The Hercules Redevelopment Agency entered the post-redevelopment era in default on its bond debt, after failing to make a $2.4 million interest payment that was due Wednesday.

On Tuesday, the bond insurer, Ambac Assurance Corp., sued Hercules in Contra Costa County Superior Court, seeking to force the city to turn over all $4.1 million in tax increments it collected in December, or at least to get the court to freeze the funds. But that could cause the city to go bankrupt, Hercules' outside attorney John Killeen warned.

Alternatively, Ambac asked the court to attach other Hercules assets such as some real estate. But court Commissioner Judith Sanders declined the insurer's petition for immediate relief and scheduled a hearing before a judge for Feb. 21.

The redevelopment agency's bond debt obligations have exceeded revenue from property tax increments in recent years, and as of this week, the agency's nonhousing component was $3.8 million underwater, City Manager Steve Duran said.

"It was inevitable there would be a default because there's not enough tax increment," Duran said late Tuesday. "You can't get blood from a turnip."

Ambac's suit accuses Hercules of misappropriating pledged property tax proceeds that were supposed to be transferred to trustee Bank of New York Mellon Trust Co. five days before the Feb. 1 due date of the interest payment. In a court declaration, Duran said Hercules deposited the $4.1 million into a Pooled Cash Investment account that is drawn on to pay for various restricted and unrestricted activities. That account was tapped in August 2011 to pay $5.3 million in bond debt service, Duran said.


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The $2.4 million that Hercules defaulted on Wednesday represents interest due Feb. 1 on two tax-allocation bond issues dating to 2005 and 2007; a principal and interest payment totaling about $5 million is due Aug. 1.

Killeen did not dispute an assertion by Ambac's attorney, Jerrold Abeles, that Hercules was technically in default.

"There is a technical default," Killeen said. "The dispute is what's the proper remedy."

"They (Ambac) don't care at all if the city shuts down," he said.

Abeles, in a brief, argued that it is Ambac that would suffer irreparable harm unless the court grants relief. Moreover, he argued, Hercules' "illegal seizure of bond collateral" shifts the burden of the city's cash flow problems onto bond investors and Ambac and threatens the integrity of the institution of bond financing.

"Failure to stop such illegal behavior will shake the public's confidence in the bond market," Abeles warned.

Duran said later Tuesday that he hopes it will not come to bankruptcy.

"If it wasn't for Ambac, we wouldn't be worried about that eventuality," he said, adding that he is disappointed Ambac sued and that the insurer would be better off negotiating a settlement with Hercules. He said he remains hopeful the two sides can come to terms before the next court hearing.

In his declaration, Duran said that during January, Hercules had proposed to Ambac a lease-back deal -- in which a property is sold and leased back to the seller by the buyer -- involving city-owned properties that the insurer now seeks to attach; the city owns several large, vacant commercial tracts.

Abeles on Wednesday said Ambac has no comment at this time.

Payments on the 2005 and 2007 bonds are due Feb. 1 and Aug. 1.

"If the agency didn't default now, there wouldn't be enough for the August payment," Duran said.

Redevelopment agencies statewide were scheduled to disband Wednesday pursuant to a state Supreme Court ruling.

"Why would any city without a redevelopment agency throw good money after bad," Duran asked rhetorically, "when the (other) choice is to run a city and maintain public safety and public infrastructure?"

Hercules spends about $1.25 million a month on general operations, including police and other salaries and expenses, according to Duran's declaration.

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