On August 21, 1999, at 1630 hours Pacific daylight time, a Bellanca 7ECA, N88408, experienced a loss of engine power in the takeoff initial climb at the Livermore, California, airport. During the attempted return to runway maneuver, the aircraft landed hard on a taxiway, ran off the pavement, and into a ditch. The aircraft, operated by Attitude Aviation under the provisions of 14 CFR Part 91 as an instructional flight, sustained substantial damage. The certified flight instructor (CFI) and a private pilot were not injured. Visual meteorological conditions existed for the recurrent training flight and no flight plan was filed. The CFI stated that the engine start and run-up were normal. At 500 feet above ground level (agl) in the initial climb, a partial loss of power was experienced. The CFI stated that the engine rpm's dropped suddenly from 2,600 to 1,500 "with roughness." He said that he took the controls from the student and found that an emergency landing could not be conducted straight ahead due to obstacles. He elected to perform a 180-degree turn back to the runway. As the turn was completed, a complete lost of engine power was experienced. Due to an airplane already on the runway, he aimed for the taxiway, and landed hard on the pavement. In the private pilot's written statement to the Safety Board, he said that the preflight, engine start, and taxi were normal. During the run-up, at 1700 rpm, a magneto check was conducted per the checklist procedures. He noted that the drop was approximately 100 rpm on each magneto, and the oil pressure and engine temperature were normal. They were cleared for takeoff and right closed traffic. When power was added it seemed normal and no discrepancies were noted with the acceleration to rotation speed. As they were climbing through 400 feet agl the engine began to run rough and subsequently a partial loss of power was experienced. The CFI immediately took the controls and declared an emergency. The pilot stated that the CFI entered a descending steep left turn to make it to runway 7R. He indicated that there "appeared to be no power from the engine," and the rate of descent was "too great." The CFI then contacted the tower to inform them that he was going to land on the adjacent taxiway for 7R. The pilot stated that there was insufficient altitude, the rate of descent was too fast, and the airplane struck the runway in a nose down left bank attitude. After the airplane departed the taxiway it came to rest in a drainage ditch parallel to the runway. The airplane was inspected by a Federal Aviation Administration (FAA) inspector on August 25, 1999, at Attitude Aviation. The investigation revealed that the number 3 exhaust valve of the Lycoming O-235-C1 engine had failed. The stem was found broken at the lower portion of the head. The FAA inspector reviewed the engine logbook and found that the engine had accumulated 3,711.0 hours since the last major overhaul, which was accomplished on November 30, 1993. In the CFI's written report to the Safety Board, he had requested on several separate occasions that the engine should be overhauled. He stated that the owner of the flight school stated that they would keep an eye on it. According to Textron-Lycoming Service Instruction number 1009AN dated November 5, 1999, the recommended time between overhaul periods for the O-235 model's (except F, G and J) is 2,400 hours. The Service Instruction letter indicates that all engines that do not accumulate the hourly period of time between overhauls specified in the letter are recommended to be overhauled in the twelfth year. A Textron Lycoming Mandatory Service Bulletin (SB) number 388B, issued on May 13, 1992, addresses the procedure to determine exhaust valve and guide condition. Compliance time for the engine inspections was specified to be at 400-hour intervals, or earlier, if valve sticking is suspected. The SB indicated that the failure to comply with the provisions in the publication could result in engine failure due to excessive carbon build-up between the valve guide and valve stem resulting in sticking exhaust valves or; broken exhaust valves which result from the excessive wear of the exhaust valve guide. No record of compliance with MSB 388B was noted during the logbook review.