Vallejo - A federal judge ruled Friday that the city of Vallejo could push forward with its bankruptcy case, rejecting a legal challenge by police and firefighters unions.

U.S. Bankruptcy Judge Michael McManus in Sacramento said Vallejo met the legal requirements of Chapter 9 bankruptcy protection. He rejected the unions' arguments that the city's finances weren't as bad as officials claimed.

The San Francisco Bay area suburb of 120,000 became the largest California city to file for bankruptcy in May, citing shrinking revenue and escalating labor costs for police and firefighters.

Vallejo faces a $16 million budget deficit after seeing revenue decline amid an economic downturn and deepening housing market crisis. The city has been forced to reduce staff and cut services to deal with its chronic budget problems. The judge will next decide whether the city can renegotiate labor contracts with the public safety unions. Compensation for firefighters and police officers now make up 75 percent of Vallejo's $87 million general fund budget, a much larger portion than most California cities.

Vallejo's case is being watched closely by other cities and counties that are saddled with employment contracts they can't afford.