Comprising six square blocks in the center of town, Petaluma's Theatre District was hailed on completion in 2007 as a visionary mixed-use development and a transformative project for the city. But new information has surfaced that calls into question conflicts of interest in the project, and shows that the developer backed out of promises to share cost overruns, leaving the city of Petaluma with a $9.6 million burden.

Such facts may not have come to light were it not for the ongoing fight over the Roblar Road quarry, which the Sonoma County Board of Supervisors approved by a 3-2 margin late last year, and which a group of over 200 residents have filed a lawsuit to stop.

The owner of the quarry property is John Barella, founder of local construction firm North Bay Construction. Barella is also a major investor in Basin Street Properties, a real estate investment and development firm headquartered in Reno. Basin Street Properties has a strong interest in the quarry because its main properties are in the North Bay, but the extent to which Barella is and has been involved in Basin Street Properties has only recently surfaced.

In April, Barella filed a declaration in the Superior Court lawsuit asserting that he is the "largest single investor in Basin Street Properties, and sits on its board of directors." Barella has been involved with Basin Street Properties since 1996 and has guaranteed $96 million in loans to Basin Street Properties [see .pdf].

"I take an active role in the management and affairs of Basin Street and its related entities," Barella declares in the filing. "The quarry project is part of my long-term strategy with Basin Street, as it will provide raw material to be used in our land developments over the next twenty years." Barella also claims that "under the . . . 'alter ego' test, Barella and Basin Street [are] considered the same for conflict of interest purposes."

This disclosure of Barella's relationship with Basin Street calls into question the propriety of the government-funded Theatre District project, say former and current Petaluma city officials. The redevelopment of the public infrastructure portion of Petaluma's Theatre District cost the city nearly $10 million more than it had initially budgeted, public records show. The construction work was performed by North Bay Construction under the supervision of Basin Street Properties, which was contracted with the city to do so.

Matt White, president of Basin Street Properties, confirms that Barella was invested in his firm's Theatre District project. White does not view this fact as posing a conflict of interest. Others disagree.

"It appears that an egregious disclosure omission occurred, if what's now been sworn to by John Barella and Matt White of Basin Street in the Roblar Road quarry litigation is true," says former city council member Pamela Torliatt. "If Barella and Basin Street are one and the same, there are a lot of questions that need to be answered regarding the millions of dollars paid to North Bay Construction and Basin Street."

Torliatt and Petaluma mayor David Glass are concerned that Barella's dual role as a Basin Street Properties investor-manager and as the owner of North Bay Construction may have impacted the ability of Basin Street Properties to impartially manage the city's financial interests in the Theatre District project.

"If I had known of Barella's financial interest in Basin Street Properties at the time, I would not have approved of the arrangement with North Bay Construction," Glass says. "Finding this out now is like being hit on the head by a 2-by-4."

How It Began

In 2003, the Petaluma City Council approved Basin Street Properties' plan to develop a $100 million residential and business complex on a riverfront site previously occupied by automobile dealers, auto body shops and gas stations. The city also agreed to pay for improving sewage, street, sidewalk and electrical infrastructure in the public portion of Basin Street's proposed Theatre District.

Eager to redevelop the downtown area, the city sweetened the deal by covering not only its share of costs for constructing public infrastructure, but also the developer's share, which was $4.8 million. The city took on the entire public infrastructure cost of $7.5 million [see .pdf], which included paying PG&E and SBC to underground their wires in the public area, normally the responsibility of the developer or the utility company.

The city contracted with Basin Street Properties, who, acting on behalf of the city, put the city's portion of the work out to bid. North Bay Construction was selected as the low bidder in early 2004. This subcontracting arrangement meant that Basin Street Properties was responsible for signing off on the payment of city funds to North Bay Construction, and that Basin Street Properties received a portion of the public infrastructure budget for supervising North Bay Construction.

Concurrently, North Bay Construction was also constructing nonpublic infrastructure for Basin Street's sprawling development, which eventually encompassed the Boulevard Cinemas multiplex, a parking garage, waterfront office buildings, residential lofts and other retail. So there was some logic to the arrangement—until the initial construction costs and management costs increased by than 150 percent to $17.1 million, and until Basin Street reneged on a promise to help defray $2 million in cost overruns.

As the project's budget skyrocketed, other city projects stalled in its wake. In the end, Petaluma was out of pocket for $9.6 million.

In order to determine how this happened, thousands of pages of public records were examined. Current and former city officials and council members were interviewed, as well as Matt White, president of Basin Street Properties, and his general counsel, Paul Andronico. Barella did not return repeated telephone calls and emails requesting comment.

AT THE GATES: North Bay Construction was adding a 15 percent markup for itself on bills from a subcontractor for the Theatre District, according to a city inspector.

Toxics? What Toxics?

In August 2003, a geotechnical study commissioned by the city reported that "soil and groundwater in the [Theatre District] improvement area are impacted by gasoline and diesel fuel range hydrocarbons. [Therefore] special handling of soil and groundwater may be required in these areas during construction."

But in its eagerness to jumpstart the public-private deal, the city council hastily forged ahead with the Basin Street Properties contract, declaring that there was "no evidence" that the massive development would have a significant effect on the environment, nor that there were hazardous wastes and toxic substances buried in the soil and groundwater of an area which had been occupied by automobile dealers, body shops and filling stations for decades.

In mid-January 2004, however, the city's engineering manager, Dean Eckerson, reported that proposals of construction costs were "exceed[ing] our original cost estimates as well as Basin Street Properties' estimates [which are] elevated due to difficult subsurface conditions due to high groundwater and unstable soils, possible contaminated soil conditions, an aggressive schedule and performing underground work during the rainy season."

