Hi Andy,
The only thing I did to BugNET's config file was remove some stuff from the ConfigSections part of the file (this was to get BugNET to actually run).
It was complaining that certain sections were already defined.
As I mentioned I was able to use your config file in the root of my site and BugNET in a physical sub-fodler configured as an app.
Nothing fancy nothing out of the ordinary.
However I tried doing the same thing on a site that was running v1.1 of .NET in the root and it was bombing out on me.
Your config file indicates that you are using .NET 3.0 in the root of the website. But i am sure this is not a problem.
On the V.1.1 website we fixed the problem by creating a new iis website listening on port 8080. We then configured the root of this website (which points to the same folder as the other website and has BugNET as a sub-folder). We then made this port 8080 website ASP.NET 2.0.
So now we access bugnet on that box using the url http://www.server.name.domain:8080/bugnet
This workaround might work for you too.