Health Net Is Still Enmeshed in Court Battles : Medical care: A Colorado company continues to challenge the HMO’s conversion to for-profit status nearly a year after it occurred.

For Health Net, the big health maintenance organization based in Woodland Hills, Qual-Med Inc. of Colorado must seem like a rash that won’t go away.

It’s been nearly a year since Health Net’s controversial plan to switch from a nonprofit to a for-profit company was approved by Thomas S. Sayles, California’s corporations commissioner. The plan requires Health Net to provide $300 million over 15 years to a newly formed charitable foundation.

But ever since Sayles’ ruling in February, Qual-Med--a much smaller HMO operator whose own bid to buy Health Net was rejected--has been chasing Health Net and Sayles in court in an attempt to overturn the conversion and, it hopes, clear the way for Qual-Med to make a renewed offer.

And the legal fight continues to escalate. Qual-Med, whose lawsuit is being heard by Superior Court Judge Roger K. Warren in Sacramento, contends that documents recently unsealed by Warren prove that Sayles’ ruling was flawed because his valuation of Health Net was short by at least $100 million. The trial is expected to start in April.

Health Net, with 901,000 members, is California’s second-largest HMO behind Kaiser Permanente. Like many other HMOs that have converted to for-profit status, Health Net made the switch so that it can eventually tap the capital markets for cash, possibly through an initial public stock offering, and finance its expansion.

But given the legal battle, Health Net isn’t likely to attempt a stock offering anytime soon.

Health Net, for its part, countersued Qual-Med last month in the same court, alleging among other things that Qual-Med’s suit is a waste of its stockholders’ money and is disrupting Health Net’s business. (Health Net was able to claim stockholder abuse because it bought 100 shares of publicly held Qual-Med last summer.)

Qual-Med is “dissipating our resources and dissipating their own,” said Douglas M. Mancino, a lawyer for Health Net. He said Health Net filed its countersuit because “we felt it necessary to communicate, in the only way they’d be willing to listen, that this thing should stop.”

But Qual-Med has no intention of stopping. “We’re going to pursue trying to acquire that company,” said J. Kevin Murphy, Qual-Med’s vice chairman.

As required by state law, Health Net’s conversion required the HMO to donate a sum equal to the company’s fair value to a charitable foundation. In the end, Sayles settled on $300 million, but only after some consumer groups and other health insurers complained that initial estimates of Health Net’s value were far too low.

So Health Net endowed the new California Wellness Foundation, which it organized, with $75 million in cash and agreed to provide an additional $225 million over the next 15 years.

The foundation also got 80% of the stock of H N Management Holdings Inc., a new holding company that owns Health Net. But the stock is non-voting. Health Net’s executives, led by Chairman Roger F. Greaves, bought the rest of the equity in H N Management--which has 100% voting control--for $1.5 million. (Health Net has since given shares to other employees, cutting the foundation’s stake to 73%.)

Qual-Med is effectively asking the court to rule that Sayles abused his office by approving Health Net’s conversion for $300 million, and to have the case reopened so that Qual-Med can try again to buy the HMO.

Previously Qual-Med made several conditional offers for Health Net, including one to the foundation for its Health Net stock, at prices of up to $440 million. Health Net and the foundation have rebuffed the bids largely on the grounds that Sayles’ ruling contains strict curbs on how and when they can sell their shares.

But to support its case, Qual-Med maintains that the recently unsealed court documents clearly show that Sayles’ adviser on the deal, the investment banking firm Bear, Stearns & Co., estimated Health Net’s value at $400 million and estimated the value of management’s stake at $28 million--sums that are both much higher than those approved by Sayles.

Sayles’ Department of Corporations “not only undervalued Health Net by at least $100 million, but it did so in the face of a conflicting conclusion from its own valuation expert,” Qual-Med said in court papers.

The Department of Corporations “abandoned its proper role as an independent regulatory ‘watchdog’ and entered into a kind of partnership relationship with Health Net’s self-dealing management to complete this transaction,” Qual-Med asserted.

Sayles said “the allegations are without merit and the court will come to that conclusion. This was clearly a fair transaction.”

Health Net also denies any wrongdoing and contends that this whole matter is upsetting its business.

Its countersuit says Health Net has “sustained and will continue to suffer the substantial damage to its business,” and that “material numbers of employees have threatened to quit Health Net” if Qual-Med took control.

Health Net also contends that Qual-Med has spent more than $2 million of its stockholders’ money on the litigation, and has made false public statements about its finances and its progress in pursuing the takeover bid.

But Murphy said Health Net’s countersuit “is going to be dismissed” and that Qual-Med has not disrupted Health Net’s business. “That’s ludicrous,” he said.

In the meantime, a restraining order that Judge Warren issued several months ago remains in effect. The order basically forbids any change in Health Net’s ownership until the lawsuits are decided. Which means that for now, Health Net can’t go public even if it so desired.

That barrier might loom large down the road.

Right now, conditions for initial public stock offerings are good, so good that Health Net’s neighbor across the street in Woodland Hills, Blue Cross of California, is planning a $400-million initial stock offering in a new company that will run its HMO and other managed-care divisions.

Mancino said Health Net “clearly” would be considering an IPO now were it not for the judge’s order. Health Net, Mancino said, “ought to have the unfettered ability to consider all of its financing and growth options.”