oversight

Deconstruction Activity Costs under the World Trade Center Memorial and Cultural Program are Impacting Other Approved Programs

Published by the Department of Housing and Urban Development, Office of Inspector General on 2008-11-06.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                                    U.S. Department of Housing and Urban Development
                                                Office of Inspector General
                                                          451 7th St., S.W
                                                       Washington, D.C. 20410


                                                                     MEMORANDUM NO. 2009-NY-0801

November 6, 2008

MEMORANDUM FOR: Susan D. Peppler, Assistant Secretary for Community Planning and
                                    Development, D



THROUGH: Kenneth M. Donohue, Inspector General, G



FROM: Edgar Moore, Regional Inspector General for Audit, 2AGA

SUBJECT:           Deconstruction Activity Costs under the World Trade Center Memorial and Cultural
                   Program Are Impacting Other Approved Programs

                                               INTRODUCTION

As part of the tenth of our ongoing audits of the Lower Manhattan Development Corporation’s
(LMDC) administration of the Community Development Block Grant Disaster Recovery
Assistance funds,1 we reviewed the nature of costs incurred under the World Trade Center
Memorial and Cultural program related to the deconstruction of the Deutsche Bank building
located in New York City. This review raised an issue of concern that we wish to bring to your
attention, namely the funding of the deconstruction activity.

Through September 30, 2007, a total of $202.8 million in Department of Housing and Urban
Development (HUD) funds had been disbursed by LMDC to purchase and deconstruct the
Deutsche Bank Building. To date, HUD has approved LMDC’s funding allocations totaling
$274.6 million for this activity, which is part of LMDC’s World Trade Center Memorial and
Cultural Program. The initial HUD funding for this activity was approved in July 2004 and
amounted to $164 million. HUD funding increased to $207.1 million in June 2005. Costs have
escalated to the point where, beginning in July 2007, LMDC has had to reallocate an additional
total of $67.5 million of HUD funds from other previously approved activities.

Although LMDC took ownership of the building more than four years ago, 26 of the 40 floors
have not been deconstructed. Deconstruction was to have been completed in September 2006.

1
    OIG has reported semiannually on the administration of the more than $3 billion provided to the State of New
    York following the September 11, 2001, terrorist attacks on the World Trade Center. The tenth audit was issued
    on March 31, 2008, under report number 2008-NY-1004.

      Visit the Office of Inspector General on the World Wide Web at http://www.hud.gov/oig/oigindex.html
Moreover, due to disagreement among the parties to the deconstruction funding and settlement
agreement, which established the guidelines for deconstruction cost sharing, LMDC officials
maintained that, as of September 30, 2007, it had disbursed $27.1 million more than its share of
applicable costs. In addition, other costs which LMDC had paid may qualify for cost sharing.
As a result, other programs previously approved by HUD have been impacted, and more HUD
funds than may have been necessary were used to pay for deconstruction activity.

                              SCOPE AND METHODOLOGY

To gain an understanding of the costs charged to the deconstruction of the Deutsche Bank
building component of the World Trade Center Memorial and Cultural program, we reviewed
partial action plan No. 7 and subsequent amendments approved by HUD; the demolition cap
agreement, dated August 2, 2004; and the deconstruction funding and settlement agreement,
executed on July 19, 2005. We also analyzed contract files, disbursement records, and escrow
account bank statements for the period August 31, 2004, through September 30, 2007.
Additionally, we interviewed LMDC management, financial, and legal staff regarding the
administration of the escrow account.

We performed our on-site work from October 2007 through April 2008 at LMDC’s office
located in lower Manhattan. Our work was not performed in accordance with generally accepted
government auditing standards because we did not independently verify the accuracy of the
classification of all costs by LMDC as aggregate versus nonaggregate deconstruction, which
would determine the extent of the deconstruction costs that LMDC would pay.

