El Cerrito filed suit last week challenging the California Department of Finance and other agencies over a demand that the city turn over $1.7 million in former redevelopment funds.
The demand came in a letter the city received as part of the state's effort to collect redevelopment money held by so-called successor agencies to California cities' redevelopment agencies.
Cities statewide with successor agencies received similar letters demanding different repayment sums.
"We knew a demand for payment was coming, but we were astonished at how high it was," said El Cerrito Finance Director Lori Trevino.
The state Board of Equalization and the Contra Costa County auditor's office, charged with collecting the payment, are also named in the suit, filed in Sacramento Superior Court, said Hildy Myall, the city's housing program director.
The city has contacted the auditor/controller's office, saying it is refusing to pay.
California dissolved redevelopment agencies and gave cities the opportunity to create successor agencies to continue with redevelopment or wind down their programs last fall as part of its effort to balance the state budget.
In the suit, El Cerrito is arguing that the state's demand is unlawful because the successor agency's money has already been spent on projects and the refund would have to come from its general fund reserves.
That would cross a boundary between the city and the successor agency, Myall
"A legal firewall has always been in place between redevelopment agencies and the general fund that the state has declared null and void," she said. "That is legally unprecedented and we had no choice but to petition the court to take a look at it."
State finance department spokesman H.D. Palmer confirmed that California is prepared to garnish sales tax revenue that goes to the city's general fund to cover the payment.
The stakes are high for El Cerrito, Myall said. The city would have to replace the money lost from its reserves from money it has already budgeted for services.
The general fund budget is around $30 million and city policy is to keep its reserves at 10 percent or about $3 million, she said.
"The payment request is based on the idea that successor agencies were sitting on a lot of money, and that's not true," Myall said. "(Making the payment) would undercut our ability to sustain ourselves as a city."
Council members stood by their action at their meeting on Tuesday.
Mayor Bill Jones, who issued a statement about the city's action earlier in the day, said at the meeting that he viewed the state's demand for payment with only three days' notice -- and its enabling legislation, Assembly Bill 1484 -- "as illegal and unconstitutional under state law."
"There's a point at which you have to say enough is enough and we can't just keep paying these demands, and we just don't have the resources to do it with," said Councilwoman Janet Abelson.
The demand would eat half of the city's reserves, she said, adding that there was no interest on the state's part in discussing the issue.
Resident Peter Loubal questioned the wisdom and cost of a legal action, asking, "What if we lose," and adding that, "Other cities, such as Richmond, decided not to battle this, as far as I know."
Loubal also questioned past city expenditures, including the purchase of the Tradeway property next to City Hall.
"Over the years I was the most outspoken one warning that our city was living beyond the means," he said. "We spent $4 million on a furniture store just to keep the state from grabbing the money."
Chris Treadway contributed to this report.