The estate of Mark Rothko and the no further inquiry rule

The self-dealing rule prevents trustees and executors from “dealing” with trust or estate property; including purchasing property from the trust or estate. The self-dealing rule embodies the executor’s duty to administer the estate without profiting or abusing their position.

At its simplest, the self-dealing rule provides that the purchaser of a property cannot also be the person, or one of the people, who has the power to set the sale price. Equity intervenes to support the beneficiaries, for example, by orders for delivery of the purported conveyance and accounting.

Under the “self-dealing rule” the sale by the trustee of the trust property to themselves is voidable by any beneficiary ex debito justitiae, however honest and fair the transaction and

“even if [the sale] is at a price higher than that which could be obtained on the open market”

If executors dealt with estate property it could conflict with their duty to act in the best interest of the estate overall.

In some jurisdictions, the “no further inquiry” rule, prohibits a trustee from profiting from transactions with the trust without advance approval from a court or trust beneficiaries. The rule also imposes harsh consequences for unauthorised trustee self-dealing.

In the Matter of the Estate of Mark Rothko, Deceased the no further inquiry rule enabled the estate to rescind transactions resulting from the fiduciary’s self-dealing, regardless of whether the transaction was fair or reasonable.

Background

Mark Rothko was a member of The Irascible Eighteen, a group of abstract painters considered the ‘first generation of abstract expressionists’ who died on February 25, 1970, leaving an estate consisting of nearly 800 of his paintings.

Rothko’s will was admitted to probate on April 27, 1970, his named executors were Bernard J. Reis, Theodoros Stamos, and Morton Levine (the executors) (defendants). Rothko’s wife Mary Alice died of a stroke six months after her husband.

In 1956 Rothko entered a contract with the Marlborough Gallery (”the gallery”) where in exchange for a monthly fee the gallery would sell Rothko’s paintings. Although prolific throughout the 1960s, Rothko continued to believe that his work was not selling for high prices on the art market.

The gallery’s owner Frances Kenneth Lloyd under-reported the sale price of Rothko’s paintings by taking payments through Swiss and Liechtensteiner bank accounts. In February 1969 Rothko renewed his contract with the gallery agreeing

“not to sell any works of art for a period of eight years, except to Marlborough A.G. if a supplementary contract is made.”

re Will of Rothko, 351 N.Y.S.2d 940, 43 A.D.2d 819 (1974)

In 1968 Rothko and his financial advisor, Bernard Reis, created a the Rothko Foundation intended to fund “research and education”.

On September 16, 1968, Rothko executed a two-page will, drafted by Reis leaving the residual estate to the foundation and naming Reis, Theodore Stamos and Morton Levine, as executors. Rothko’s two children were not included in the will.

Believing that his works would fetch higher prices following his death Rothko gave his children Kate and Christopher, key paintings he owned to provide them with financial security. However, after Rothko died, the gallery informed his children that under the terms of the agreement made in 1956 and renewed in 1969, the gallery owned all of Rothko’s paintings.

Following Rothko’s death, the executors agreed to sell 100 works to the gallery for a total of $1,800,000 – which was less than a quarter of their fair market value – however, only $200,000 was paid upfront to the estate with the balance to be paid with no interest over 12 years.

A second contract consigned approximately 700 paintings to the gallery with a commission of 40 to 50 per cent for each painting. The paintings were estimated to be worth at least $32m.

The Case

In 1971, Rothko’s children filed a lawsuit against the executors of his estate, and the gallery over the sales claiming that the former had conspired with the latter to ‘waste the assets’ of Rothko’s estate and defraud them of their proper share. They contended that the three trustees had conspired to sell the paintings to the gallery at less than their true market value.

Importantly Reis had become a director of the gallery in August 1970 and Stamos a fellow member of the irascible eighteen was represented by the gallery from 1971.

Kate was joined by the guardian of her brother, Christopher (plaintiff), and the state attorney general (plaintiff), representing a foundation that benefited from the will.

The Court found that Reis and Stamos breached their fiduciary duties by entering the contracts with conflicts of interest. Additionally, Levine breached his fiduciary duties as he was aware Reis and Stamos conflicts of interest but did not act in the interests of the estate.

Additionally, the court found the executors had a conflict of interest; Reis and Stamos could not negotiate with the gallery as they were both on its payroll. Similarly, Levine was aware of the transactions. They were removed for

‘improvidence and waste verging on gross negligence’

re Will of Rothko, 351 N.Y.S.2d 940, 43 A.D.2d 819 (1974).

All contracts between the gallery and the Rothko estate were declared void, and the judge awarded damages of more than $9m against Frank Lloyd, the founder of the gallery who had laundered art through International holding companies, and the executors.

In the year after Rothko’s death, the value of his work more than doubled while early works were selling at auction for over $80,000.

On appeal, the executors, and the gallery objected to the damages and the court’s use of the no-further-inquiry rule, which allows the rescission of a self-dealing transaction regardless of the transaction’s fairness.

However the Court held that the damages were not punitive in a true sense, rather they are intended to make the estate whole.

Although the executors, were authorised to sell, they

did not merely err in the amount they accepted but sold to [a party] with whom Reis and Stamos had a self-interest…since the paintings cannot be returned, the estate is therefore entitled to their value at the time of the decree, i.e., appreciation damages.

Matter of Rothko, 43 NY 2d 305 – NY: Court of Appeals 1977

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: