April 14 (Bloomberg) -- Patrician fourth-generation jeweler Ralph O. Esmerian, on the hook for $200 million, is battling Merrill Lynch & Co. to stop what Christie's International calls the most important antique jewelry auction in history.

The New York sale, scheduled for tomorrow night, features a $15 million pink diamond ring and a $6 million diamond-encrusted brooch once owned by the wife of Napoleon III. The jewelry is part of the collateral Esmerian pledged to Merrill for a $178 million loan. He used $100 million to buy glitzy gem retailer Fred Leighton in 2006. Merrill declared the loan in default.

While Christie's didn't identify the seller, Esmerian, 68, said players in his world know that the jewels are his.

``People approach me as if they're going to a funeral,'' Esmerian said in an interview in his Rockefeller Center office, seated at a cluttered desk beside two safes the size of Sub-Zero refrigerators.

Esmerian objects to liquidating his family's heirlooms at an auction that he likens to a fire sale. New York State Judge Helen Freedman denied Esmerian's motions to stop what he called the ``commercially reckless'' auction. He appealed in an emergency motion earlier this month and a decision is expected today. Esmerian said in the interview that the 115-lot collection, estimated to sell for up to $34 million, would fetch more in private sales.

Relinquished Painting

``You need to do it gradually; you need to package it properly,'' he said. ``An auction is just a huge spread the whole world can feed on.''

Said Merrill spokesman Bill Halldin: ``The court conducted a full hearing and said the auction could go forward and is reasonable.''

Merrill is a passive, minority investor in Bloomberg LP, the parent of Bloomberg News.

Esmerian's financial pickle threatens to roil the markets for luxury jewelry and American folk art. Even New York's American Folk Art Museum, an institution Esmerian championed for three decades, was forced to relinquish a prized painting because of his woes.

``Everything about Ralph has always been first class,'' said folk art dealer Marguerite Riordan, who calls Esmerian's forced liquidation ``shocking.''

Some 20 lots of a Christie's jewelry auction scheduled for April 16 are collateral that Esmerian pledged to the auction house. Christie's is suing him to recover $7.8 million, the balance of what had been its $25 million loan. The auction includes a pair of cabochon emerald earrings, almost 18 carats each, estimated to fetch up to $800,000. Christie's declined to comment.

Promised Gift

Separately, on May 22, Sotheby's will offer a painting of about 1846 from Edward Hicks's famous ``Peaceable Kingdom'' series, plucked from the wall of the Folk Art Museum. A star of its collection since 2000, featuring a languid leopard and sheep, the Hicks is projected to sell for up to $8 million. (It failed to sell privately for $10 million, also through Sotheby's.)

The painting is one of approximately 400 American folk art works that Esmerian promised to give to the museum in 2000. The museum celebrated the gift by publishing a lavish 571-page catalog and mounting a major exhibit of the works. Esmerian said that while about 200 of the artworks were outright gifts, in an unusual arrangement, he pledged the other 200 in 2005 as collateral for an $11 million Sotheby's loan.

The son of a renowned stone cutter and antique jewelry merchant who left Paris in 1940, Esmerian grew up in a Fifth Avenue apartment below actress Grace Kelly. He attended Groton, an elite Massachusetts boarding school that, like the Folk Art Museum, is a beneficiary of his estate.

Murray's New Name

Building on the reputation of his father, Raphael Esmerian, Ralph Esmerian became known for selling colored gemstones and rare vintage brooches and necklaces by Cartier and Tiffany & Co. He stocks the shelves at retailers around the country, including Neiman Marcus and Van Cleef & Arpels. Pieces from his collection appear in museums and coffee table books.

In 2004, a Merrill financial adviser met an associate of Esmerian, which eventually led to discussions about Merrill financing the purchase of Fred Leighton, according to a confidential chronology disclosed in court papers. Leighton was founded by Murray Mondschein, who began his career selling Mexican wedding dresses in Manhattan's Greenwich Village. Mondschein bought the trade name ``Fred Leighton'' and eventually changed his own name to Fred Leighton.

Ripe for IPO

Leighton's branches on Madison Avenue and in the Las Vegas Bellagio hotel are famous for selling to the gilded set. Customers include Ronald Perelman, who bought in bulk for former wife Ellen Barkin.

In a 2005 confidential PowerPoint presentation made public, Merrill projected it would earn $22.3 million in fees over three years from arranging the Esmerian loan.

``No other firms are competing against Merrill Lynch in this transaction,'' the presentation said. ``This will allow for more aggressive pricing.''

A Merrill memo made public concluded Leighton ``can withstand an economic downturn, as we view their business model as non-cyclical.''

Esmerian said Merrill bankers told him that after expanding, Fred Leighton would be ripe for a public offering. But once the deal was consummated, Esmerian said he struggled to find a site for its third store, in Beverly Hills. The global credit crunch hurt business, as did Merrill-imposed restrictions preventing Esmerian from sending jewelry abroad, he said.

Subprime Woes

Esmerian said he paid interest promptly for 16 months. But Merrill Lynch Mortgage Capital, which arranged the loan, wouldn't grant his request in September 2007 for an extension on a payment. Esmerian blames Merrill's ``improvident investment in over $20 billion of subprime loan portfolios,'' he said in court papers.

Moreover, his hiring of Peter Bacanovic as chief executive officer of Fred Leighton was a sore point at Merrill. Bacanovic, a former Merrill broker, was sentenced to five months in prison for his role in the 2001 Martha Stewart scandal.

```He's a felon, we won't allow this,''' Esmerian said he was told by Merrill bankers.

``He paid his time,'' Esmerian said, adding he hired Bacanovic in part because he's a tireless networker.

Merrill spokesman Halldin declined to comment about Bacanovic. Halldin said Merrill's subprime losses were unrelated to the dispute, which Merrill was unable to resolve out of court.

``As a result, we initiated this action to enforce the terms of the loan agreements,'' he said.

Working on Faith

Mondschein, aka Fred Leighton, has sued Esmerian to recover money for consulting work and other funds he said he's owned. Esmerian countersued, alleging Mondschein's ``business records were rife with inaccuracies,'' according to court papers. Mondschein wasn't available for comment.

The museum world is still buzzing about Esmerian's decision to pledge promised folk art to Sotheby's. The arrangement was ``very unusual, borderline unethical, in my opinion,'' New York trust and estate lawyer Herbert Nass said. ``It really undermines what you have promised.''

Both Sotheby's and the Folk Art Museum signed off on using the promised gift as collateral.

``A promised gift is just that, a promise,'' said Maria Ann Conelli, the director of the museum. ``We work on faith.''

Esmerian, the chairman emeritus of the museum, said: ``I don't have stocks or bonds I can put up as collateral. And when you give away $50 million or $60 million of folk art -- I could've sold that and not had to borrow anything.''

To contact the writers of this story: Philip Boroff in New York at pboroff@bloomberg.net; Lindsay Pollock at lindsaypollock@yahoo.com.

Last Updated: April 14, 2008 00:01 EDT