Tenet

(THC) - Get Report

is still taking its medicine.

The hospital chain, which hoped to return to health by

reaching a $900 million settlement with the government, now faces a legal battle over one of its most prominent facilities.

The University of Southern California sued Tenet this week in an effort to regain control of its USC University Hospital, which the hospital chain has managed for two decades. USC claims that Tenet has violated its obligations by neglecting the hospital and hurting its reputation.

"Starting in 2003, Tenet Healthcare has reduced its capital investment in the hospital to zero, and has reduced its support of the hospital," the lawsuit claims. "Tenet Healthcare's and Tenet Hospital's ability to maintain patient admissions and recruit physicians to practice at the hospital and retain the physicians at the hospital has been materially diminished as a result of Tenet Healthcare's poor reputation."

But Tenet says it has spent $150 million on recent upgrades at the USC hospital. The company also notes that

US News and World Report

has ranked the hospital among the best in the country for the past four years.

"USC and Tenet have successfully managed a successful hospital for the past 20 years," Tenet spokesman Steven Campanini said in an email to

TheStreet.com

Tuesday. "Today was the first we heard of a notice of termination. They didn't tell us; they chose to do it this way, and it is unfortunate."

The lawsuit, filed in Los Angeles Superior Court, notes the huge huge drop in bonus payments from Medicare and managed-care players as a result of Tenet's past payment schemes. USC Hospital has seen its own bonus "outlier" payments from Medicare drop 76% in recent years, according to the suit. Those schemes were the subject of June's Justice Department settlement with Tenet.

The dispute threatens to saddle Tenet with another distraction just as Wall Street is crossing its fingers that a

long-awaited turnaround will finally take hold. On the bright side, though, USC Hospital is hardly a big moneymaker for the company.

"It was so unprofitable," says Mark VanderPluym, a research associate at CRT Capital Group, which doesn't own the stock but recently upgraded the company's stock to buy. "Losing it isn't a worst-case scenario for Tenet."

Shares rose 3 cents Wednesday to $7.41.

Damaged Reputation?

In any case, USC Hospital's reputation may need some work.

Recently, the

Los Angeles Times

reported, USC's busy liver transplant center has come under government scrutiny for its unusually poor results. The

Times

reported that the center's survival rate began to drop in 2002 -- the year that Tenet first ran into trouble over its government billings -- and fell below federal and state standards in a recent government study.

John Lake, chairman of the liver transplantation committee at the United Network for Organ Sharing, sounds worried.

"You have twice as many deaths as expected," Lake said in an interview with the

Times

. "It's pretty hard to chalk that up to bad luck."

More recently, one of USC's own health care experts has started fretting about Tenet as well. David Goldstein, co-director of the USC Pacific Center for Health Policy and Ethics, last month told the

Times

he felt stunned by allegations involving a Tenet hospital in New Orleans. There, a doctor and two nurses stand accused of euthanizing patients during the aftermath of Hurricane Katrina.

"The Katrina situation was so unbelievably unusual in the United States that it is a wholly unique moment," Goldstein told the

Times

. "You couldn't easily come up with a justification" for the alleged killings.

Tenet itself has denied any wrongdoing.

Lost Faith

The publicity surrounding the USC and New Orleans cases shows that Tenet still has a long way to go to win over its skeptics.

By now, many physicians at Houston Northwest Medical Center -- another prominent Tenet-owned hospital -- have lost their faith in the company. For years, they watched huge sums of money flow out of their top-notch hospital and seen very little spent on upgrades or even regular maintenance. As a result, some of those physicians have started referring their patients to other facilities instead.

"That's not going to change," says Phillip Sutton, a so-called splitter physician who sends patients to Houston Northwest and to a competing state-of-the-art breast center nearby. "The hospital is still going to have that battle."

Yet Sutton holds out more hope for Houston Northwest than he did last summer. After scrimping for years to save for a big government fine, Tenet finally has some money to spare for much-needed hospital improvements. At Houston Northwest, for example, Sutton has already seen "a significant infusion of capital into imaging services" -- and formal plans for a new breast center to boot.

But Sutton credits local hospital CEO Drew Kahn, rather than corporate management, for that progress. Indeed, he suggests that the hospital's turnaround will likely come in spite of -- rather than because of -- leadership at the top.

"I think that, as long as management at the corporate level doesn't interfere, this place has a chance," Sutton recently told

TheStreet.com

. Kahn "does not do the smoke-and-mirrors routine. He doesn't tell you things just so you'll walk away; he tells you the truth. And that's refreshing, coming from a representative of this corporation."