                                     BACKGROUND

The Deutsche Bank building, a 40-story office building located at 130 Liberty Street in New
York City, was heavily damaged as a result of the terrorist attacks on the World Trade Center.
The building was unoccupied, and its status was uncertain due to litigation between the prior
owner and its insurers, Allianz Global Risks U.S. Insurance Company and AXA Corporate
Solutions Insurance Company. The building site was envisioned to be part of the World Trade
Center plan. To facilitate action to release the space to LMDC, the governor of New York at the
time directed that a settlement be reached via mediation among the parties. On August 2, 2004,
the parties signed the demolition cap agreement, which provided that LMDC purchase the
building for $90 million and pay the first $45 million of covered demolition costs plus any
noncovered demolition costs above that amount. The demolition cap agreement further provided
that the insurers would pay the prior owners $140 million and be responsible for covered
demolition costs above the first $45 million. LMDC used $90 million in HUD funding for the
building purchase and took ownership of the building on August 31, 2004.

Due to disputes among the insurers and LMDC under the demolition cap agreement, the terms
were renegotiated and resulted in execution of the deconstruction funding and settlement
agreement on July 19, 2005. This agreement provided that LMDC pay (1) the first $45 million
of aggregate deconstruction costs, (2) an additional $5 million for pre-September 11, 2001,
asbestos and other hazardous material removal, (3) 25 percent of the aggregate deconstruction
costs in excess of $50 million, and (4) all additional costs not considered aggregate



                                                2
deconstruction costs. The deconstruction funding and settlement agreement further provided that
the insurers pay 75 percent of aggregate deconstruction costs in excess of $50 million.

The deconstruction funding and settlement agreement defined deconstruction as all actions
necessary to clean and deconstruct the building in a manner that complies with the contract
documents and all legal requirements. The agreement further defined aggregate deconstruction
costs as amounts paid to contractors for materials, work, and/or services to perform and complete
the deconstruction.

The deconstruction funding and settlement agreement further required the establishment of an
escrow account into which the insurers would deposit $10 million no later than 30 days after the
date of the deconstruction funding and settlement agreement and 75 percent of the insurers’
anticipated aggregate deconstruction costs less the initial $10 million previously deposited no
later than 30 days after executing a contract related to the deconstruction. The deconstruction
funding and settlement agreement also provided that any interest earned2 on the escrow funds
would not be used to meet insurers’ liabilities.

The deconstruction plan, approved in September 2005, provided that deconstruction would
consist of three phases: the preparatory phase, phase I, and phase II. The preparatory phase
consisted of the erection of scaffolding and hoists; construction of interior hoist vestibules; and
erection of sidewalk sheds, perimeter fencing, and exterior pressure tent enclosures. Phase I
included environmental cleaning and removal of all interior surfaces and nonstructural
components within the building. Phase II encompassed the actual floor-by-floor structural
deconstruction of the building, as well as the removal of the remaining cleaned building
components. The preparatory phase was completed in 2006. Phases I and II commenced in
March 2006 and March 2007, respectively, and are not presently completed.

The total deconstruction process was initially scheduled to be completed in September 2006;
however, replacement of the initial deconstruction contractor and subcontractors, deconstruction
contract renegotiations, and increased environmental testing required by regulatory agencies3
caused delays. Further, a fire at the site in August 2007, in which two New York City
firefighters died, resulted in an ongoing investigation by local, state, and federal authorities,
which caused the suspension of deconstruction activity.

As of September 30, 2007, HUD had approved $237 million through partial action plan no. 7 and
its amendments for the Deutsche Bank building deconstruction as an activity within the World
Trade Center Memorial and Cultural program. HUD initially approved $164 million for the
purchase and deconstruction of the building via partial action plan no. 7 on July 16, 2004. The
approved amount was increased to $207.1 million via amendment on June 8, 2005. An
additional $30 million was approved via amendment on July 11, 2007, that reallocated $23
million from a previously approved economic development activity and $7 million from the Job
Creation and Retention program. As of September 30, 2007, LMDC had disbursed $202.8

2
    The escrow account had earned $2.7 million in dividends as of September 30, 2007.
3
    Primarily includes the Federal Environmental Protection Agency, Occupational Safety and Health Administration,
    NYS Dept of Environmental Conservation, NYS Dept. of Labor, NYC Dept. of Environmental Protection, and the
    NYC Dept of Buildings.