Eckerson concluded that "based on a comparison to our recent bid prices for similar work, many of the items of work are higher than expected. . . . Consequently, it seems reasonable for Basin Street Properties to pay for the apparent cost differences since they are controlling the schedule resulting in the elevated costs for public infrastructure [see .pdf]."

But Eckerson was overruled.

In February 2004, Matt White, president of Basin Street Properties, wrote to city manager Mike Bierman that Basin Street Properties was contracting with North Bay Construction for a "guaranteed maximum price contract" of $8.7 million [see .pdf]. White informed Bierman that the city's redevelopment commission "will need to fund an additional $4.4 million" in related costs, including costs of design, engineering, landscaping, legal fees and construction management. This brought the city's total cost to $13.1 million—already $5.6 million beyond the original budget.

White softened the bad news to Bierman with a promise: "The balance will be paid by means of an assessment district [generating] $4.1 million. As we have discussed, Basin Street Properties will participate in such an assessment district up to $2 million." The dedicated property tax was to be paid only by property owners in the Theatre District. Taking White at his word, city managers went along and approved the mounting cost overruns.

Part of the problem was that when the hard costs of materials and construction labor increase, the "soft" costs of overseeing construction rise in tandem. The hard cost approved by the city council in 2003 was $6.2 million. In July 2008, the city recalculated the hard costs at $14.6 million. The increased soft costs brought the total to $17.1 million.

Several city redevelopment officials did try to rein in costs by rejecting Basin Street Properties' bills for "defective" construction work. They disputed tens of thousands of dollars in North Bay Construction invoices passed along to the city after having been approved by Basin Street's outsourced construction manager, Matt Sherrill, of San Franciscobased Conversion Management Associates Inc., which charged $311,000 for his services.

The city's staff of construction managers and building inspectors on the job site had their hands full. For example, on Feb. 10, 2005, a city inspector reported that North Bay Construction was impermissibly adding a 15 percent markup for itself on bills from a subcontractor that was itself overcharging for travel and overtime and making "excessive" and "unreasonable" surcharges. And in May, a city redevelopment manager wrote to Sherrill that a $600,000 "super contingency" in the project budget was intended to be used only for construction change orders, and not assigned to unspecified "potential impacts" to Basin Street Properties.

Andronico defends Sherrill's performance, saying that he and the city's construction managers were a good team. In fact, after the Theatre District job was completed, Basin Street Properties hired Sherrill as a staffer.

And, as Andronico points out, some of the cost overruns were due to inadequate planning by city engineers. Delays also occurred because the city tried to minimize the effect of construction-related street closures on traffic and local businesses. All in all, there were plenty of unanticipated consequences. The burning question became: who pays?

The Money Hits the Fan

On Sept. 19, 2005, the city council amended its original agreement with Basin Street Properties and upped the original project budget of $7.5 million to $17.1 million. Searching for ways to fund the $9.6 million gap, the council, acting as the redevelopment commission, snatched money away from an array of redevelopment projects already in the works, including Turning Basin improvements, railroad depot reconstruction and street pothole repairs. It also took funds out of budgets for wastewater operation, flood mitigation and street reconstructions. City services deteriorated as a result.

At the Sept. 19 meeting, city council members castigated city manager Bierman for allowing overruns to occur for a year and a half without informing the council that the project was in deep financial straits. Bierman said he was "personally embarrassed" and that he "would not do it this way again." Councilman Mike Healy tried to soften the blow: "This is a teachable moment," he said, while voting for the increase.

Only council member Torliatt voted against the measure to absorb the extra costs. Objecting to the city picking up the increased tab, she noted, "We [originally] picked up $4.8 million as a public agency which a normal developer would pay for."

In approving the massive Theatre District cost overrun, the city council relied on White's promise to pay a portion of the overruns through the formation of the special tax assessment district, which would assess Basin Street Properties and other property owners in the area for construction and upkeep of public improvements. The city paid a consultant $72,000 to write a proposal for forming the tax assessment district.

But when the matter was slated to come before area property owners for a vote in late 2006, Basin Street Properties informed the city that it would not vote to assess itself, thereby forcing Petaluma to cover the $2 million in additional costs that White had said Basin Street would cover. By that time, Basin Street Properties was the sole property owner subject to the proposed tax, so it only took one vote to kill it.

According to the final audit trail [see .pdf] on the project, the city ended up on the hook for the whole $17.1 million. That figure does not include the interest on bonds the city sold to finance payments to North Bay Construction and Basin Street Properties or to cover all the internal costs of its own project managers, engineers and technical consultants.

Key to the city's ability to pay off the bonds it sold to finance the Theatre District project was an arrangement that Basin Street's newly developed property deliver the $500,000 per year in "tax increment" funds that the city had calculated in 2003 would flow from an increase in district property taxes. But City Manager John Brown says he does not know if the tax increment is generating the amount needed to service the debt or not.

Regardless, it's clear that the Theatre District cost overruns flooded the city in red ink, even as the economy was sinking into deep recession. And it is clear that despite its own administrative failings, which were considerable, the city relied upon Basin Street Properties to act independently of North Bay Construction. But unbeknownst to top Petaluma officials contacted for this story, Basin Street Properties and Barella are, as Barella swears under oath, "considered the same."

That's not just another run-of-the-mill conflict of interest. In Petaluma's case, it turned out to be a very expensive one.

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