ABSTRACT: The settlement in question has a higher starting population (1100) than the "level" of settlement it is (It's a village and villages upgrade to towns at 1000). Moreover, the wooden palisade required for village->town upgrading is already built when the campaign starts. This results in a permanent no-progress bug where the wall upgrade cannot be built "again" to upgrade to a town.
SOLUTION: In your descr_strat.txt (Located in \Medieval II Total War\mods\Third_Age\data\world\maps\campaign\imperial_campaign\), find (ctrl+f) the West-Mirkwood province. Change "level village" to "level town". Restart your campaign.
Enjoy