Audit Report on the Compliance of South Street Seaport Associates with Its City Lease Agreements

As the City’s primary agent for economic development, 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. As part of its management responsibilities, EDC leases space to and collects rent from tenants occupying its industrial, commercial, and market spaces. These market spaces include the historic South Street Seaport located in lower Manhattan along the East River.

The City (as successor-in-interest to the South Street Seaport Corporation) and South Street Seaport Associates (Seaport Associates), a limited partnership, are parties to two leases for spaces within the South Street Seaport. Under the terms of these agreements and subsequent amendments, Seaport Associates was to: develop, maintain, and operate designated spaces within the Seaport Historic District as first-class business offices; maintain specified types and amounts of insurance coverage; and pay taxes and utilities charges. In exchange for the use of these spaces, Seaport Associates agreed to pay the City a Base Rent that is the greater of: a Minimum Base Rent which is based on Gross Leasable Area square footage or an Alternative Base Rent of 20 percent of Gross Income. Accordingly, Seaport Associates was required to: submit to the City certified quarterly and annual statements setting forth all rents and other income received; keep complete and accurate books of account and records to enable the City to confirm reported Gross Income; and retain such books and records for at least six years and make them available for inspection and audit.

For the year ending June 30, 2011, Seaport Associates reported income of $991,131 for which it paid Alternative Base Rent of $198,226.

Audit Findings and Conclusions

Seaport Associates improperly calculated rent payments and did not report all Subtenant rental income or other income and, therefore, owes the City at least $1,294,836— $787,664 for unpaid rent and $507,172 for accrued interest. As noted, Seaport Associates was required to pay the City the greater of a Minimum Base Rent, which is based on Gross Leasable Area square footage, or an Alternative Base Rent of 20 percent of Gross Income. However,  Seaport Associates improperly calculated Alternative Base Rent as 20 percent of net income, i.e., Gross Income after deduction therefrom of all Operating Expenses, which include maintenance, operations, or Imposition expenses that were not reimbursed by Subtenants, and legal, accounting, and management expenses. Seaport Associates also did not report all Subtenant rental income or other income of at least $24,490.

These issues occurred, in part, because EDC did not adequately monitor Seaport Associates to ensure its compliance with lease terms. As the agency responsible for administering the leases, EDC should have ensured that Seaport Associates complied with significant lease terms. EDC also improperly adjusted Seaport Associates’ interest and rent charges totaling $27,032.

Finally, an EDC Board Member, who is a former Seaport Associates principal and lease signatory, utilized Seaport Associates’ office space rent-free in violation of EDC’s conflict of interest code. Further, the EDC Board Member did not disclose his relationship with Seaport Associates or his use of office space on his certified 2010 and 2011 Disclosure Statements.

Audit Recommendations

To address these issues, we make 14 recommendations—three to Seaport Associates and 11 to EDC—including that Seaport Associates should: 

• Immediately remit to EDC unpaid rent and interest charges totaling $1,294,836 related to Subtenant rental income;
• Immediately pay EDC reinstated interest and rent charges totaling $27,032; and
• Report all Subtenant rental income or other income from all Tenant or Affiliate of Tenant businesses and/or transactions conducted in, on, or from the City Lease Premises and pay additional rent and unpaid interest due the City.

With regard to Seaport Associates, EDC should:

• Send written notice to Seaport Associates advising it that unpaid rent and interest charges totaling $1,294,836 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 leases;
• Identify all Tenant or Affiliate of Tenant businesses and/or transactions conducted in, on, or from the City Lease Premises; quantify any and all revenues received by Tenant or any Affiliate from such businesses and/or transactions net of related direct costs and expenses payable; and calculate additional rent and unpaid interest due the City;
• Reinstate interest and rent charges totaling $27,032; and
• Send written notice to Seaport Associates advising it that interest and rent charges totaling $27,032 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 leases.

With regard to its Board Member, EDC should:

• Immediately direct its Board Member to cease using space in EDC-leased premises regardless of whether the Board Member pays rent in consideration for such space;
• Direct its Board Member to make all facts known to EDC’s General Counsel regarding his relationship with Seaport Associates; and
• Direct its Board Member to detail any and all activities that would be considered in violation of the Code of Ethics for Directors of EDC on his certified Disclosure Statement for Directors.

Auditee Responses

In its formal response, Seaport Associates rejected the report’s findings and thus, its recommendations, in their entirety on the basis that they are politically motivated and the result of “[p]olitical infighting between the Comptroller’s Office and EDC.” However, EDC substantially agrees with the Comptroller’s Office on the report’s findings and recommendations.

Seaport Associate’s response offers no facts to refute the findings. If they wish to support their position they need to provide supporting documentation that shows that the findings are incorrect not unsupported conjecture that deflects attention away from the serious issues raised over their compliance with their lease with the City.   

With regard to specific report findings, Seaport Associates disagreed that it improperly calculated rent payments and did not report all Subtenant rental income or other income and therefore owes the City at least $1.3 million, stating:

“The Draft Audit Report, including the recommendations and conclusions set forth therein, cannot be reconciled with the plain language of the Lease Agreements or the parties’ long-standing prior course of dealing. The Draft Audit Report also is entirely inconsistent with the estoppel certificates that the City executed in 2010 and 2011, in which the City expressly represented without qualification that Seaport Associates had satisfied all of its rent obligations. The Draft Audit Report is also premised on an interpretation of the Lease Agreements that is contrary to the long standing shared-understanding reached between Seaport Associates and the EDC, the City’s designated agent under the Lease Agreements. Finally, the City has no legal claim to any unpaid rent from 2005 because the relevant statute of limitations has expired.”

Additionally, with regard to unreported Subtenant rental income or other income derived from Seaport Associates and related entities that conducted their businesses, in whole or in part, from the lease premises, Seaport Associates maintained that other income is limited to “revenue derived…by reason of Seaport Associates being a tenant in the South Street Seaport Historic District.” Further, Seaport Associates asserted that other income is limited to such revenues generated by “Seaport Associates’ then-existing corporate affiliates” as of “[w]hen parties entered into the Lease Agreements in the 1980’s.”

Seaport Associates has disregarded the unambiguous language of the leases, which stipulate that Alternative Base Rent “shall mean twenty percent (20%) of all Gross Income” and that Gross Income shall include “any and all revenues received by Tenant or any Affiliate.” (Emphasis added.) Instead, Seaport Associates offers an “interpretation” of the leases that reduces Gross Income by both providing for broad deductions rather than limited exclusions and limiting the types and sources of revenue to be included in other income, and thereby, reduces payments to the City. 

Further, Seaport Associates’ alternative arguments are without merit because: Seaport Associates did not provide us purported evidence that EDC accepted and adopted its alternative methodology for rent payment calculations; the City appropriately qualified its estoppels and, therefore, did not waive its right to contest payments due it; and Seaport Associates’ breaches related to improper calculation and underpayment of Alternative Base Rent all occurred on or after May 3, 2007, and are within the Statute of Limitations.

In their response, EDC officials substantially agreed with all of the report’s findings and recommendations and detailed steps they took or will take to implement the recommendations.