotheby's as its exclusive agent to sell by private treaty the painting that was the subject of the dispute. The painting was sold in June 2011, however the contract contained an offer by Sotheby's to rescind the sale and return the purchase price if the buyer, a Mr Hedreen, provided written evidence raising doubts about the painting's authenticity. Hedreen did so in May 2016, having obtained a report to that effect from an art expert, Mr Martin.

Sotheby's then appointed a second expert, Mr Twilley, who conducted a peer review of Martin's report and confirmed that the painting was a counterfeit. Sotheby's refunded Hedreen, then brought proceedings against the seller to recover the amount of the refund. During those proceedings, Sotheby's disclosed the existence of correspondence between itself and the two experts leading up to, and following, their reports. However, it claimed that litigation privilege allowed it to withhold those documents from the seller.

The test for whether litigation privilege can be claimed was confirmed by the House of Lords in 2004, in its decision in the Three Rivers case, 'Three Rivers (No. 6)'. It applies to confidential communications and documents that have been prepared for the dominant purpose of conducting adversarial litigation which is "in progress or in contemplation". A document which is privileged need not generally be shared with regulators, enforcement agencies or counterparties to litigation.

Mr Justice Teare, in his judgment, found that although there was "no doubt" that Sotheby's was contemplating litigation, "what was also contemplated was the need for Sotheby's, in the context of its agreement with the buyer, to determine whether the painting was counterfeit and, if so, to rescind the sale and return the purchase price".

"Both purposes were, it seems to me, of equal importance and relevance," he said. "At any rate Sotheby's is unable, in my judgment, to establish that the [litigation] purpose was the dominant of the two purposes."

Earlier this year, the Court of Appeal ruled that litigation privilege applied to internal documents generated by mining company ENRC in connection with a Serious Fraud Office (SFO) investigation into allegations of fraud, bribery and corruption. Sotheby's argued that this judgment had effectively changed the law so that documents brought into existence for two purposes, one of which was for use in litigation, could be protected by privilege. However, Mr Justice Teare rejected any suggestion that this case had changed the law.

"The assessment of dominant purpose is fact sensitive and so it is unsafe to use the determination of dominant purpose in one case to assist in identifying the dominant purpose in another," he said. "That is particularly so where the facts of the two cases are so very different, as they are here ... I do not read the ENRC case as deciding that whenever litigation is the 'inevitable' consequence of taking a particular commercial decision, the dominant purpose of documents produced for the making of that decision is necessarily their use in the contemplated litigation."

While the privilege aspects of the case meant it was of broader commercial significance, the case also "illustrates the challenges which counterfeits bring to the art market", according to art litigation expert Sinéad Esler of Pinsent Masons.

"The increasing sophistication of counterfeits can make identifying a fake extremely difficult, even for experts in the field who may be divided on whether or not an artwork is authentic," she said. "Further, it may take years before a counterfeit is discovered, during which time the artwork may have had several owners - all of whom, if they are not time-barred - may have a legal claim."

"Buyers are advised to exercise caution: if a deal looks too good to be true that might be because it is; and provenance should be requested, carefully scrutinised and confirmed. In this case, the buyer was protected by Sotheby's contractual offer to rescind the sale if it determined the painting was counterfeit, but other sellers may be less willing to offer this, especially if they would be out of time to bring their own claim."

"As a minimum, buyers should ensure that any significant transactions are made by written agreement clearly recording any representations about authenticity and provenance. Another consideration is whether the agreement should be in the form of a deed, as this may extend the time within which a claim can be brought. To ensure the best possible position and protection, both buyer and seller to any significant art transaction should obtain independent legal advice on the terms of that transaction," she said.