Due Diligence: A Legal Concept

The concept of due diligence arises in different areas of the law related to art, as determined and shaped by domestic and international instruments, as well as case law.

Different legal instruments refer, directly or indirectly, to the concept of due diligence. In general, the emphasis is placed primarily on the notion of good faith, as is the case, for example, in Article 7(b)(ii) of the 1970 UNESCO Convention on the Means of Prohibiting and Preventing the Illicit Import, Export and Transfer of Ownership of Cultural Property (1970 UNESCO Convention). Diligence obligations can also be found in Article 4(1) of the 1995 UNIDROIT Convention on Stolen or Illegally Exported Cultural Objects (1995 UNIDROIT Convention), which imposes on the owner of an object the duty to establish that he or she has acted with due diligence—a reversal of the usual burden of proof regarding good faith. Article 4(4) of the 1995 UNIDROIT Convention also sets out the aspects of a transaction subject to the duty of diligence, namely the circumstances of the acquisition, the experience of the parties and the price paid. It also sets out some specific obligations, including the obligation to consult a register of stolen cultural objects and to review any other relevant and accessible information. The recent European Directive 2014/60/EU of 15 May 2014 on the Return of Cultural Objects Unlawfully Removed from the Territory of a Member State contains a provision similar to that of the 1995 UNIDROIT Convention.

In domestic law, there has been little codification of the concept of due diligence—the applicable national legislation referring primarily to the principle of good faith.^{Footnote 6} In Switzerland, professionals active in the art trade and auction business must comply with various duties of diligence when engaging in transactions concerning cultural property. These include verifying the seller’s identity, keeping and recording the transaction documents and granting access to the business premises to the relevant authorities.^{Footnote 7} In England and Wales, the notion of due diligence in the acquisition of cultural goods is not regulated by any specific law or regulation, but appears in the 2007 Money Laundering Regulations.^{Footnote 8} The Netherlands has, in contrast, made a specific effort to codify the concept of due diligence. The Dutch national law implementing the 1970 UNESCO Convention sets out in detail the circumstances of the acquisition to be taken into account and the steps that must be taken by the buyer, commercial dealer, and auctioneer in order to establish good faith.^{Footnote 9}

More generally, in a civil context—as understood under continental law and in contrast to administrative and criminal laws—due diligence is a key element for ascertaining ownership, authenticity, or provenance of an artwork or a cultural object. The concept is directly connected to the principle of good faith; the requirement to act diligently by verifying authenticity or origin may be a criterion or an indicator in establishing good faith. In most civil law countries, the acquisition of a good faith purchaser is protected (usually after a certain period of time), even if the object turns out to have been stolen.^{Footnote 10} In common law systems, title in stolen property cannot generally be transferred by virtue of the nemo dat quod non habet principle (literally meaning “no one gives what he doesn’t have”).^{Footnote 11} However, due diligence and good faith will play a role in determining the compensation due to a purchaser who is forced to return stolen property to its rightful owner.^{Footnote 12} Due diligence is also a benchmark to determine the existence of possible criminal activities, including money laundering, terrorism financing, document forgery, or concealment. Unfortunately, these activities are not unusual in the art world due to factors such as the existence of valuable cultural objects in areas dominated by armed conflicts, the relative ease with which high-value objects can be transported, customs officers’ lack of specific training and enforcement authorities’ lack of formal or material powers. The increasing commoditization of art for investment purposes but also as a “refuge value” implies additional due diligence obligations, as set in particular by financial and banking regulations among others, to ensure tax compliance (e.g. the 2012 Revised Recommendations of the Financial Action Task Force (FATF) expanded the scope of money laundering predicate offenses to include tax offenses).^{Footnote 13}

The concept of due diligence is further shaped by case law. The recent ACA Galleries, Inc. v Kinney decision before the New York Southern District Court constitutes an example of a court inquiring into the relevance and scope of due diligence obligations.^{Footnote 14} In that case, an art gallery sued an art dealer for selling a forged Milton Avery painting. The New York Southern District Court dismissed the fraud claims, holding that ACA could not “establish justifiable reliance [on the dealer’s misrepresentations] because it had the opportunity to fully investigate the authenticity of the painting but failed to do so.”^{Footnote 15} The court held that such reliance without fully investigating the authenticity of the object could not be deemed to be reasonable given that “ACA [was] in the business of buying and selling art [and must therefore have been] cognizant of forgery of the works of well-known artists like Avery.”^{Footnote 16} The court observed that, depending on the situation, diligence might mean seeking authentication through an artist’s foundation, calling upon additional experts, requesting detailed documents, or consulting lawyers.

