Seems that the send lowercase is checked, but on the initial connection to a server, it is still passing XTERM instead of xterm.
Dunno about the rfc allowing for it, but none of the distributions I work with support XTERM currently. (Fedora, RHEL/Centos, Apple OSX, etc).
it seems this is no longer affecting me.
I could reproduce it initially, but I seem to have found a work around as well:
1.) Set a different terminal.
2.) Apply the terminal
3.) Restore "xterm"
4.) Apply the setting
5.) Set as default.
Seems to fully set it and correct the original issue. Maybe it was just the first usage was somehow created incorrectly?