Audit Report Of The Howard Hughes Corporation’s Compliance With Its City Leases For The South Street Seaport Marketplace And Theatre

Audit Report In Brief

The New York City Economic Development Corporation (EDC) is responsible for the management of select industrial and commercial spaces throughout the five boroughs as well as several retail and wholesale food markets. Part of EDC’s management responsibilities include leasing space to and collecting rent from tenants occupying the historic South Street Seaport Marketplace (the Seaport Marketplace) and Theatre located in lower Manhattan along the East River.

The City and the Howard Hughes Corporation (HHC) are parties to a December 15, 1981, lease, as amended and supplemented, for designated spaces within the South Street Seaport (the Marketplace Lease), and a July 27, 1983, lease for the Seaport Theatre located at 133 Beekman Street (the Theatre Lease). Under the terms of these leases, HHC is required to maintain and operate: the Marketplace premises as a first-class, specialty retail marketplace and the Theatre premises as either: a theater, a venue for other customary theater activities, or a first-class, specialty retail marketplace. In exchange for the use of the Marketplace and Theatre premises, HHC agreed to pay the City Marketplace and Theatre base rents that are the greater of: a Minimum Base Rent that is generally equal to the product of $3.50 and Gross Leasable Area square footage or an Alternative Base Rent of 15 percent of Gross Receipts exclusive of certain operating and administrative expenses and offset by a portion of its real estate obligation. HHC also agreed to pay supplemental rents if certain financial conditions were met.

For the year ending June 30, 2011, HHC reported:

• Marketplace Gross Receipts of $7.5 million for which HHC paid Minimum Base Rent of $1.3 million and no Supplemental Rent, and
• Theatre Gross Receipts of $2,000 for which HHC paid Retail Minimum Base Rent of $22,866 and no Retail Supplemental Rent.

Audit Findings and Conclusions

HHC improperly calculated Marketplace Minimum Base Rent and Theatre Retail Minimum Base Rent because it understated square footage upon which rents were based. We could not determine the total Marketplace Lease and Theatre Lease premises square footage and thus total minimum base rents due the City because EDC did not commission an independent certified engineering survey of the premises. However, based on an HHC survey, HHC may owe the City as much as $1,222,751 for unpaid rents, plus accrued interest, for the period January 1, 2007, through December 31, 2012.

HHC also improperly calculated its Marketplace Alternative Base Rent due the City and, therefore, may owe the City additional rent. Specifically, when calculating Marketplace Alternative Base Rent for the period January 1, 2011, through June 30, 2011, HHC did not generate or report income, improperly calculated imputed reimbursement rates because it overstated expenses and understated square footage, deducted from Gross Receipts direct reimbursements that were not supported by Subleases and Subtenant invoices, and deducted duplicative explicit and imputed reimbursements.

Additionally, for the year-ending June 30, 2011, HHC reported Theatre income of only $2,000, and consequently, the City did not realize any Theatre Retail Alternative Base Rent or Retail Supplemental Rent.  Since 2001, HHC allowed certain groups to use the Theatre generally rent free.  While this may have been civic-minded, HHC was supposed to generate income from this property—not donate it.

Finally, HHC inappropriately conducted business in the name of the South Street Seaport Merchants Association, Inc. (the Merchants Association) because the Merchants Association was solely represented and managed by the landlord—and not largely by the merchants as intended. Therefore, the Merchants Association is a defunct organization and HHC should not have assessed dues, conducted business, and filed tax returns in its name.

Our review also determined that EDC did not adequately monitor HHC to ensure its compliance with lease terms. As the agency with oversight responsibility over the lease, EDC should have ensured that HHC complied with financial reporting and rental terms. Additionally, we noted that the City and EDC entered an agreement that proved not to be in the City’s best interests because it provided HHC more favorable rent terms.

Lastly, the City did not ensure that a wholesale fish market operated in the South Street Seaport and thus, did not preserve the historic and cultural importance of the historic district in fulfillment of the South Street Seaport Project.