                                                          3
million in HUD funds for costs relating to this activity. Another $16.2 million was disbursed
from funds provided by the insurers. Subsequent to our fieldwork, the latest amendment to
LMDC’s action plan for this activity was approved on September 2, 2008 and provided an
additional $37.5 million in HUD funds for the activity. These funds were reallocated from a
previously approved activity under the Utility Restoration and Infrastructure Rebuilding
Program.

                                          RESULTS OF REVIEW

Although LMDC took ownership of the Deutsche Bank Building more than four years ago, 26 of
the 40 floors have not been deconstructed. Deconstruction was to have been completed in
September 2006. Moreover, due to disagreement among the parties to the deconstruction funding
and settlement agreement, which established the guidelines for deconstruction cost sharing, the
insurers had not made deposits to the escrow account since November 2006, and LMDC had
stopped drawing funds from the account.4 LMDC officials maintained that, as of September 30,
2007, it had disbursed $27.1 million more than its share of applicable costs. In addition, other
costs which LMDC had paid may qualify for cost sharing. As a result, LMDC had to reallocate
funds from other programs previously approved by HUD, and more HUD funds than may have
been necessary were disbursed for deconstruction activity. Further, continued escalating costs
could result in the need for additional reallocations.

LMDC Estimated That It Paid More Than Its Required Share of Deconstruction Costs

The deconstruction funding and settlement agreement, executed in July 2005 between LMDC
and the prior insurers of the Deutsche Bank building, directed how deconstruction costs would
be allocated between LMDC and the insurers. Payments by the insurers, funded from the escrow
account, depend upon, among other issues, the proper classification of costs as aggregate
deconstruction costs. However, correspondence, dated in May 2007 between the insurers and
LMDC, indicate that LMDC and the insurers differed on the classification of costs as aggregate
deconstruction costs and the extent of the insurers’ liability. The lack of additional insurer
funding of the escrow account caused LMDC to use HUD funds allocated for other activities to
continue necessary deconstruction activity.

As shown in table 1, LMDC classified $107.8 million of the $218.9 million spent as of
September 30, 2007, on the demolition of the Deutsche Bank building as aggregate
deconstruction costs. As further shown in table 1, LMDC had paid $91.6 million of the $107.8
million, which it classified as aggregate deconstruction cost. However, LMDC maintained that
its liability according to the agreement should have been $64.5 million as follows: (1) the first
$50 million in aggregate deconstruction costs and (2) an additional $14.5 million [25 percent of
the aggregate deconstruction costs in excess of $50 million, or $57.8 million ($107.8 million less
$50 million)]. Consequently, LMDC officials maintained that LMDC paid $27.1 million more
than it should have been responsible for under the deconstruction funding and settlement
agreement.


4
    After our fieldwork, LMDC provided documentation for four additional withdrawals from the escrow account as
    of July 23, 2008, totaling $3.5 million.


                                                        4
                                                  Table 1
                      Difference in classification of aggregate deconstruction cost
                                        as of September 30, 2007

                                                                                                     Aggregate
                                                      Portion classified        Aggregate          deconstruction
                                       Total            by LMDC as            deconstruction        costs paid by
                                  deconstruction         aggregate             costs paid by       insurers from
Nature of cost                    costs disbursed      deconstruction             LMDC                 escrow
Building purchase                     $90,000,000
Cleanup/deconstruction                 76,652,948              $67,437,948         $52,561,764         $14,876,184
Insurance                              16,162,491                6,306,505           6,306,505
Scaffolding erection                   12,229,364               12,229,364          12,229,364
Air monitoring                         10,856,402               10,563,113           9,256,429           1,306,684
Deconstruction supplemental
agreement                                                        9,215,000            9,215,000
Construction mgr/owner’s
representative                         7,503,333                 2,041,499            2,041,499
Administrative and other               5,544,940
                       Total        $218,949,478              $107,793,429         $91,610,561         $16,182,868

LMDC analyzed and classified deconstruction costs for which funds were disbursed related to
the Deutsche Bank building as aggregate deconstruction costs through July 2007. Between July
and September 2007, an additional $2.2 million was disbursed and included in the $218.9 million
total cost but had not been analyzed and classified by LMDC as either aggregate or nonaggregate
at the end of our audit period.