In another recent decision, the Swiss Supreme Court held that a collector had not employed all necessary due diligence when buying a Malevich painting.^{Footnote 17} In that case, the collector had carried out a substantial amount of research before buying the painting in July 1989, including consulting an art expert in Russian avant-garde as to the authenticity and origin of the painting. Interpol and the Soviet Embassy were also contacted in connection with the purchase. It appears that the art expert warned the collector about a stolen painting of Malevich supposedly being on the market, albeit without identifying the relevant painting as the stolen work. The Swiss Supreme Court considered that the collector had not shown enough diligence in this case, and should have solicited the opinion of another expert in order to remove any doubt as to the origin of the work in light of the first expert’s warning that there was a stolen Malevich painting on the market. Holding that the purchaser had acted in bad faith, the Swiss Supreme Court should arguably have granted the applicant’s claim for recovery of property. However, the Court instead referred the case back to the lower court to determine whether the applicant had himself acquired the painting in good faith, on the basis that a purchaser in bad faith may refuse to return an object by establishing that the applicant had also acquired it in bad faith. This case importantly sets a more stringent threshold for the exercise of due diligence, requiring a buyer to obtain a second expert opinion and remove any doubt as to the origin of the object.

These cases illustrate a general trend towards a more stringent test to meet the due diligence threshold; actors of the art market may find it difficult to determine how far-reaching their enquiries must be in order to meet their due diligence obligations and for their purchases to be deemed to have been made in good faith.

Due diligence: An ethical concept

The concept of due diligence is further delineated in professional and ethical rules, as set forth in codes of conduct, codes of practice, or codes of ethics drafted by professionals in the art market.

By way of illustration, the ICOM Code of Ethics for Museums defines due diligence as follows in its glossary: “the requirement that every endeavour is made to establish the facts of a case before deciding a course of action, particularly in identifying the source and history of an item offered for acquisition or use before acquiring it.”^{Footnote 18} Article 2.3 of this Code adds that:

A number of other international codes of practice or ethics include due diligence obligations with varying degrees of detail such as the UNESCO International Code of Ethics for Dealers in Cultural Property, the Association of International Antiquities Dealers (AIAD) Code of Conduct, the Rules of the International Association of Dealers in Ancient Art (IADAA), the International Confederation of Art Dealers (Confédération Internationale des Négociants en Oeuvres d’Art, CINOA) Code of Ethics, or the International League of Antiquarian Booksellers (ILAB) Code of Ethics. These codes aim at developing a positive public image of—and maintaining public confidence in—both the art market in general and the professionals associated with it.^{Footnote 19} Violations of these codes can lead to various sanctions such as warnings, disciplinary actions or dismissal from a professional body. These ethical and professional notions of due diligence may also help courts shape the contours of the legal meaning of due diligence and offer some guidance to lawyers advising parties in the context of art transactions.

The FATF Recommendations

Legal professionals have been included in the 2012 FATF Recommendations to combat money laundering and terrorist financing.^{Footnote 32} Pursuant to Recommendations 22(d) and 23(a), legal professionals must, when they engage in certain financial activities described under Recommendation 22(d), undertake a thorough Customer Due Diligence (CDD) and complete a Suspicious Transaction Report (STR) if they suspect criminal activities.

It is noteworthy that the FATF has now expanded the scope of money laundering predicate offenses by including serious tax crimes. This will bring the proceeds of tax crimes within the scope of the powers used to investigate money laundering. The offense of smuggling has also been expanded to include offenses relating to customs and excise duties and taxes.^{Footnote 33} This is likely to have important implications for the due diligence to be exercised in relation to international art transactions. Indeed, complex offshore structures, once favored for their tax-mitigation or even tax-avoidance impact, will have to be reassessed in light of the new standards set by the FATF, thus requiring an extra duty of care on the part of all the advisors involved, including art lawyers.

Building on its 2012 Recommendations, the FATF issued, in June 2013, a “Report on the Vulnerabilities of Legal Professionals in the Context of Money Laundering and Terrorist Financing” which seeks to determine the degree to which legal professionals in general are likely to be involved in money laundering.^{Footnote 34} The report identifies a range of services provided by legal professionals that are attractive to criminals wanting to launder the proceeds of their criminal activity. Some of the services identified include the use of trust accounts held for clients, the purchase of real property, the creation of trusts and companies, the management of trusts and companies, the setting up and the management of charities and the purchasing of real estate. The report does not specifically mention art transactions. However, the FATF already acknowledged in its 1997–1998 Report on Money Laundering Typologies that “sellers of high-value objects like artworks are unquestionably a significant presence in laundering activities.”^{Footnote 35}

The 2013 report on legal activities concludes that criminals seek out the involvement of legal professionals in their money laundering or terrorist financing activities, sometimes because a legal professional is required to complete certain transactions, sometimes to access specialized legal and notarial skills and services that assist the laundering of the proceeds of crime or the funding of terrorism, and other times simply because the involvement of legal professionals adds perceived respectability to a transaction.

