NEW YORK, July 28 (Reuters) - A state appeals court on Thursday dismissed a lawsuit claiming that the New York City Department of Education misused funds earmarked for reducing class size, ruling that the matter should be resolved by the DOE itself, not the state judiciary.

The United Federation of Teachers and a coalition of community groups and parents sued the DOE over funding allocated through the Contract for Excellence program, which the legislature established in 2007 to help underperforming school districts throughout the state. The union and community groups claimed that instead of using the funds to reduce class size, the city used them to offset budget cuts.

After the plaintiffs filed suit in state Supreme Court in the Bronx, the city asked that the case be dismissed on the grounds that the court lacked jurisdiction. School officials cited the law's provision that "the sole and exclusive remedy" for any claimed violation is a petition to the education commissioner, according to the ruling. They also argued that the plaintiffs had failed to exhaust their administrative remedies at the DOE.

But even without the explicit language, Justice David Saxe wrote for the Appellate Division, First Department, the overall legislative scheme -- which, among other things, gives the DOE extensive oversight and monitoring responsibilities over the program -- makes it clear that the legislature intended to grant the DOE original jurisdiction over claimed failures of compliance.

Corporation Counsel Michael Cardozo said in a release: "We are pleased that the court properly recognized that complex questions about education budgeting should first be addressed by the officials entrusted with administering education programs before individuals who are unhappy resort to the courts."

Schools Chancellor Dennis Walcott said the case was without merit. "We've remained committed to minimizing the growth of class size in all of our schools," he said in the release.

Leonie Haimson, executive director of Class Size Matters, one of the plaintiffs in the case, said she was disappointed in the ruling.

UFT president Michael Mulgrew said the union will keep battling to reduce class size. "Lowering class size is a key issue for the parents and teachers of New York City and we intend to pursue it vigorously," he said in a statement.

The case is Michael Mulgrew et al v. the Board of Education of the City School District of the City of New York, Appellate Division of the Supreme Court of New York, First Department, No. 4593.

For the Board of Education: Alan Krams, Emily Sweet and Jesse Levine of the New York City Law Department, and Robin Singer of the Department of Education.

For Mulgrew et al: Charles Moerdler, Alan Klinger and Dina Kolker of Stroock & Stroock & Lavan; Basil Paterson and Barry Peek of Meyer, Suozzi, English & Klein and Carol Gerstl and Adam Ross of the United Federation of Teachers.

(Reporting by Jennifer Golson)