Last week, the cash-strapped city of Vallejo approved a five-year plan to steer itself out of bankruptcy. But that plan has angered some of the city's more than 1,000 creditors, some of whom are now threatening to plunge the town into costly legal battles.

Some of those up in arms are Vallejo's more than 400 retirees and surviving spouses, to whom the city had guaranteed $135 million in health-care benefits. Jim Paul, an attorney for the retirees, says the city has "not negotiated with us in any sense at all, and now they are forcing this plan on the retirees." He says he intends to file a challenge to the plan.

The flap comes as Vallejo—California's largest municipal bankruptcy since Orange County filed in 1994—tries to find firmer financial footing since filing for bankruptcy protection in May 2008. Under its plan, Vallejo says it will defer any debt repayment until 2013, given that it has just $5 million to pay back unsecured creditors owed more than an estimated $50 million. The city also plans to cut health-care benefits for retirees to $300 a month, down from $1,500 a month now for some retirees.

Stephanie Gomes, a Vallejo city councilwoman, says the plan tackles some of the city's most vexing issues of employee costs and pension obligations. She adds city leaders knew there would be legal challenges to the plan but their chief concern is exiting from bankruptcy in a solid financial position.

"There are a lot of people unhappy right now, and that's unfortunate," says Ms. Gomes. "But we're insolvent. We don't have the money."