SAN FRANCISCO - U.S. Bankruptcy Court Judge Michael McManus said late Friday that Vallejo, Calif., can use Chapter 9 bankruptcy protection to reject its collective bargaining agreements.

The ruling clarifies McManus's view on one of the most contentious questions of the 10-month-old bankruptcy process and is a blow to the two public employee unions that have not yet reached settlements with the San Francisco Bay Area city.

But the judge stopped short of actually rejecting the union contracts.

"Despite having concluded that the city may potentially reject the remaining CBAs, the court will defer determining whether the city has satisfied" the legal standards for rejection, McManus wrote in a memorandum published late Friday. "The court wishes to give the parties every reasonable opportunity to settle this motion."

McManus scheduled a status conference to discuss the labor contracts and settlement negotiations for March 23. He also told the two sides' lawyers that he'll want more detailed evidence on the apportionment of shared labor costs among the city's various funds. The judge has ruled that the city's general fund is bankrupt, but other city funds - such as its marina and water enterprise funds - remain solvent.

Two public employees unions - the Vallejo Police Officers Association and the Confidential Administrative, Management and Professional employees union - agreed to new contracts just days before McManus heard arguments on the motion to reject the CBAs in early February.

They agreed to reductions in contracted pay rates, deep cuts in health care payments for both current and retired workers, increased staffing flexibility for city management, minimal or no bankruptcy damage claims, and dropped their legal opposition to the bankruptcy.

The city's two remaining unions - the International Association of Firefighters and the International Brotherhood of Electrical Workers - have had a harder time reaching an agreement with the city and have continued to press an appeal of McManus's earlier ruling that the city is eligible for municipal bankruptcy protection. They say the city is not really unable to pay its bills, just unwilling.

Vallejo said in a press release Friday that it would press for "an early decision" on the actual motion to reject the CBAs, signaling that it may not see much use in continuing negotiations.

McManus' memorandum accepted the city's contention that federal bankruptcy law preempts California law as the legal standard for rejection of the collective bargaining agreements.

McManus wrote that the Constitution gives the federal government the exclusive right to determine bankruptcy laws. The bankruptcy code requires state permission for Chapter 9 bankruptcies in deference to states' rights, but California law specifically authorizes Vallejo to seek Chapter 9 protection, which includes the power to reject contracts like labor agreements, the judge wrote.

Union lawyers had argued that state labor laws govern collective bargaining agreements even during bankruptcy, which would have made it more difficult to reject valid contracts.

McManus found that California had waived such protections for public workers when it allowed its municipalities to file for bankruptcy.

"When a state authorizes its municipalities to file a Chapter 9 petition, it declares that the benefits of chapter 9 are more important than state control over its municipalities," he wrote.

He also found that municipalities are not subject to revisions in the bankruptcy code that made it harder for corporations to reject labor contracts because Congress considered but declined to make such changes to the municipal bankruptcy code.

That led him to conclude that the U.S. Supreme Court's 1984 ruling in case of the National Labor Relations Board v. Bildisco & Bildisco sets the standard Vallejo will have to meet to reject its labor contracts.

The Bildisco ruling only requires a bankrupt debtor to show three things before rejecting a labor agreement: that the agreement is burdensome, that it has tried to reach a voluntary settlement, and that "the equities balance in favor of contract rejection," McManus wrote.

The final equities test is a sort of fairness test that takes into account a host of factors, including the public interest and the rights of other creditors.

McManus told the lawyers he either wanted to see evidence that they'd made progress in reaching a settlement at the March 23 conference or to be prepared to answer one last round of his questions before he ruled whether the city has met this three-part test.

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