Audit Recommendations

To address these issues, we make 19 recommendations—9 to HHC and 10 to EDC—including that HHC should:

• Upon notification, remit to the City EDC-assessed Marketplace Minimum Base Rent and Theatre Retail Minimum Base Rent and accrued interest resulting from understated square footage for the period January 1, 2007, through December 31, 2012.
• Sublease Marketplace Lease and Theatre Lease spaces at market rate.
• When calculating imputed reimbursement rates, calculate Landlord’s Qualifying Floor Area square footage based on an EDC-commissioned independent certified engineering survey of the Marketplace Lease premises.
• Deduct either explicit reimbursements or imputed reimbursements.
• Immediately operate the Merchants Association in accordance with its Articles of Incorporation and By-Laws or dissolve it.

With regard to HHC, EDC should:

• Immediately commission an independent certified engineering survey to determine and document the Gross Leasable Area square footage, total square footage, and Landlord’s Qualifying Floor Area square footage of designated spaces within the Marketplace Lease and Theatre Lease Premises.
• Calculate Marketplace Minimum Base Rent and Theatre Retail Minimum Base Rent and accrued interest owed the City resulting from understated square footage for the period January 1, 2007, through December 31, 2012.
• Send written notice to HHC advising it that unpaid Marketplace Minimum Base Rent and Theatre Retail Minimum Base Rent and accrued interest charges are to be paid in full immediately and that a failure to pay these charges in full within 15 days of written notice constitutes an Event of Default under Article 24 of the lease.
• Routinely review quarterly and annual reports submitted by HHC to ensure the accuracy of the calculation of Alternative Base Rent.
• Ensure that HHC’s redevelopment plan provides that the Fish Market Premises be continually used for wholesale fish market purposes and work with HHC to find a year-round wholesale fish market operator.

Auditee Responses

In their response, HHC officials generally disputed the report’s findings and maintained they report revenues and expenses, and calculate rents due the City in accordance with the terms of its leases as amended and supplemented. Most notably, based on a recent survey and a review of the lease terms, HHC officials asserted that HHC “remitted all rents due to the City as of December 31, 2012 and may be due a refund for minimum base rent overpayments of approximately $74,198 since its emergence from bankruptcy in November 2010.” However, the survey proffered by HHC does not cover a significant portion of the Marketplace Lease premises, i.e., Pier 17 and the Fish Market Stalls. More importantly, this survey is not reliable because it is not consistent with an earlier survey performed by the same firm.

HHC officials also maintained that a Stipulation and Agreed Order dated October 21, 2010, settled “all claims and obligations through October, 21, 2010.” However, it appears that this Stipulation and Agreed Order settled only certain specified issues regarding Marketplace ABR, i.e., the methodology for calculating the Telco Credit and Gross Receipts. Additionally, the Stipulation and Agreed Order appears to have been limited to the period 2002 to 2008 and does not appear to settle or waive any claims that may arise after that period.

Lastly, HHC officials argued that HHC is not obligated to pay minimum base rents resulting from understated square footage until it became aware of such understatements in 2013. However, HHC provided no evidentiary or other support for its position.

In their response, EDC officials agreed in principle with most of the report’s findings and recommendations related to HHC and EDC lessees that pay income-based rent and detailed steps they took or will take to implement the recommendations. EDC did not agree to pursue collection of rents for the period January 1, 2007, through October 21, 2010, on the basis that the Stipulation and Agreed Order dated October 21, 2010, settled “[a]ll outstanding issues concerning rent payments.” However, as noted, it appears that this Stipulation and Agreed Order settled only certain specified issues regarding Marketplace ABR, i.e., the methodology for calculating the Telco Credit and Gross Receipts and for the period of 2002 to 2008.

EDC also disagreed with two recommendations regarding HHC’s leasing practices and ensuring that HHC’s redevelopment plan provides for a wholesale fish market.