SAN FRANCISCO - A long-running lawsuit filed by a spurned oil-drilling company has the potential to force a Southern California beach city into bankruptcy or take on debt to settle the case, though Hermosa Beach officials hope state lawmakers will pass a bill that could eliminate much of their liability.

The story began 16 years ago, according to a legislative staff report, when Hermosa Beach signed a lease allowing the Macpherson Oil Co. to drill for oil and gas from city-owned property.

In 1995, however, citizen activists passed an initiative banning oil drilling in the Los Angeles-area city, launching years of litigation. So far, the courts have ruled that the initiative banning drilling was legal, but that the oil company was entitled to damages from its breached contract.

The next step in the process is a trial to determine the amount of damages, said Jim Bright, attorney for Macpherson Oil.

With the price of oil at historic highs, the theoretical cost of Macpherson's lost opportunity has soared, Bright said. "If you used those historical oil prices and production, ballparkish, you'd be looking at $750 million," he said, adding that he knows those damages are far beyond the city's ability to pay.

Hermosa Beach's city attorney and city manager did not return calls or e-mails, but city officials have told local newspapers that damages in the $10 million range could force it into bankruptcy.

Bright, however, said the city has the capacity to finance a $125 million to $180 million in judgment bonds.

The city has a population of about 20,000 and annual general fund revenue of about $27.8 million. It reported no outstanding debt in its most recent comprehensive annual financial report, though officials are considering issuing of pension obligation bonds, according to its fiscal 2009 budget.

"The settlement discussions have all been a tiny, tiny fraction of that damage number I gave you," Bright said. The city's most recent settlement offer was $4.5 million, he said.

"It's not in the city's interest to settle," he said. "You might as well spin the wheel."

The city might get help from the Legislature. Both the city's assemblyman and state senator are carrying bills designed to cap Hermosa Beach's liability in the case.

The language in the bills is evolving, but the bottom line is that they would preclude public entities, such as Hermosa Beach, from being liable for damages after the date of enactment of a valid initiative invalidating an oil and gas lease.

According to the staff's analysis of the bill sponsored by Assemblyman Ted Lieu, D-Torrance, "opponents contend that this bill 'violates the basic principles of contract law, establishes a precedent that undermines the sanctity of contracts, proposes to alter hundreds of pre-existing contracts, [and] exposes the state to massive litigation.'"

No date has been set for a trial to determine the damages, Bright said, adding that, absent a settlement, any result is likely to be appealed by the party that disagrees with the outcome.

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