Settlement Proposed for Minnesota City's Defaulted Broadband Bonds

CHICAGO – A Minnesota city that defaulted on $26.4 million of revenue bonds for a broadband communications network would pay bondholders $5.75 million and free up escrowed funds under a proposed settlement.

If approved, the settlement between the city of Monticello and bondholder trustee Wells Fargo NA would stave off litigation threatened by investors accusing the city of securities fraud and misrepresenting the bonds in its offering statement. It would also save bondholders from what could be a costly legal battle with no certainty of recouping any of their investments. 

The city’s fiber optics broadband communications network, which provides cable television, internet access, and telephone services, was once envisioned as a potential model for other local governments to follow. However, the system failed to generate enough revenue to service the tax-exempt revenue bonds issued in 2008 and the city last year stopped subsidizing debt service, leading to a default.

The Monticello City Council late last week adopted a resolution advancing the term sheet for the proposed settlement, according to a notice published by the city.

“The term sheet describes a basis for resolving in advance of litigation of claims asserted and litigation threatened by the trustee and certain bondholders relating to the bonds,” the notice reads. The city denies the claims.

In addition to the $5.75 million, the settlement would free up escrowed funds held by the trustee for distribution to bondholders. The term sheet does not disclose the amount of those funds.

The trustee had previously reported holding two reserves with $25,000 and $2.6 million and another $635,700 in a surplus account. City officials said Tuesday the funds held about $2.6 million at the end of May. The final number is uncertain as trustee fees can be paid from the funds and a recent trustee notice reported that its fees and expenses to date were $350,000.

The city is exploring how to cover the settlement costs and may eventually issue judgment bonds backed by a general obligation pledge, city finance director Wayne Oberg said. “We still have to go through the legal hoops” before the settlement is finalized and a new financing contemplated, he said. 

The bondholder notice from the city cautions that the term sheet “is not legally binding and any definitive settlement agreement must be approved by the City Council, the trustee, and certain bondholders. Implementation of the settlement will also require court approval.”

The settlement would free the system of its debt and allow it to better compete with other providers. The city owns and operates the system under the name FiberNet Monticello. Private companies lowered their prices in response to the new competition, hurting the city’s ability to lure and keep customers.

Under the proposed terms and conditions, a class action lawsuit would be filed in federal court with class members seeking appointment of Schiff Hardin LLP as class counsel. The firm has advised the trustee on the settlement.

Simultaneously a settlement would be filed stipulating that the parties had reached an agreement that resolves claims relating to securities fraud and misrepresentation. Holders participating in the class action would release all claims against the city under the indenture or under state and federal securities laws. Holders that opt out would retain their bonds but would have no lien on the system’s revenues. Investors with at least 90% of principal must participate.

With the system’s revenues falling short, the trustee had previously drawn from various bond reserves to cover debt service payments. Between July 2011 and June 2012, the city supplemented debt service by loaning the project money generated by its liquor sales operations.

The bonds are special, limited obligations of the city with principal and interest payable solely from the system’s operating revenues after operational and maintenance expenses. Under no obligation to make up the shortfalls, Monticello, a city of about 12,700 residents just north of the Twin Cities, informed the trustee of its intention to halt that practice last June as it sought a restructuring.

Without any agreement between bondholders and the city on a restructuring and with the city in default on bond terms for failing to raise rates to a level sufficient to cover debt service, Wells Fargo went to court late last year and received an order allowing it to skip the Dec. 1 payment for $883,000.

The city, trustee, and bondholders entered into a tolling agreement that suspended to Oct. 1 the time accrued against the statute of limitation on legal claims while prohibiting bondholder litigation against the city. The move was taken to allow for negotiations over a potential restructuring to be conducted until at least Aug. 30, according to past bondholder notices.

The latest debt service payment that included $883,000 of interest and $85,000 of principal due June 1 was not made.

The unrated revenue bonds were structured as term bonds due in 2023 and 2031 and carried original yields of 6.5% and 6.75%, respectively. They most recently were trading at 14 cents on the dollar, according to data posted on the Municipal Securities Rulemaking Board’s EMMA disclosure website.

Oppenheimer served as underwriter and Faegre & Benson LLP as bond counsel on the issue.

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Minnesota
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