As illustrated by the Security Council Resolution 2199 of 12 February 2015, the trade in cultural goods can also be connected with terrorism financing as is the case with IS which is funding its horrendous activities through trafficking of Iraqi and Syrian cultural goods.^{Footnote 36} This trafficking has led the Security Council to condemn the destruction of cultural heritage in Iraq and Syria and to call on the Member States to take necessary measures to prevent the trade in cultural property illegally removed from Iraq since August 1990 and from Syria since March 2011.^{Footnote 37} The FATF Recommendations aiming to combat money laundering and terrorist financing are therefore directly relevant to the art market—and to art lawyers.

European and Domestic Law

Many jurisdictions have incorporated the FATF Recommendations into their national anti-money laundering legislation, or have created new pieces of legislation specifically to incorporate the Recommendations.

In response to the FATF Recommendations applicable to the legal profession and considering that money laundering increasingly involves non-financial professions, the European Union has extended the scope of anti-money laundering obligations to lawyers.^{Footnote 38} The third European Union Anti-Money Laundering Directive provides that lawyers have to report their suspicions of money laundering activities to the relevant national authorities without disclosing to their clients that such a step was undertaken.^{Footnote 39}

The duty to report suspicious activities under the third Money Laundering Directive does not concern all of a lawyer’s activities. In particular, Article 23(2) of the Directive states that it does not apply:

In France, a national authority named TRACFIN (Traitement du Renseignement et Action Contre les Circuits Financiers Clandestins) was created in 2006, and the French Monetary and Financial Code was amended to provide an obligation for lawyers to prepare suspicion reports where they suspect or have good reasons to suspect that money laundering is involved in transactions. Such reports must include the reported client’s occupation, identity and professional details, along with the beneficial owner of the object at the heart of the transaction. They must also include a description of the relevant transaction, its main steps, and the reasons justifying the decision to report it. Suspicion reports are in principle confidential. As compared to the stricter terms of the European Union’s Third Anti-Money Laundering Directive, French lawyers need not submit their suspicion reports directly to TRACFIN, but may first submit it to the president of the Bar to which they belong. This derogation is based on the principle of lawyers’ professional secrecy provided by French law as well as professional and ethical rules and standards. The European Court of Human Rights (ECHR) upheld this approach, holding that, as far as professional secrecy is concerned, it is appropriate for a lawyer to submit his or her suspicion report to the president of his or her Bar, who, also being a lawyer elected by his or her peers, is subject to professional secrecy.^{Footnote 40} Neither the reporting lawyer, nor the president of the Bar may inform the client that its transaction has been reported to TRACFIN.

German law adopts a similar approach to that taken by French law. Pursuant to the German Money Laundering Act, lawyers again have an obligation to report any suspicious activity where they know, suspect, or have reasonable grounds to suspect that money laundering or terrorist financing is being or has been either committed or attempted.^{Footnote 41} However, Article 12 of the German Money Laundering Act specifies that said obligation to report does not apply to professionals (including lawyers):

In the same vein, Swiss law distinguishes between the typical activities of giving legal advice and representing clients before courts and atypical activities of lawyers such as acting as financial intermediaries for clients or acting as the client’s business partner. While there is no duty to report for lawyers practising a typical activity, lawyers acting as financial intermediaries are subject to the Federal Act on Combatting Money Laundering. Accordingly, in cases where a lawyer acting as a financial intermediary knows or has a reasonable suspicion that the assets involved in the business transaction are linked to money laundering or the financing of terrorism, he must report the same without delay to the Money Laundering Report Office Switzerland (MROS).^{Footnote 42} A lawyer coming across a transaction involving Mesopotamian antiquities presumably originating from Syria or from Iraq without accurate information as to their origin may be confronted with the difficult question on whether to report the transaction and its actors to the relevant authorities.

In the United States, under ABA Model Rules 1.6 and 3.3, if a lawyer takes cognisance of a misrepresented material issue by a client in a civil case’s deposition, the lawyer has to advise the client to correct the testimony. In the event that the client refuses to do so, the lawyer must disclose the false statement to the court, all the while minimizing the disclosure of confidential information. The lawyer is also required to withdraw any false evidence, even if such disclosure to a court would reveal confidential information. However, the attorney should use other, less harmful, measures to the extent that they are available to rectify the falsehood.^{Footnote 43}