SAN FRANCISCO — National Public Finance Guarantee Corp. withdrew a motion Monday asking a federal bankruptcy court to allow California state payments to the bankrupt city of Vallejo to flow to bondholders instead.

The insurer pulled its challenge after bankruptcy court Judge Michael McManus issued a tentative ruling Friday denying the motion, which had urged that funds from a state vehicle-licensing fee program be diverted from the city to owners of its certificates of participation, on procedural grounds.

“National intends to pursue the promised vehicle-licensing fees on behalf of bondholders through an adversary proceeding against [Vallejo], which is the procedural route the court has indicated it prefers,” said Kevin Brown, a spokesman for NPFG. “We expect to file our complaint shortly.”

James Spiotto, a partner with Chapman and Cutler in Chicago, who specializes in municipal bankruptcies, said the judge’s tentative ruling basically asked the insurer to present its case in a different way and is a minor change.

“This gave them some guidelines,” Spiotto said.

Vallejo filed for Chapter 9 bankruptcy in May 2008, citing unsustainable labor contracts that rendered it unable to meet its obligations. The city defaulted on its certificates of participation principal and interest payments a year later. It has renegotiated some labor contracts since then and has been trying to work out the problems with creditors.

In August, National filed the motion asking McManus to order the resumption of the state intercept payments that back Vallejo’s COPs. The insurer argued that the bankruptcy filing did not abrogate the vehicle-licensing fee pledge.

The COPs are secured by vehicle-license fees and successor taxes the state distributes to Vallejo. As part of the 1999 COP issue, the city agreed to allow the state controller to intercept vehicle-licensing fee payments to the city and remit them to the bond trustee in the event of non-payment.

Vallejo has taken the position that the intercept mechanism is unenforceable given its Chapter 9 bankruptcy filing, and the disputed state revenues should continue flowing to the city.

The bankruptcy filing affected $53 million of debt backed by the general fund, including the bond issue in question — $4.8 million of COPs sold in 1999. The deal carried insurance by MBIA Insurance Corp., as well as a debt-service reserve surety bond from National. NPFG is a public finance insurance subsidiary of MBIA. It has had to pay $204,408 as draws on the surety bond and expects to pay substantial additional claims, according to court documents.

Lawyers for the city said the ruling just pushes the legal battle down the road.

“The fight will be fought in the future,” said city bankruptcy attorney Marc Levinson of Orrick, Herrington & Sutcliffe LLP. “The underlying merits will still be decided by the judge within a few months.”

As a result of the pulled motion, the National Federation of Municipal Analysts also withdrew their amicus curiae — or friend of the court — brief to the U.S. Bankruptcy Court for the Eastern District of California supporting the request by National.

The federation brief claimed that denying the motion in the case would have a “devastating effect” on access to capital for cities, towns, counties, school districts and other municipal issuers in California and across the country.

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