About 20 years ago, three country doctors worked side by side at the tiny community hospital in Wheaton, Minn.

Since then, one has gone to prison for sexually abusing patients. Another was run out of town. The third was accused of defrauding Medicare.

It has been a bumpy road for the only hospital in rural Traverse County in far western Minnesota. Last week, the little hospital with just 15 acute-care beds announced it would pay more than $1 million to settle a Justice Department lawsuit for allegedly billing Medicare for years of wasteful and unnecessary treatment.

No one admitted wrongdoing. But the case exposed a bitter internal feud over the way medical and financial decisions were made behind the scenes. And it serves as a cautionary tale about the struggles facing rural hospitals.

"If you are having chest pains, do you want to call an ambulance that takes a half hour to get there, then another half hour back to the hospital? I sure don't,'' former Mayor Janet Wieck said last week. "It's very, very important to keep the hospital going. But that had nothing to do with the charges in the lawsuit."

Exactly what went wrong at the 60-year-old Wheaton Community Hospital depends on whom you believe.

To Dr. Steven Radjenovich, the whistleblower who alerted the Justice Department, it's the story of a community so desperate to keep its city-owned hospital afloat that it was willing to wink at evidence of fraud and shoddy medical care.

To Jesse Tischer, hospital administrator since 2005, it's really about a hospital and doctor who tried to do right by their patients and got caught in a regulatory minefield. "These things aren't always black and white," he said.

Last week, the hospital and Dr. Stanley Gallagher said they would pay $846,461, plus $469,539 for the whistleblower's legal bills, to close the case. That's on top of the hospital's $1.5 million in legal fees.

Few were surprised when Radjenovich filed the whistleblower suit in 2004. He had complained for years about the way Gallagher, his rival, practiced medicine, according to court records and interviews.

Gallagher, one of the busiest doctors in town, had joined Radjenovich at the Wheaton hospital in the late 1970s, and they hadn't gotten along since, Gallagher recalled. They would see each other's patients and rotate as chief of staff -- all while nursing a nasty rivalry.

With Radjenovich's lawsuit, it all came to a head.

Radjenovich, 68, won't talk about it. But he began raising concerns with hospital administrators in the late 1980s, said his lawyer, David Graham.

"Dr. Radjenovich would go to the hospital administrator and tell him that Dr. Gallagher was admitting people that shouldn't be in the hospital, and running tests on people when they didn't need them," said Graham. The hospital, he said, did nothing.

In a court filing last summer Gallagher said that "Radjenovich has been critical of me since the beginning of our relationship," attributing it to professional jealousy. The criticisms, he said, "have no merit."

At the time, the hospital had other problems. Another Wheaton physician, Dr. James Poole, was convicted in 1991 of sexually abusing 11 female patients. He was sentenced to 12 years in prison, and then committed to the state's sex offender treatment program.

As the years wore on, Radjenovich continued to press his case against Gallagher. He asked the hospital to review Gallagher's patient admissions; lodged complaints with Medicare and Blue Cross and Blue Shield; and assisted with an investigation by the Minnesota Board of Medical Practice. Two of those reviews resulted in temporary sanctions against Gallagher; the Medical Board reprimanded him in 2004 for inappropriate and substandard care. The insurer suspended him for a year, Gallagher said in an interview. All of those issues have since been resolved, he said.

But by then, Gallagher said, he'd had enough. "I decided this is it, I'm not going to put up with this," he said.

He refused to work in the same hospital as Radjenovich, and made plans to leave. Instead, the hospital evicted Radjenovich.

He moved his practice to Alexandria, Minn., then filed suit under the federal False Claims Act, accusing Gallagher and the hospital of "conspiracy to defraud the United States." The suit prompted an investigation by the U.S. Attorney's office, which joined the lawsuit in 2007. The government reviewed 170 of Gallagher's patient admissions, and found that many were "not medically necessary" -- for example, hospitalizing people for blood transfusions -- and that Medicare shouldn't have paid for them. The government suit also accused the hospital of ignoring the abuses because it needed the money. It noted that Gallagher generated more than $4 million a year in billings for the hospital, 10 times that of its other doctors.

At one point, court records show, city and hospital officials wrote a letter warning it would mean "financial disaster" if Gallagher couldn't admit Medicare patients anymore.

Both the hospital and Gallagher vigorously denied the allegations.

At the heart of the investigation is the ambiguous question of what's medically necessary.

"Don't get this wrong. Medicare should be billed only for what Medicare regs say it will pay for," Tischer said. "But reasonable people, educated people can disagree about just what constitutes a medically necessary hospitalization."

Terry Hill, a rural health expert, agrees.

"The fact is that medicine is practiced differently in rural areas than urban areas," said Hill, executive director of the national Rural Health Resource Center in Duluth. "In the Twin Cities, you can be practically anonymous as a doctor, but not so in small cities. There, if you make a mistake by under-treating a patient -- say you send 91-year-old Mr. Jones home alone and he falls and dies -- everybody in town knows about it.

"So you say, 'OK, what's the best medicine here? Treating him at home alone or in the hospital, where he can be monitored?'''

But D. Gerald Wilhelm, an assistant U.S. attorney who led the federal investigation, said Medicare doesn't pay for custodial care. "We're not saying you can't put anybody in the hospital. You can," he said. But if it's not justified medically, "we won't pay for it."

In general, experts don't see widespread Medicare fraud among small hospitals. But they say the government's billing system is complex and can lead to misjudgments. Medicare has hired contractors to begin auditing U.S. hospitals for improper billing under a new Recovery Audit Contractor program that will start soon in Minnesota.

At Wheaton, hospital officials say they were ready to defend their decisions, but decided to cut their losses and move on. Later this year, the hospital plans to merge with the MeritCare Health System of Fargo -- bringing with it far more expertise in billing than small hospitals can offer.

Weick, the former mayor, is looking forward to that day.

"That business is so much more complex than when the city started the hospital in 1950," she said. "It was time for the city to get out of the business."

Warren Wolfe • 612-673-7253 • wolfe@startribune.com Maura Lerner • 612-673-7384 • mlerner@startribune.com