The insurers deposited $36.4 million into the escrow account through November 2006. LMDC
officials maintained that the insurers’ share of deconstruction costs incurred based upon executed
contracts through September 30, 2008, should require deposits of $87.6 million into the escrow
account. Consequently, LMDC officials maintained that the escrow account was underfunded by
$51.2 million5 as of September 30, 2007. LMDC officials stated that this condition caused
LMDC to disburse $27.1 million more than that for which it should be responsible and could
result in LMDC disbursing an additional $24.1 million. Further, LMDC officials stated that the
insurers believed the $36.4 million was sufficient to fulfill their obligation under the agreement,
and that they were not responsible for what they classified as nonaggregate deconstruction costs
and additional costs that resulted from delays in deconstruction. As of September 30, 2007, the
escrow agent had released to LMDC $16.2 million from the account.

The escrow agreement, executed in August 2005 among LMDC, the insurers, and the escrow
agent, provided that the escrow agent could refuse to comply with claims, demands, or
instructions for payment if disputes arose between the insurers and LMDC. The escrow
agreement further stipulated that payments would be refused until a final order settled the
conflicting claims and instructed the escrow agent on how to proceed or a settlement was
reached by a written agreement between the conflicting parties. The insurers and LMDC had

5
    This amount excludes additional deconstruction costs that may have been incurred as a result of the August 2007
    fire.


                                                          5
differed over the composition of aggregate deconstruction costs since May 2007, and legal
counsel advised LMDC that it should request no more than $20.7 million from the escrow
account, which was the amount the insurers calculated as their liability at that time.

LMDC officials said that they had not notified the escrow agent of the disagreement. However,
on May 12, 2008, LMDC lawyers sent to the prior insurers’ lawyers a request that an additional
$80.9 million be deposited into the escrow account to cover what LMDC maintained was the
insurers’ liability as of May 8, 2008. LMDC officials stated that an additional $24 million was
deposited into the account in October 2008.

Additional Costs Could Potentially Be Classifiable as Aggregate Deconstruction

Accurate classification of deconstruction costs is important so that the insurers and LMDC may
each pay their proper share of aggregate deconstruction costs. As noted previously, the
deconstruction funding and settlement agreement provided that aggregate deconstruction costs
are amounts paid to contractors for materials, work, and/or services to perform and complete the
deconstruction. The agreement further defined deconstruction as all actions necessary to clean
and deconstruct the building in a manner that complies with the deconstruction documents and
all legal requirements. Although these costs complied with the deconstruction documents and
were legally required, LMDC did not classify more than $1.1 million disbursed for an initial
building characterization study and air monitoring services as aggregate deconstruction costs.
Consequently, LMDC may have understated the costs that could be shared by the insurers.

A Building Characterization Study Was Required

Federal and New York State regulations require the completion of a building characterization
study before demolition of a building. Specifically, Environmental Protection Agency
regulations at 40 CFR (Code of Federal Regulations) 61.145(a) require a thorough inspection of
the demolition site for the presence of asbestos before demolition of a building. Further, New
York State Labor Law, section 241, part 10, requires that a survey be conducted to determine
whether a building to be demolished contains asbestos material before contracting for or
commencing work on any demolition work on buildings covered under this section.
Accordingly, on January 7, 2005, the New York State Department of Labor advised LMDC that
Industrial Code Rule 56 mandates that a comprehensive asbestos demolition survey be
completed before the development of a final asbestos project design and deconstruction plan for
any building.

