A planned project to rebuild a Highway 101 interchange in north Petaluma remains in limbo as the city and state dispute whether the city can pay its share with former redevelopment dollars.

The $42.5 million budgeted for the Old Redwood Highway interchange includes about $15 million from Petaluma redevelopment funds - and 80 percent of it has been disqualified by the state Department of Finance.

Petaluma is appealing, but so far has received no response from the state, said Ingrid Alverde, the city's economic development director.

When the Legislature abolished redevelopment agencies throughout the state last year, it required agencies to submit lists of contracted projects, creating so-called "enforceable obligations." Those projects would be allowed to keep redevelopment money already committed while other funds would be redistributed to help balance the state budget and to other taxing entities in the county.

In Petaluma, the Old Redwood Highway redesign was identified as a redevelopment priority in 2003. The city and the Sonoma County Transportation Authority, which administers local transportation tax money, signed cooperative agreements in May 2010 to fund environmental review, design and construction.

In addition to Petaluma's portion, other funding includes $21.4 million in Measure M county sales tax proceeds and $4.6 million in state funds, said Suzanne Smith, SCTA executive director.

The project is set to go to bid in September or October.

However, the state has identified the planned use of redevelopment money as not being an "enforceable obligation." If the state disallows Petaluma's plan, there is no other funding source.

"That could jeopardize the project," said Councilman Mike Healy, the city's representative on the redevelopment oversight board that is winding down the agency's funding obligations.

Petaluma Mayor David Glass said he thinks the state will eventually agree with Petaluma's contention that the agreement is a valid contract.

"We should prevail on those," he said. "In my gut, I'll be shocked, once they see where everything is."

It's unclear what the state Department of Finance objects to, although Smith said it may be that the state doesn't see intergovernmental agreements as contracts.

Smith agreements were in place well before the state began talking about taking redevelopment funds from cities for its use.

"It is absolutely crazy to think that we don't have a contract in place committing those funds," she said. "We absolutely did."

The joke in Sacramento, Healy said, is that once local agencies heard the state wanted to take redevelopment money, they ran around committing funds to anything and everything.

"They call it Mardi Gras," he said.

But the Old Redwood Highway funding isn't like that, he said.

"That's been on the books and planned for a significant period of time," he said. "I think any reasonable person would conclude it was planned."

Glass is meeting with state Sen. Lois Wolk this week to receive an update on new legislation that may clarify redevelopment obligations. He said he will continue to defend the Old Redwood Highway plan as a valid redevelopment project.

"It's not a swimming pool, it's not a sports stadium," he said. "It's Highway 101 and we're spending our redevelopment dollars for what the state should have done a long a time ago."