When Burlington several years ago set out to build a municipal telecom network, it envisioned a self-sustaining system providing fiber-optic internet service to residents, business, and government in Vermont’s most populous city.

Since the city was precluded by state law from issuing municipal bonds for the project, it entered into an equipment-leasing agreement with creditors that it now wants to restructure as it struggles to repay the debt.

Burlington’s bond rating has suffered as a result, a lawsuit has been filed against the city, and its chief administrative officer and the lender could seize the system because it serves as collateral for the loan.

Burlington Telecom, the municipal telecom network owned by the city, in late June entered into a three-month forbearance period as it negotiates with ­lender CitiCapital to restructure its debt.

The leasing business of CitiCapital was sold to GE Capital in 2008, but this particular lease has been retained by Citi.

The utility is unable to make rental payments for its fiber-optic equipment, which is the collateral for the $33.5 million lease-purchase financing agreement on which it missed two payments earlier this year.

The telecom provider also owes the taxpayers of Burlington $17 million and litigation is pending against the city and an official over that money. Burlington and its chief administrative officer, Jonathan P. A. Leopold, face a taxpayer civil suit filed by two citizens seeking to recover funds that BT borrowed from the city and has not repaid in two years. 

A city-appointed blue-ribbon committee reported in February that BT had a debt load of $51 million, while revenues stood at $7 million. It estimated annual debt service of $3 million would be needed to refinance the $51 million.

“The current cash-flow situation is that BT is close to cash-flow positive before debt service,” Leopold said in a phone interview.

“The budget for fiscal year 2011 shows BT cash-flow positive for the fiscal year, inclusive of approximately $1 million of capital expenditure for customer acquisition and hook-up, without debt service,” he said.

Current revenues of $7 million are within 4% of the revenues projected in a December 2007 revised business plan. The budget for fiscal 2011 projects a margin of 19%, Leopold added.

The August 2007 lease agreement with CitiCapital included an escrow ­account of $1 million for the lessor’s protection. ­CitiCapital has already accessed the account to cover the February and May 2010 interest payments amounting to $386,673.75, according to information provided by the city. 

Because Citi has received this money, Burlington says the telecom agency has cured any default on the lease agreement.

To avoid missing another payment in August amounting to $706,894.31, including principal and interest, the city entered into the 90-day forbearance agreement on June 28. Burlington cannot access the reserve fund and the lessor has the right to access the remainder of the escrow account during the forbearance period.

Under the lease-financing agreement, Burlington makes rental payments for equipment during a 20-year term, at the end of which the city will own the equipment. The payments are not a debt of the city and are subject to annual appropriation. If a payment is not appropriated, the agreement would be terminated, according to a statement from Leopold’s office.

Both Leopold and Mark Rodgers, a director of public affairs for CitiCapital, confirmed that the lessor and the city are in discussions but wouldn’t disclose details of any proposed restructuring of BT’s debt.

“The projections provided to CitiCapital in July 2007 in hindsight were optimistic,” Leopold said. “The city is working with much more realistic projections today. At that time, it was not expected that the revenues from BT would be the exclusive source for lease payments — an issue which has not yet been fully resolved.” The lease did not specifically address the source of the appropriation, he said.

While state law prohibited the use of taxpayer-backed bonds to fund the system, the legislature in 2000 amended Burlington’s charter, enabling the city to own and operate its telecommunications services, either by itself or in a joint venture.

The General Assembly also asked the state Public Service Board, a quasi-judicial agency, to ensure that any losses should be borne by investors in the business and in no event by the city’s taxpayers. Accordingly, such provisions were incorporated into the license for a utility to offer services.

Further, Leopold cited an opinion from Joseph E. McNeil, former city attorney and corporation counsel for Burlington who acted as counsel on this transaction. The opinion was of the view that the city charter and state law prohibited the use of tax funds, but did not otherwise restrict the use of other funds.

Based on that opinion, it was understood that there was no prohibition of utilizing general fund revenues of the city for telecommunications.

