SAN FRANCISCO, Jan. 3 -- A Roman Catholic priest who saw a fellow priest wrestling with a teenage boy, reported it to police and was placed on administrative leave can sue his church, says a state appellate court.

The Rev. John Conley's legal duty to report suspected child abuse and the "compelling state interest in protecting children" justify legal scrutiny of disciplinary actions by the Archdiocese of San Francisco, said the three-judge Court of Appeal panel.

Conley's suit had been dismissed by San Francisco Superior Court Judge Ronald Quidachay, who said allowing it to proceed would violate the church's freedom of religion.

The archdiocese contends it encouraged Conley to report the incident, and placed him on leave for unrelated behavioral problems. Even if Conley was being disciplined for going to the police, as he claims, the Constitution would forbid court review, said Paul Gaspari, a lawyer for the archdiocese.

"A religious institution should be free from governmental interference and should be free to hire, fire and discipline its clergy as it sees fit," Gaspari said Tuesday after receiving the ruling. He said an appeal would be seriously considered.

Conley, a priest since 1993, is seeking damages under a state law that requires members of the clergy, among others, to report suspected child abuse to the police, and protects them from retaliation on the job. He also says he was libeled by a letter from an archdiocese spokesman, published in the San Francisco Examiner in 1998, that accused him of conducting a witch hunt against his fellow priest.

The archdiocese has already paid $750,000 to settle a suit by the former altar boy who accused the Rev. James Aylward of inflicting physical and mental abuse for over a year, starting when he was 15. The Chronicle reported the confidential settlement in November.

Conley saw Aylward wrestling with the youth in a darkened rectory room at St. Catherine of Siena Church in November 1997 and reported the incident.

Aylward, investigated by police and the archdiocese, said he was engaging in nonsexual horseplay, and was not prosecuted or removed as pastor. He resigned seven months later and became assistant pastor at a Mill Valley church.

But in a deposition for the youth's lawsuit last February, Aylward admitted a history of touching boys for sexual pleasure during previous church jobs dating back about a dozen years. He was immediately relieved of his duties.

Conley, meanwhile, was removed as associate pastor at St. Catherine and assigned to lesser priestly duties at St. Philip the Apostle Church in San Francisco while on administrative leave. Among the conditions he must fulfill before returning to full pastoral status is undergoing psychological counseling, which he says he doesn't need, and dropping his lawsuit.

After Conley publicly criticized the church's actions against him, archdiocese spokesman Maurice Healy wrote to The Examiner in April 1998, saying the actions were prompted by Conley's "verbal harassment and anger" against parishioners, including a woman whose car blocked a driveway. Writing before Aylward had revealed his past sexual misconduct, Healy said the veteran pastor was a "good priest" whose one-time "lapse in judgment does not warrant a witch hunt" by Conley.

Healy said Tuesday that the letter wasn't libelous because the church had reason to believe Aylward was being unfairly attacked, based on the facts known at the time.

Subsequent events and yesterday's ruling add up to "a complete vindication" for Conley, said his lawyer, Michael Guta.

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