CHICAGO — A group of investors who hold a piece of Menasha’s $24 million of city appropriation-backed steam plant revenue bond anticipation notes allege in a federal lawsuit filed earlier this month that the Wisconsin city committed fraud in misrepresenting its intent to repay the now-defaulted notes.

“We hope the city makes a good faith attempt to develop a plan to pay its obligations to the noteholders who trusted the city when they made this investment,” said Michael Wukmer, an attorney at Ice Miller LLP representing bondholders who filed the lawsuit.

The city defaulted on its appropriation pledge that backs up a revenue pledge on the notes Sept. 1. The $24 million of debt comprises $12.6 million of Bans sold in 2005 to convert Menasha Utilities’ power plant to coal-fired steam operations and $11.5 million issued in 2006 to cover the project’s growing costs.

The coal-fired plant — burdened with growing construction costs, unfavorable regulatory rulings, and pricing disputes — has failed to generate sufficient revenue to cover both operations and debt. Given the plant’s losses and dim prospects, the city could not refinance the Bans into long-term debt as originally intended.

The complaint — Lafayette Life Insurance Co. et al v. Menasha et al — was filed Sept. 18 in the U.S. District Court for the Northern District of Indiana. The suit was brought by Lafayette, which is based in Indiana, Mercy Ridge Inc., and American Bank, but class action status is being sought on behalf of individual investors, retirement communities, unions, church groups and other nonprofit bondholders.

Lafayette holds $4.2 million, Mercy holds $550,000 and American Bank holds $1.8 million. Attorneys for the plaintiffs said they represent additional investors who hold a majority of the notes and others are expected to join the litigation, but they declined to name other members of the potential class.

The lawsuit alleges that Menasha and its utilities division “misrepresented” the plant’s business prospects and the true costs of the conversion in the official offering statement for the note sales and that they omitted information regarding pending litigation involving the plant. The city also omitted or misrepresented material facts as to the true costs of addressing environmental issues involving the plant, the complaint charges.

The 12-count complaint includes alleged violations of state and federal securities laws, breach of contract, and negligent misrepresentation.  It calls on the city to make good on its appropriation pledge.

The lawsuit asserts that investors “trusted and believed” Menasha’s representations that it had contracts and an operational plan in place for the steam utility that would produce sufficient revenue to repay the notes, that the city would issue long-term bonds to retire the notes, and that it would appropriate the funds necessary to cover deficiencies. “Unfortunately it has become apparent that Menasha had no plan and never intended to make good on its promises,” the suit alleges.

Without the financial resources to honor the debt payment, the city had hoped to reach a forbearance agreement with a committee representing 77% of the bondholders ahead of the Sept. 1 payment date that would have averted a default. Mayor Donald Merkes said at the time of the default that negotiations were continuing and the city would make a good faith effort to repay bondholders. City officials could not be reached for comment Friday.

Menasha drained a bond reserve fund of $1.9 million to make a $600,000 interest payment and a partial $1.38 million principal payment. Market participants said the default on appropriation-backed debt pledge may have marked a first for a municipality in Wisconsin.

Unless a resolution is reached, the city faces a costly and difficult time accessing the tax-exempt market on its own. It could still seek low-cost loans from the state’s trust fund loan program. Officials had hoped for help from various state agencies, but it appears that special state legislation might be needed to aid in any workout plan.

Stern Brothers and the law firm Hunton & Williams LLP are advising Menasha on its negotiations. A report from its advisers this past spring warned the city that absent an agreement with bondholders, it faced negative credit action and potential litigation from bondholders.

The steam plant’s fiscal struggles have taken a steep toll on the city’s credit ratings. Moody’s Investors Service last month downgraded its $29 million of general obligation debt to B1 with a negative outlook, four notches below investment-grade.

The downward slide began this spring when Moody’s lowered the city’s GO rating to Baa2 from A3 and then dropped the rating to junk-bond status at Ba2 following the Menasha Utilities Commission’s vote to close the plant.

Moody’s also downgraded $5.8 million of water and electric revenue debt one notch to Baa3 with a negative outlook. Moody’s speculative short-term rating of SG remains on the $24 million of defaulted debt and on $14 million of taxable GO promissory notes. Those latter notes come due on Sept. 1, 2010.

“The negative outlook reflects Moody’s expectation that the city will continue to be challenged by the steam utility’s cost over-runs and failure, as well as by the large amount of debt associated with the project,” analysts wrote.

Menasha has approval for a $7 million state Bureau of Public Lands loan and the city is expected to seek approval for additional loans that could help in a workout plan or help cover the Bans coming due next year that carry its GO pledge. The cost to shut down the plant is estimated at $5 million.

With its eye on preserving its economic base, the city decided in 2004 to convert a portion of its electric generation plant to produce industrial steam to support the area’s paper mills that were interested in purchasing steam from a central plant that used coal as its primary fuel in an effort to save money.

The costs skyrocketed from an initial $12.6 million to $40 million as equipment and other costs grew. The utility struggled with mechanical difficulties and other technical problems through 2007. The plant also has faced pricing battles with two of its steam customers and regulatory challenges.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.