CHICAGO — Menasha would pay holders of $23 million of defaulted steam-plant bond anticipation notes $17.5 million under a proposed cash settlement that would end bondholder litigation and put the Wisconsin city on a path towards rebuilding its credit.

The city defaulted on the notes in September 2009. The notes include $12 million sold in 2005 to convert Menasha Utilities' power plant to coal-fired steam operations and $11 million issued in 2006 to cover the project's growing costs.

The city's appropriation pledge backed up the revenue pledge that repays the notes. The plant was shuttered in the fall of 2009.

A group of bondholders — led by American Bank, Lafayette Life Insurance Co. and Mercy Ridge Inc. — filed a federal complaint after the default alleging that Menasha and its utilities division misrepresented the coal-fired plant's business prospects and the true costs of converting it to steam operations.

Lawyers for the debt holders and the city had been meeting in an attempt to resolve the litigation, but their efforts failed until late last week when the $17.5 million settlement was announced.

"It's a good settlement for the bondholders given the structure the of the deal, Menasha's financial position, and the inherent risks of continuing litigation," said Michael Wukmer of Ice Miller LLP, which represented the noteholders behind the litigation. The city has not confirmed news of the settlement.

The noteholders alleged Menasha violated federal and state laws by misrepresenting the prospects of the steam plant and by failing to make good on the appropriation pledge. They claim to have been misled about the plant's final costs, completion date, and prospects and the city's intent to refinance the notes with long-term debt.

The city had countered that the bond offering statements offered only an "estimated" cost and an "expected" completion date.

They also cautioned that the plant had four "potential" users, but offered no guarantee all would use the plant. The city also asserted that at the time of the offering it fully intended to convert the notes to long-term bonds when they came due and only the plant's failure prevented them from doing so.

The settlement will be funded in part from proceeds from a sale-leaseback of city utilities approved by Wisconsin Public Power Inc., other city funds, and from funds contributed by third parties involved in the underlying transactions, according to Wukmer.

RBC Capital Markets, underwriter of the notes and a defendant in the lawsuit, is contributing to the settlement, but the firm did not disclose details.

"RBC is pleased that the city of Menasha is settling this case. We remain confident that the lawsuit against RBC was without merit and we feel the claims against us would have been dismissed, however we decided to help facilitate the settlement because we view it as a positive development for both the taxpayers of Menasha and the noteholders," said company spokesman Kevin Foster.

The settlement hinges on approval from the federal district court in Indianapolis and the successful closing of the asset sale. Wukmer said the process could take up to 180 days to complete.

The lead plaintiffs will ask the court to approve the settlement on behalf of the class of noteholders, who will then have a chance to comment on the settlement. They could oppose the settlement or opt out of the deal.

Menasha voters last April signed off on the sale of the city's electric utility assets to WPPI Energy — a regional wholesale supplier of power to 51 members, including Menasha.

Under terms of the deal, WPPI would purchase the utility's distribution assets in a deal that would provide about $15 million to settle claims.

The city would then lease the assets back in a 20-year deal. The sale will result in a small rate increase. If the referendum had failed, officials warned of a steep increase in property taxes.

Any money under the deal must go to settle noteholder claims and pending arbitration claims and regulatory fines. WPPI would use cash on hand to complete the purchase.

Moody's Investors Service rates the supplier's $422.7 million of debt A1.

The deal involves the city utility's other electrical generation assets and not the steam plant. The WPPI sale was approved by the Wisconsin Public Service Commission on Feb. 12.

The defaulted debt has strained city finances, led to its loss of an investment-grade general obligation rating, and hurt its near-term ability to access the tax-exempt market.

With its eye on preserving its economic base, Menasha decided in 2004 to convert a portion of its electric generation plant to produce industrial steam to support area paper mills.

The mills were interested in purchasing steam from a central plant that used coal as its primary fuel in an effort to save money.

But the coal-fired plant — burdened with growing construction costs, unfavorable regulatory rulings and pricing disputes — failed to generate sufficient revenue to cover both operations and debt service. The plant conversion was originally supposed to cost just $13 million but the price tag rose to $41 million.

Given the plant's losses and dim prospects, the city could not refinance the notes into long-term debt as originally intended.

Menasha has another $14 million of taxable GO promissory notes issued for the plant, but the city is retiring them with two loans form the Wisconsin Bureau of Public Lands trust fund. The city must begin repaying those loans in its fiscal 2011 budget.

As part of the WPPI asset sale, the city also must defease its $2 million of utility debt. City and utility officials did not return calls to discuss the timing of refinancing plans.

Moody's in 2009 downgraded the city's $29 million of general obligation debt to B1 with a negative outlook, four notches below investment grade.

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