After a number of emails with Gerrit and a lot of hair pulling, I've finally got an answer on this one (and a fix). The problem is a compatibility issue that is specific to the ssh server he is using. The server in question is OpenSSH 3.5p1 embedded in a netasq firewall.
Stock OpenSSH 3.5p1 from openssh.org does not exhibit this problem, so I imagine that the incompatibility was introduced by customization of the OpenSSH server by Netasq. The Netasq OpenSSH version, in combination with a seemingly innocuous change in version 5 created an incompatibility between AbsoluteTelnet (5 & 6) and any netasq products with the same or similar firmware.
Absolute has been modified to account for the difference and a new beta is now available:
http://www.celestialsoftware.net/telnet/...uteTelnet7.13RC6.exe