Audit Report on the Compliance of the Marriott Marquis with Its City Lease Agreement

On July 2, 1982, Times Square Hotel, Inc., a wholly-owned subsidiary of the Empire State Development Corporation (ESDC), and the Times Square Marquis Hotel, L.P. (the Marriott Marquis) entered a 75-year lease for the premises located at 1535 Broadway between 45th and 46th Streets in Manhattan. Simultaneously, ESDC, the Marriott Marquis, and the City entered a three-party agreement naming the City as the third-party beneficiary to this lease. These agreements provided for the Marriott Marquis to: purchase the land and immediately convey title to the State and the City; develop a first-class hotel on the land; and pay the City rent for each year of the 75-year lease term. A portion of this rental payment was payable within 120 days after the current lease year, and the balance was payable with 10 percent simple interest per annum upon the sale of the land to the Marriott Marquis or lease expiration, i.e., July 1, 2057. Since rental payments were based, in part, on revenue, the Marriott Marquis was required to annually submit to the City certified financial statements and “keep and maintain…full and accurate books of accounts and records” for at least six years. These agreements also allowed the Marriott Marquis an option to purchase the property for an amount equal to the fair market value of the land.

In 1998, the Marriott Marquis proposed and, upon the New York City Economic Development Corporation’s (EDC) recommendation, the City agreed to amend the lease rent, interest, purchase, term, and other provisions. The amended lease: provided for the Marriott Marquis to make a fixed payment and/or a payment based on its gross operating revenue for the period October 1, 1998, to December 31, 2007, and real estate tax-based payments thereafter; reduced the interest rate to 5.04 percent, compounded semi-annually; provided for a purchase price that is the greater of a formula-based price or fixed price of $19.9 million; and shortened the lease term by 40 years, i.e., to 2017.

As the third-party beneficiary of Marriott Marquis payments, the Department of Citywide Administrative Services (DCAS) was responsible for monitoring the Marriott Marquis to ensure that it complied with financial reporting, record-keeping, and other significant lease terms, and remitted all money due the City. For the lease years ending December 31, 2006, and 2007, the Marriott Marquis reported revenues of $309.5 and $343.4 million and paid the City $15.5 and $17.2 million, respectively. And for the lease years ending December 31, 2008, 2009, and 2010, the Marriott Marquis made real estate tax-based payments of $17.9, $21, and $20.4 million, respectively.

Audit Findings and Conclusions

The Marriott Marquis owes the City $3.6 million in interest. Under the terms of the amended lease, the Marriott Marquis was required to pay the City 5.04 percent interest, compounded semi-annually, on Accrued Unpaid Rent. On January 29, 1999, the Marriott Marquis made a lump-sum payment of $53.4 million to EDC composed of loan, rent, and Accrued Unpaid Rent payments. However, the Marriott Marquis did not remit to the City the associated Accrued Unpaid Rent interest of nearly $1.9 million. Consequently, the Marriott Marquis owes the City the outstanding $1.9 million of interest, which compounded semi-annually, totals $3.6 million.

Additionally, the Marriott Marquis failed to “keep and maintain…full and accurate books of accounts and records” to enable the City to confirm reported revenue and ensure that the City received all money due it. Two previous audits issued in 1990 and 1997 also cited the Marriott Marquis for failing to retain and produce critical records to substantiate reported revenues. For more than 20 years (1986 through 2007), the Marriott Marquis disregarded the records retention provision of its lease and thus rendered the City unable to verify the accuracy of the Marriott Marquis’ reported revenues and revenue-based payments for the entire lease term. This occurred, in part, because DCAS did not adequately monitor the Marriott Marquis to ensure compliance and accurate financial reporting.

Our review also found that EDC advised the City to execute a lease amendment that was not in the City’s best interests, in large part, because it provided for vastly reduced purchase, rent, and interest payments. When evaluating lease terms and advising the City on real estate matters, EDC should exercise due care and diligence to determine and document whether terms are fair, equitable, and in the City’s best interests. EDC should then adequately and clearly disclose to the City the advantages and disadvantages of proposed terms. However, based on available documentation, EDC did not perform appropriate quantitative analyses comparing purchase, rent, and interest revenue under the original and amended lease terms or adequately disclose to the City all relevant issues. Most notably, EDC did not disclose to the City that, at the time of the amendment, it would lose land sale revenue of $75 million as well as significant rent and interest revenue.

Audit Recommendations

To address these issues, we make seven recommendations—one to the Marriott Marquis, three to DCAS, and three to EDC.

The Marriott Marquis should immediately remit $3,643,468 to the City—the initial interest payment of $1,867,773 along with additional accumulated interest of $1,775,695 as of July 1, 2012.
With regard to the Marriott Marquis lease agreement, DCAS should ensure that the Marriott Marquis remits $3,643,468 to the City. And with regard to its lessees that pay revenue-based rents, DCAS should:

• Conduct routine audits or other reviews to ensure that lessees retain required financial records, accurately report revenues, and pay the City all money due it.
• Take appropriate enforcement action and follow up in a timely manner on lessees’ non-compliance.

When evaluating lease terms, EDC should:

• Exercise due care and diligence to determine and document whether lease terms are fair, equitable, and in the City’s best interests. This should include, but not be limited to, conducting and retaining comparative quantitative analyses of the financial-related terms.
• Document the advantages and disadvantages of proposed terms.
• Publicly disclose and discuss significant proposed lease amendments prior to approval and execution.

Auditee Responses

In their responses, the Marriott Marquis, DCAS, and EDC either did not agree with or did not acknowledge the report’s findings and recommendations.

With regard to the $3.6 million owed to the City, the Marriott Marquis and DCAS claim that the Marriott Marquis made its initial Accrued Unpaid Rent interest payment and, therefore, does not owe the City any money. However, the Marriott Marquis and DCAS offer inconsistent explanations as to how this payment was made. Moreover, the Marriott Marquis’ 1998 certified financial statements refute these varying explanations and evidence that the $3.6 million is, in fact, owed the City.

The Marriott Marquis and DCAS did not dispute that the Marriott Marquis failed to retain source records to support reported revenues upon which payments were based. Nor did they dispute the critical importance of such records. Nevertheless, DCAS refused to acknowledge or implement recommendations aimed at ensuring that DCAS lessees retain required financial records, accurately report revenues, and pay the City al money due it.

EDC did not acknowledge the report’s most significant finding, i.e., that EDC did not perform comparative analyses to determine and document whether Marriott Marquis’ amended lease terms were fair and equitable and, consequently, advised the City to enter an agreement that was not in its best interests. Instead, EDC trivialized it as a records-retention issue, maintaining that documents evidencing the deal’s benefits were 15 years old and thus “difficult for any organization to identify and locate.” Additionally, EDC claimed that the audit failed to take “into account anticipated community and economic development.” However, while such benefits are significant and were relevant to and factored into initial Marriott Marquis lease terms negotiated in 1982, they are not applicable to the amended terms negotiated in 1998. In 1998, when the Marriott Marquis proposed amending its lease, Times Square was a successfully redeveloped, burgeoning real-estate market.