Petaluma has paid the state $8.75 million after losing a lawsuit over redevelopment tax proceeds that were supposed to go toward the construction of two major Highway 101 interchange projects.

The payment was in response to a "demand letter" from the state Department of Finance after a judge ruled against the city late last month in its suit. The city hasn't decided whether to appeal, City Attorney Eric Danly said.

The state said if the city didn't pay up, it would begin withholding sales tax and property tax revenues the city would normally receive.

Petaluma's suit, filed in November in Sacramento, argued that the redevelopment funds had been legally obligated to projects at 101 and East Washington Street and Old Redwood Highway well before the state dissolved redevelopment agencies.

In a move to shore up the state budget in 2011, the state did away with redevelopment agencies, which kept increases in tax revenues in a redevelopment districts instead of being distributed among several local entities with other taxes.

But a Sacramento judge ruled that the financial agreements – made in 2007 and 2009 – between Petaluma's redevelopment agency, Caltrans and the Sonoma County Transportation Authority were not legally enforceable contracts. Therefore, the state was due the local tax receipts.

Both highway projects are under construction, with East Washington Street's work underway the better part of a year.

The $8.7 million had already been collected and was available in the former redevelopment agency's fund, Danly said. It doesn't affect the city's general fund, which pays for most city services and salaries.

A second, similar lawsuit against the state involving funds the city planned for the Rainier Avenue crosstown connector is still pending. But, given the first ruling, Danly said the city isn't hopeful about keeping that disputed $7.5 million.

The loss of redevelopment funds has forced a second look at funding the the road projects, but won't halt work.

The payment prompted the state to issue "certificates of completion" on bond sales issued in 2007, in part to help fund East Washington and Old Redwood. Those funds will be spent now, City Manager John Brown said.

Additional funds will be taken from traffic-impact fees paid by developers seeking city approval for projects such as the new Target and Friedman's shopping centers and other large developments.

Proceeds from another bond sale in 2011 are earmarked for Old Redwood and Rainier, Finance Director Bill Mushallo said. Those funds can't be spent pending a ruling on the second lawsuit.

No hearings have been scheduled in that suit.

"It's hard to be optimistic," Danly said. "The city made those plans consistent with law. All of that was lawfully done and the money committed years before the redevelopment dissolution law was on anyone's radar. It's been incredibly frustrating and futile."

You can reach Staff Writer Lori A. Carter at 762-7297 or

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