LMDC contracted for an initial building characterization study report as the first step in the
cleaning and deconstruction process to provide an initial characterization of any hazardous
substances present in the building. The study included tests necessary to make determinations
regarding (1) appropriate safety precautions for workers and public health and safety; (2)
appropriate cleaning and disposal procedures; and (3) compliance with applicable federal, state,
and local authorities. The report was issued in September 2004, and the deconstruction contract,
dated October 20, 2005, listed the results of the initial building characterization study as one of
the understandings, assumptions, and risks that the contractor assumes. Further, the contract’s
scope of work section provided that the contractor is responsible for the building’s



                                                 6
deconstruction plan, which addressed the abatement, cleaning, and removal of contaminants
identified in the initial building characterization study report.

Since a building characterization study was required by federal and state regulation and the
study’s recommendations were incorporated into the deconstruction contract, and as a principle
for LMDC’s deconstruction plan, the associated costs were necessary to complete the
deconstruction of the Deutsche Bank building. Therefore, the $598,788 paid for the study should
be considered an aggregate deconstruction cost and should be shared subject to the terms of the
agreement.

Air Monitoring Was Required

New York State Department of Labor Industrial Code Rule 56-17.1 provides that air sampling is
required before the start of a project and during preabatement. Additionally, New York City
Department of Environmental Protection Regulations at section 1-41(b)(1) require that five air
samples within the proposed work area be taken before commencement of abatement activities.
In addition, the September 2004 Deutsche Bank building initial characterization report and
LMDC’s environmental consultants recommended that the air monitoring program that had been
implemented before the start of deconstruction should continue.

During the period September through December 2004, LMDC retained the prior Deutsche Bank
building owners’ consultant for air monitoring services. These services included air monitoring
at the same locations provided by the Deutsche Bank building owners before its purchase by
LMDC. LMDC stated in its request for funding that the air monitoring was part of the interim
and preparatory work necessary as part of the cleanup and deconstruction. The documents also
stated that it would be critical to continue the air monitoring and sampling already in place and
regarded it as imperative that the consultant retained by the former owner perform the phase I
services. Doing so was reported to prevent any potential airborne hazardous materials from
being released into the surrounding neighborhoods and assures the public, government
regulators, and other stakeholders that LMDC would continue to provide air monitoring and
sampling at a level no less than that previously provided.

As a result, since air monitoring provided by the building’s prior consultant was necessary to
clean and deconstruct the building in compliance with both the deconstruction documents and
legal requirements and since continuing this air monitoring was incorporated as a principle into
the deconstruction plan, the $558,545 paid for air monitoring services should be considered an
aggregate deconstruction cost that should be shared subject to the terms of the agreement.

                                     CONCLUSION

Proper classification of costs as aggregate and nonaggregate deconstruction is important to
accurately fund the escrow account and maximize funds available for other programs. However,
LMDC and the former Deutsche Bank building insurers differed over the classification of
aggregate deconstruction costs based upon executed contracts. As a result, LMDC officials
estimated that the escrow account was underfunded by $51.2 million and that it had disbursed
$27.1 million more than its share of applicable aggregate deconstruction costs as of September



                                                7
30, 2007. Further, the additional $2.2 million in costs paid by LMDC between July and
September 2007 needs to be analyzed and classified as either aggregate or nonaggregate
deconstruction costs. In addition, LMDC’s classification of $598,788 disbursed for an initial
building characterization study and $558,545 disbursed for air monitoring services as
nonaggregate deconstruction costs precludes the sharing of these costs in accordance with the
deconstruction funding and settlement agreement. However, classification of the costs as
aggregate deconstruction would allow them to be shared among LMDC and the insurers. LMDC
paid the costs in full, thereby reducing funds available for other activities.

                             RECOMMENDATIONS

We recommend that Assistant Secretary for Community Planning and Development, before
approving any additional funds for the deconstruction of the Deutsche Bank building under the
World Trade Center Memorial and Cultural program, direct LMDC to

1A. Provide an updated accounting of deconstruction costs, including the $2.2 million not yet
    classified, both aggregate and nonaggregate, and an estimate of anticipated additional
    expenditures in each of these categories so that HUD may assess the extent to which
    additional funds may need to be reprogrammed for deconstruction activity.

1B. Periodically provide HUD a report on the status of efforts to resolve the escrow account
    underfunding so that HUD may be kept up-to-date on the potential amount of funds that
    may be recouped and repaid to the World Trade Center Memorial and Cultural program.