Approximately 50% of general fund revenues are derived from other sources than through taxation of the city’s taxpayers. The only restriction was that the losses from telecommunications not be borne by the city’s taxpayers or  the state, or recovered in rates from electric ratepayers, he said.

“The legislature had placed significant restrictions on Burlington’s ability to finance the initiative,” Leopold said. “It prohibited the city from using traditional municipal credit sources such as general obligation bonds to build BT.”

Following voter approval of the ­project, the city in 2002 secured $2.6 million in lease-purchase financing from Koch ­Financial with approval of the City ­Council.

The initial phase of the project brought fiber-optic service to city departments and schools, according to Leopold’s office. In 2006, BT began offering services to the public and businesses. 

In 2007, BT needed additional funding. The City Council authorized BT to refinance, which resulted in the $33.5 million financing with CitiCapital. At the time, BT anticipated another refinancing, even after the lease agreement was struck with CitiCapital.

“The terms of financing have CitiCapital with a 100% lien on not only assets that they financed, but all assets subsequently,” Leopold said. “We had two options — one was to either take out the Citi financing, or get Citi to finance a second time based on the underlying lease. By December 2007, we had a good idea of our additional refinancing requirements.” 

In January 2008, BT was authorized by the City Finance Board to seek additional refinancing. However, in March of that year, CitiCapital declared that they were getting out of the municipal leasing business, and the onset of the worldwide financial crisis made it impossible to refinance.

“Just as the city began to pursue additional financing, this country faced the worst financial crisis since the Great Depression,” Leopold said. 

In their complaint filed in January 2010 in Superior Court, local taxpayers Fred Osier and Eugene H. Shaver claim that in 2008, Leopold began to meet operating expenses of BT using funds from the city’s pooled cash management system. The company failed to reimburse the cash pool within 60 days as required, the suit claims. On behalf of Burlington taxpayers, they are seeking to recover from Leopold or his insurer the funds they say the city inappropriately paid from the cash management pool to BT.

The city refused to comment on the allegations contained in the complaint, since it is in litigation.

Though the city was authorized to make payments to BT, it is supposed to have cash reserves or revenues receivables from BT that collectively equal or exceed the payments due to the city, according to the complaint. And BT may receive funds provided it can repay the city within 60 days.

In January, the city filed a motion with the Public Service Board seeking permission for BT to be allowed access to the city’s pooled cash to the extent necessary to make the interest payments due to CitiCapital. The board denied the motion , which led to BT missing the two interest payments to CitiCapital. An amended petition by the city is still pending before the board.

Moody’s Friday downgraded Burlington’s general obligation bond rating to A2 from Aa3, affecting $87 million of debt. The downgrade incorporated the city’s reduced liquidity resulting from the use of its pooled cash account to finance the expansion of BT, the agency said. The rating also factored in the city’s inability, through BT operations, to make successive lease payments to CitiCapital, resulting in draws on the debt-service reserve fund to pay debt service.

“The negative outlook reflects the possibility of further downward rating movement over the near term,” Moody’s noted.

The rating agency also said that given the city’s reliance on cash-flow borrowing, it will continue to monitor the city’s cash position, and its ability to meet day-to-day operating requirements and general fund debt-service payments.

It will also monitor how a potential default of its outstanding telecom lease obligation would impact operations of the enterprise, the agency said.

Last year, the city created a committee to assess the viability of BT and review financing options. The blue-ribbon ­committee concluded that the network is a significant asset but its debt load is too great.

Burlington has hired financial adviser Dorman & Fawcett to assist in restructuring negotiations with CitiCapital.

Meanwhile, a regulatory investigation initiated by the Public Service Department is expected to be completed by the end of July.

James Volz, chairman of the Public Service Board, declined to comment, citing the board’s position as a quasi-judicial agency.

Geoffrey Commons, the board’s special counsel, said that if Citi declares BT in default, it can take back the collateral, which is the fiber-optic system.

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