SAN FRANCISCO — The city of Vallejo, Calif., filed a plan to exit bankruptcy that proposes to pay unsecured creditors 5 to 20 cents on the dollar. 

The plan for the city to exit Chapter 9 bankruptcy also calls for exchanging new debt to its largest creditor, Union Bank, and says Vallejo has reached an agreement over fees owed to a bond insurer.

The proposal filed Tuesday outlines the reorganization of debt the city owes to its largest creditors, Union Bank and bond insurer National Public Finance Guarantee Corp. It sets aside a pool of $6 million to pay unsecured creditors about 5% to 20% of their claims over two years, according to court documents filed in U.S. Bankruptcy Court for the Eastern District in Sacramento.

“The city regrets that it cannot pay a higher percentage,” Vallejo officials said in the court filings. “The fact is that the city lacks the revenues to do so while maintaining an adequate level of municipal services, such as the provision of fire and police protection and the repairing of the city’s streets.”

Vallejo said it has settled with NPFG over fees related to insured certificates of participation, which finance tied lease revenues, according to the filing.

The legal plan is based on a five-year road map approved by City Council that tackles $195 million in unfunded pension obligations, cuts payments for retiree health care, reduces pension benefits for new employees, raises pension contributions for current workers, and creates a rainy-day fund.

The filing starts a long legal process that will likely end sometime in the summer if a  plan eventually is approved by Judge Michael McManus.

Vallejo, a 50-square mile city in the Bay Area with a population of around 120,000 residents, filed for bankruptcy in May 2008 in response to what it called ­unsustainable labor contracts and dwindling tax collections.

It is largest municipal bankruptcy in California since Orange County in 1994.

Union Bank is owed roughly $50 million after it issued letters of credit to back four series of defaulted COPs. It would get a new “lease-leaseback” obligation in exchange for cancelling the certificates.

It will also get $6 million of unspent proceeds from the COPs held under trust agreements that will be used to reduce the amount owed by the city.

Union Bank is slated to get 40% less than what it would have received from the original COP scheduled payments, according to the Vallejo filing.

NPFG had sued for access to state vehicle-license fees that backed $4.8 million of defaulted 1999 COPs. Under the plan, it would get reduced and restructured payments through fiscal 2024-2025.

Vallejo, NPFG and the California state controller entered into a settlement agreement that will allow the city to defer a portion of payments owed to the insurer through fiscal 2012-13, but will then be required to resume full payments and to apply motor-vehicle license fee revenue available to repay the deferred amounts.

Interest on the deferred amounts will accrue at the annual rate of 5.25%, which is estimated to be 1% to 2% less than the amount the city would be obligated to pay under the original COP agreement, according to the documents.

The state controller’s office filed a ­motion last month to intervene in the bankruptcy case as it relates to NPFG, saying state intercept funds should be used to protect debt owners.

The city also said it will pay $400,000 to NPFG for reimbursement of its attorney fees and costs, which the insurer contends exceeded $600,000 at the end of last year. The city said it has so far spent around $8.3 million on lawyers’ fees.

Vallejo’s exit strategy includes restructuring debt owed to unsecured creditors, including employees and retirees, by ­creating a $6 million pool of cash that will be paid out over two years. But the unsecured creditors would still be able to pursue one of the city’s insurance pools, according to the documents.

The city received 1,013 proofs of claims, of which 969 where general unsecured claims, 12 unsecured priority claims, and 32 secured claims, according to the court documents.

The claims totaled $479 million, with $262 million of general unsecured claims, $45 million of unsecured priority claims and $172 million of secured claims, the filing said.

Despite all of the liabilities, Vallejo said it will pay out the full amount of workers’ compensation claims because the city and injured workers would lose state coverage if it didn’t. The city will also continue to pay its California Public Employees’ Retirement System obligations.

The plan does not alter restricted obligations of city funds, such as $175 million in water revenue bonds and other special taxes.

Eventually, creditors will vote on the plan and the court will evaluate the voting before any approval or disapproval.

Marc Levinson, the city’s bankruptcy lawyer from Orrick, Herrington & Sutcliffe LLP, said votes on the plan by creditors couldn’t be made until the city’s disclosure statement is approved by ­McManus.

Before that happens, Levinson said the city expects to amend the court ­documents, potentially based on comments from ­creditors.

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