Beverly Hills art gallery apparently doesn’t appreciate benefits of purchase-money escrow, loses $2 million that get applied to reduce supplier’s debt to subcontractor

From the 20-20 Hindsight Department:  When you spend big bucks on a tangible asset, you might want to insist on withholding payment until the asset is delivered to you, or at least to insist on paying the money into escrow for release upon delivery. A Beverly Hills art gallery probably wishes it had re­mem­bered this rule of thumb in Pre-War Art, Inc. v. Stanford Coins and Bullion, Inc.

Here’s a simplified account of what happened in that case:

• The art gallery planned to display a work of art that was to fea­ture a tower of identical gold bars.
• The art gallery ordered 101 gold bars from Stanford Coins and Bullion (“SCB”).  You might recognize the name, for reasons that will become apparent.
• The art gallery wired approximately $3 million to SCB, paying the entire purchase price in advance. SCB then contacted a wholesale supplier of coins and bullion, with which SCB had an ongoing business relationship and placed an order for the art gallery’s gold bars; arranging for the bullion dealer to drop-ship the gold bars directly to the art gallery. SCB wired the art gallery’s $3 million to the bullion dealer, less SCB’s commission.
• SCB, though, owed the bullion dealer money from transactions on­behalf of other SCB clients. So, the bullion dealer took around $2 million of the money that SCB had sent it and used it to pay down SCB’s past-due balance.
• Then things fell apart:  Before the scheduled delivery date for the gold bars: SCB’s owner, R. Allen Stanford, was arrested and charged with massive financial fraud — and a federal court placed SCB, among other Stanford-owned businesses, into receivership. (Mr. Stanford is now serving a 110-year sentence in federal prison for perpetrating a Ponzi scheme.)
• The art gallery contacted the bullion dealer, asking about delivery of the gold bars that the art gallery had ordered and paid SCB for. The bullion dealer responded that, because it had applied SCB’s payment (of the art gallery’s money) to SCB’s previous debt, the bullion dealer would not ship the gold bars to the art gallery until it received an additional $2 million.
• The art gallery sued the bullion dealer for breach of contract; it claimed that it was a third-party beneficiary to the subcontract between SCB and the bullion dealer. The jury, though, returned a verdict in the bullion dealer’s favor.

The appeals court affirmed judgment in favor of the bullion dealer, on grounds that under Texas law:

• third-party beneficiary status can arise only when the main con­tract­ing parties intend to confer a direct benefit, not merely an incidental benefit, on the third party;
• such an intent to confer a direct benefit upon a third party must be “clearly and fully spelled out” in the main contract, failing which the third party may not enforce its alleged benefit.

Pre-War Art, Inc. v. Stanford Coins and Bullion, Inc., No. 15-10033 (5th Cir. Feb. 29, 2016) (per curiam; affirming judgment entered on jury verdict in favor of the bullion dealer) (unpublished).

The art gallery presumably still has its claim against SCB’s receiver. In view of all the other Ponzi-scheme claims against Stanford, though, the art gallery probably has a greater chance of getting its gold by having a solid-gold meteorite land in its parking lot — which is almost certainly why the art gallery sued the bullion dealer in the first place.

(Some of Stanford’s trade creditors are actually having to refund money to the receiver.)

Lessons learned: We can note — with the benefit of 20-20 hindsight — that the art gallery could have tried to protect itself by doing one or more of the following:

1. A clunky move would have been for the art gallery to try to require SCB to state, in its sub­contract with the bullion dealer, that the art gallery was a third-party beneficiary of the sub­contract. That wouldn’t have been a great solution, though, because if SCB had breached that obligation, then the art gallery would have had the same, unsecured, breach-of-contract claim against SCB and its receiver as it did in the actual case.
2. Another clunky move might have been for the art gallery to try to contractually require SCB to obtain the art gallery’s approval of any subcontractor that SCB would use — but that would have been subject to the same objections mentioned above, plus it might raise its own issues;
3. Most easily (and most obviously): The art gallery could have insisted on paying the majority of its money to a neutral escrow agent, so that the escrow agent would hold the money and pay it to the bullion dealer, only upon delivery of the gold bars to the art gallery. (This is an-almost universal practice in American resi­dent­ial real-estate sales.)

Hat tip: Thanks to my contract-drafting student Ian Ashe for bringing this case to my attention.