A proposed five-story housing project in downtown Los Altos can move forward after the city announced Sept. 5 that it will drop its legal battle against the controversial development.

The Los Altos City Council voted 5-0 over the weekend to drop its appeal against the project at 40 Main Street, citing the financial risks of continuing its fight against the development. If the city lost, it would have been required to pay out $7 million on top of legal fees, threatening a critical blow to an already strained budget.

"The council determined that the potential cost of the litigation could severely impact the city's ability to provide even basic municipal services," city officials said in a statement Sept. 5. "In light of this huge financial risk to the city and the uncertainty and risk of losing the appeal, the City Council decided to withdraw the appeal."

The proposal, a 15-unit apartment building with first-floor offices, is one of the first in California to seek streamlined approval under a new state housing law, SB 35. The law was designed to clear the way for housing development in cities that have failed to produce enough housing -- particularly affordable housing -- by allowing certain projects to sidestep discretionary review.

But city building officials, and later the Los Altos City Council, have repeatedly denied that the project qualifies for streamlined approval, blocking the project from proceeding in April 2019. At the time, the project also faced heavy opposition from Los Altos residents, who decried the size of the 66-foot-tall project as a departure from quaint, "village" feel of the city.

Two months later, housing advocates sued the city, arguing that it violated SB 35 and other state housing laws. They ultimately prevailed: Santa Clara County Superior Court Judge Helen Williams ruled in April that the project must proceed, and that the city acted in bad faith by blocking the project in ways that go beyond "benign" errors.

The city filed an appeal against the judgment in July, doubling down on its determination that the project doesn't comply with downtown zoning standards and is not eligible for streamlined approval.

The clincher that forced the city to back down was the financial repercussions of losing the appeal. A 2005 revision in state law requires that cities battling housing projects in court must pony up money in the form of a bond and, in the event that they lose, must pay out that money to the developer. The rationale behind the law was that cities could delay housing projects in lengthy court battles to the point of killing the financial viability of the developments.

Though the law is fuzzy on how big the bond should be, Ted Sorensen, one of the property owners of 40 Main Street, argued in court filings that the city should be on the hook for $13.8 million -- a number that takes into account past and projected losses due to delays dating back to February 2019. Daniel Golub, an attorney representing 40 Main Street, argued the bond should be set at $13.3 million, in part because of the recent downturn in the economy due to the coronavirus pandemic.

"Instead of allowing the project to begin when the law required, in February 2019, which would have allowed the project to be well underway before COVID-19 hit California, the city's bad faith actions succeeded in delaying project initiation into the highly uncertain pandemic economy," Golub wrote in court filings.

The city of Los Altos, on the other hand, contends that the bond should be set at $100,000.

In a Sept. 2 ruling, Judge Williams landed in the middle, requiring the city to post a $7 million bond within 10 business days -- giving the city limited time to put up the money or drop the appeal. Williams also noted that the city did not comply with the court's requirements to allow the project to move forward in April, apparently seeing its appeal as an automatic stay on the court's judgment, and failed to offer a bond as "expressly required" under state law.

In its statement, Los Altos city officials said that describing the decision to drop the appeal as difficult "would be an understatement," but that the appeal bond -- combined with attorney's fees -- could cost the city upwards of $10 million that the Los Altos can't afford to lose. They also warned that the use of appeal bonds will have a chilling effect on any city's ability to challenge lower court rulings.

City officials also fiercely denied that the appeal was an attempt to stop housing, particularly affordable housing, from being built in Los Altos, and that the legal fight was specifically to stop a project that they believe was inconsistent with downtown zoning rules.

"It was in no way to prevent the construction of the two affordable housing units that would have been part of this five-story structure," according to the statement. "State laws such as SB 35 and the Housing Accountability Act should not be used as tools to strip cities of their ability to review projects to ensure they conform with its zoning and safety requirements."

The City Council is scheduled to discuss the project on Thursday, Sept. 10, and is expected to formally rescind its denial of the project. City officials say they will "continue to reach out to the developer in good faith" in hopes of revising the project to better match the surrounding properties.