LOS ANGELES — San Bernardino City Attorney James Penman filed a lawsuit against the California government  claiming that if the city’s sales and property taxes are docked to pay $15 million the state says San Bernardino owes as a result of dissolution of its redevelopment agency, the city will be forced to shut down.

Penman requested an injunction from U.S. Bankruptcy Judge Meredith Jury against the state, which he said would prevent a forced shutdown of the city due to insufficient cash to meet its payroll and obligations necessary to provide basic essential services to its residents.

“We are simply trying to protect the city of San Bernardino from dissolving,” Penman said. “If the taxes are taken, we will not be able to provide police protection, operate sewer and water, or provide other municipal necessities for our residents.”

Penman claimed in the filing that state officials violated federal bankruptcy code by making the claim.

“The city is protected by the “automatic stay” provision of the bankruptcy code, which prohibits creditors and other third parties from taking actions against the property, assets, monies, funds/and or other interests of the city without first obtaining bankruptcy court approval of such actions,” according to the city’s filing. “The harm to the city if a preliminary injunction is not issued will significantly outweigh any harm suffered by the defendants if the March 4 order is enjoined.”

The city is one of many squabbling with the state about how to divide money after the dissolution of redevelopment agencies across California in 2012, but its Chapter 9 bankruptcy filing puts San Bernardino in a unique position.

The California Department of Finance sent a letter on March 4 telling the city it had until April 4 to hand over $15 million in unencumbered funds for affordable housing from the former redevelopment agency.

State officials claim the city improperly transferred the money to the city from the  redevelopment successor agency.

In the city’s lawsuit, Penman claims the disputed amount only involves $300,000 in cash, the remainder concerns real estate assets – and the insolvent city doesn’t have the money to give the state.

The city named Ana Matosantos, director of the Department of Finance; state Controller John Chiang; Cynthia Bridges, director of the state Board of Equalization; and Larry Walker, San Bernardino County Auditor Controller/Treasurer Tax Collector in the suit.

“The suit doesn’t come as a surprise to us,” said H.D. Palmer, a finance department spokesman. “It doesn’t change the fact that the former redevelopment agency improperly transferred money to the city.”

The fact that lawsuit was filed doesn’t change that underlying fact in the finance department’s view, Palmer said.

“There was an unencumbered amount based on redevelopment that was owed to the local taxing agency,” Palmer said. “The root issue is whether there was an improper transfer of money from the redevelopment agency to the city.”

The city sent letters to state officials informing them if they didn’t rescind  threat to the city’s taxes, they intended to pursue litigation; which is why, Palmer said, the filing doesn’t come as a surprise to them.

Karol Denniston, a partner in the San Francisco office of law firm Schiff Hardin LLP who has focused on California Chapter 9 issues, considers the odds good for the city to receive an injunction based on the fact they are in the midst of a bankruptcy case.

The issues related to redevelopment dissolution are complex – and the state is being sued by many cities – but the bankruptcy code prevents claims outside of bankruptcy court when a debtor is under bankruptcy protection, she said.

“The reason is that you can’t have creditors coming at the debtor piecemeal while the debtor is attempting to go through a reorganization process,” Denniston said.

It’s likely the judge will move quickly on the request for an injunction through either declarative relief from an injunction or a motion to enforce the stay.

“It will definitely come to a resolution before the state can implement a set off of the property and sales taxes,” Denniston said.

A hearing has yet to be held determining whether the city will be eligible to remain in bankruptcy.

Judge Jury postponed the issue at a status hearing held in December so the city could respond to complaints from creditors that it wasn’t providing sufficient financial documents to creditors.

It’s up to the bankruptcy judge to decide when an eligibility hearing will be scheduled, Penman said.

“We are ready to proceed with the eligibility hearing and have been ready to proceed with the eligibility hearing since the first hearing was held in December on objections to our eligibility,” Penman said.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.