The countersuit is a rebuttal to an October 1 lawsuit that Highmark filed in the Pennsylvania Court of Common Pleas. Highmark is seeking to block West Penn from talking to other potential investors and claims that West Penn violated their contract by pulling out of the deal.

The suit by Pittsburgh-based Highmark, a top-10 U.S. health insurer, "is nothing more than an attempt to prevent West Penn Allegheny from determining what options other than… bankruptcy exist," the health care system said in court papers.

"West Penn Allegheny's demise would not only irreparably harm the health system and its employees, it would also result in great harm to the community, reducing competition and health care choice and increasing costs," it said.

The heated dispute and the abrupt end to their planned alliance caused concern among all three major credit rating agencies. On September 28, the same day the public learned of the collapsed deal, the agencies warned that they might downgrade the regional nonprofit health system.

About $737 million in outstanding municipal bond debt issued by the Allegheny County Hospital Development Authority in 2007 is affected by the rating agency actions.

West Penn comprises five hospitals and additional healthcare and research facilities. It had about $1.2 billion in unrestricted net assets as of March 31, but about $1.4 billion of total liabilities, according to Standard & Poor's Ratings Services analyst Martin Arrick.

West Penn said in court filings that it "could and would not stand still in the face of Highmark's demands to close the through a ‘pre-packaged' bankruptcy filing that Highmark would control and to seek a distressed termination of its pension plans."

In response to Highmark's "unrelenting bankruptcy and debt restructuring demands," West Penn proposed a third-party joint venture and other alternatives, which Highmark rejected, West Penn said.

The health care system also claimed that Highmark "absolutely and unequivocally" was the one to reject the affiliation agreement and repeatedly told West Penn that it wouldn't consummate the transaction even if state regulators approved it.

West Penn cannot talk to other potential suitors until after a two-day hearing, scheduled to begin October 25, on Highmark's request for an injunction.

In its countersuit, West Penn asked for unspecified monetary damages. It also said that because it has lost value as it tried to meet Highmark's demands over the past year, it should be allowed to recoup the difference between any eventual sale price to another buyer and what it could have received under its agreement with Highmark.

The insurer has already provided $200 million in grants and loans to West Penn.

Highmark, which is readying for major shifts in healthcare funding under U.S. reforms by assembling an integrated health-delivery network, struck the affiliation agreement with West Penn last November.

(Reporting By Hilary Russ; Editing by Ken Wills)

• A Permanent Economic Emergency