The racino has been seen as a way to generate hundreds of millions of dollars to help support public education and the state's horse racing industry.
AEG attorney Barry Berke called the state decision "arbitrary and capricious" and said the group remains ready and able to close a deal and pay an upfront $300 million fee. He also raised the possibility of a lawsuit.
"In the event that AEG is not given an opportunity to address the issues raised by the Lottery, and the decision to reverse the prior selection of AEG as the successful bidder is not reconsidered, AEG intends to pursue all available remedies," he said.
Problems with applications filed by AEG included a changing list of participants, with some dropped only after reviewers discovered they were unqualified, an administration official familiar with the review told The Associated Press on condition of anonymity. The official was not authorized to speak publicly about the review.
Applications were never filed on behalf of some others who withdrew, the official said.
The group includes builders, bankers and a casino operator. A minor stakeholder, the Rev. Floyd Flake, recently withdrew. The politically influential Queens pastor and former congressman said his involvement had become a distraction from his church and community work.
Paterson, Senate Democratic leader John Sampson and Assembly Speaker Sheldon Silver chose AEG in late January from among a half-dozen bidders to build and operate the racino. Sampson said he respects the Paterson administration's decision.
"We need now to move forward with the selection of a new vendor in a responsible and timely manner," he said.
Silver had set four conditions on AEG's selection before he would sign an agreement, including payment of an upfront $300 million licensing fee, which another bidder offered and which AEG agreed to pay by March 31. He also required all investors to get a New York gaming license, which would exclude anyone denied a license elsewhere or convicted in the past 15 years of fraud, theft, tax evasion or any other financial crime.
"According to information put out by the governor today, those conditions could not be met," Silver spokesman Dan Weiller said.
After AEG was chosen, losing bidders quickly raised complaints, including political favoritism.
State Inspector General Joseph Fisch and federal investigators have requested records related to the bidders from the Lottery Division. Silver had asked Fisch to examine whether the selection process broke any laws and his conditions were followed.
Last week, Paterson recused himself from negotiations with AEG, citing the advice of his lawyer, and delegated the task to his staff.
The governor has said that a meeting with Flake to seek his political support shortly after AEG was selected was unrelated to the decision. He said that meeting had been postponed for six months while the Aqueduct bids were reviewed.
The governor subsequently dropped out of the race for election to a full term. Flake is also a political mentor to Senate President Malcolm Smith of Queens.
"You know, the bottom line for me is we need to get this done. This is the problem with government," Sampson said Wednesday as the deal appeared to be collapsing. "This is what people are saying. This is exactly what is wrong with government. Too many bureaucrats, red tape going on, investigations. If this was private industry, the deal would have been made."