1C. Provide documentation to support why funds disbursed for the initial building
    characterization study and air monitoring should not be classified as aggregate
    deconstruction costs. If these disbursements are determined to be aggregate deconstruction
    costs, LMDC should seek recovery of the estimated $868,000 (the insurers’ 75 percent
    share based upon the agreement) from the insurers and reimburse the program, thereby
    ensuring that these funds are put to better use.

We further recommend that the Assistant Secretary for Community Planning and Development:

1D. Closely monitor the remaining disbursement of HUD funds under this activity.

In accordance with HUD Handbook 2000.06, REV-3, for each recommendation in this
memorandum, please provide a status report within 60 days on (1) the corrective action taken,
(2) the proposed corrective action and the date to be completed, or (3) why action is considered
unnecessary. Additional status reports are required 90 days and 120 days after this memorandum
is issued for any recommendation without a management decision. Also, please furnish us
copies of any correspondence or directives issued because of this review.




                                               8
                                    APPENDIXES

Appendix A

     SCHEDULE OF FUNDS TO BE PUT TO BETTER USE

                     Recommendation        Funds to be put
                            number          to better use 1/
                                    1C     $ 868,000

1/   Recommendations that funds be put to better use are estimates of amounts that could be
     used more efficiently if an Office of Inspector General recommendation is implemented.
     This includes reductions in outlays, deobligation of funds, withdrawal of interest subsidy
     costs not incurred by implementing recommended improvements, avoidance of
     unnecessary expenditures noted in preaward reviews, and any other savings which are
     specifically identified. In this instance, if our recommendations are implemented, costs
     that have been charged to and paid from the World Trade Center Memorial and Cultural
     program will be reclassified as costs recoverable from the insurers, thereby resulting in a
     reduction in outlays from HUD.




                                              9
Appendix B
        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1




Comment 2




                         10
Appendix B
        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 3




                         11
                         OIG Evaluation of Auditee Comments

Comment 1   HUD does not object to requesting the information recommended, provided that
            the information is already collected by LMDC. However, HUD does not agree
            that this information should be requested to enable HUD to assess the extent to
            which additional funds should be reprogrammed for deconstruction activity.
            Since LMDC already collects the information recommended, HUD should receive
            the information so that it can assess the need for funds to be reprogrammed.
            While LMDC has discretion to reprogram funds, it may do so only within certain
            parameters, above which HUD must provide approval through the amended
            partial action plan process. Additionally, given the history of escalating costs for
            the 130 Liberty Street site, HUD needs as much information as possible so it can
            anticipate and assess the impact of expected cost increases upon previously
            approved activities.

Comment 2   HUD agrees that the periodic reporting recommended would be informational, but
            it would not ensure that the funds are put to better use. LMDC’s advance of
            Disaster Recovery Assistance funds to pay aggregate deconstruction costs is
            contrary to the deconstruction funding and settlement agreement. The intent of
            the periodic reporting to HUD, in addition to being informational, is to provide
            HUD with a more informed means to assess the effects of the advance of HUD
            funds on other programs. In addition, periodic reporting allows HUD to more
            accurately monitor LMDC’s efforts to aggressively recover amounts that were
            advanced in lieu of using other nonfederal funds as provided by the agreement.
            Although this increased oversight might prevent additional advances or achieve
            recapture of previously advanced funds, that is not a certainty; therefore, we have
            deleted reference to funds to be put to better use.

Comment 3   HUD agrees that LMDC should seek recovery of all costs to which it is entitled.
            Accordingly, we have updated the costs to $868,000. Since LMDC is entitled to
            cost sharing of costs classified as aggregate deconstruction but did not classify the
            costs in question as aggregate deconstruction, these costs are not being considered
            for cost sharing with the insurers. Further, providing documentation to HUD
            should not impact any legal arguments. Therefore, in accordance with HUD’s
            agreement that LMDC should seek recovery of all costs to which it is entitled,
            HUD should ensure that these costs are not improperly classified, thereby
            ensuring that the funds are put to better use.




                                             12