SAN FRANCISCO - Vallejo, Calif.'s firefighters this week agreed to let the bankrupt San Francisco Bay Area city rip up their labor contract.

The International Association of Firefighters fought to block the city's bankruptcy bid and its motion to reject collective bargaining agreements in court for the past year. The union dropped its appeal of Vallejo's bankruptcy eligibility earlier this month, and the parties earlier this week filed an agreement that allows the city to reject the labor contract with the U.S. Bankruptcy Court for the Eastern District of California in Sacramento.

Bankruptcy Judge Michael McManus is expected to approve the agreement this morning. Under the deal, the city will reject a labor contract that expires on June 30, 2010, and immediately open negotiations on a new contract. The parties agreed to go to binding arbitration if they can't reach an agreement by Sept. 30.

"The parties are quickly going to go to arbitration if they can't reach a replacement contract," said union bankruptcy attorney Dean Gloster of Farella Braun + Martel LLP.

The firefighters did not waive their right to seek damage claims in the bankruptcy, and the International Brotherhood of Electrical Workers, which represents Vallejo's front-line, non-public safety employees, continues to oppose rejection of its contract.

McManus could rule on the city's motion to reject the IBEW contract as soon as today. The judge delayed ruling for several months while the parties negotiated to reach an agreement with the help of a mediator.

The new agreement with the firefighters means that the city is well on its way to resolving the biggest municipal bankruptcy since Orange County, Calif.'s 1994 Chapter 9 filing. Vallejo's biggest creditors are current and former workers.

It owes about $50 million in general fund certificates of participation, and the debt is primarily held by Union Bank of California, which was the letter-of-credit bank on the variable-rate debt. Both the city and Union Bank have said they cannot negotiate to adjust the debt until the city and its workers reach new labor agreements.

Vallejo reached new contracts with police and management employees in February. Gloster said the city and the firefighters should have a new contract in place this year.

While the city and the IBEW are further apart in their negotiations, the IBEW salaries represent a much smaller general fund expense than those of police or firefighters. The city declared bankruptcy because it said it could no longer afford police and firefighter contracts that ate up more than three-quarters of its general fund.

The firefighters' contract was valid through June 30, 2010, but Vallejo has been paying firefighters less than their contracted salaries since June 2008 under the protection of the bankruptcy court.

This week's agreement requires the city to make a written proposal to the firefighters by Sept. 2. The IAFF must reply by Sept. 15. If no agreement is reached by Sept. 30 or the Vallejo City Council rejects an agreement, the two sides will go to binding interest arbitration.

When a contract is rejected in bankruptcy, the injured creditor - the IAFF in this case - has a right to receive bankruptcy damages. Creditors generally receive less than they're owed and are paid in proportion to their claims against the bankruptcy estate. The earlier agreements with police and management employees included agreements to accept minimal bankruptcy damages.

The city and the firefighters this week agreed that they will negotiate the bankruptcy damage claims as they negotiate the labor contract, but if they cannot agree, they will let McManus decide on damages.

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