Regrouping after a legal setback, Transactive Corp. has signed a letter of intent with the Illinois Department of Public Aid to equip and service its statewide electronic benefits transfer system.

The Austin, Tex.-based processing company, a subsidiary of the lottery system operator Gtech Corp., said it is negotiating a five-year contract with two one-year extension options.

The system will enable the distribution of food stamp and welfare benefits through point of sale terminals. Initially, it will serve about 65,000 households in two counties before expanding statewide to serve 500,000 households through 7,300 retailer locations.

The arrangement "reaffirms Transactive as a leader in EBT," said Marc Palazzo, a company spokesman. "State governments are always looking for opportunities to streamline, and EBT provides that."

Transactive has been opposing a Treasury Department procedure that requires a bank to be the primary contractor on EBT systems. The company is appealing a September federal court ruling that affirmed the Treasury's bidding method, known as an invitation for expressions of interest, or IEI.

Under this process, which differs from a conventional request for proposals, Citibank recently won the designation of the Southeastern Alliance of States.

Citibank runs similar programs in South Carolina, Pennsylvania, North Dakota, South Dakota, Ohio, and parts of New York and Texas.

Mr. Palazzo said a hearing on the appeal is scheduled for February.

IEI rules require a depository institution to serve as the government's financial agent, though data processing work can be subcontracted to a nonbank.

States still have the option to invite proposals from nonbank providers. If the federal government is not a party to these deals, they do not need a bank agent. This is the way a coalition of northeastern states has chosen to go.

The Northeastern Alliance winner should be decided by the end of this month, according to Liam Carmody of Carmody & Bloom, a consulting firm in Woodcliff Lake, N.J.

Mr. Carmody said the three front-runners are Citicorp, Chemical Bank, and Gtech, which is entering jointly with Fleet Financial Group.

Transactive has "a chance of getting the Northeast, but just a chance," said Mr. Carmody. "If they don't get the Northeast, they'll lose New York," where the company has been servicing a public assistance identification card program for several years.

In February 1994, Transactive was awarded the biggest EBT contract to date, a $200 million, seven-year deal in Texas. It now distributes about $3 billion in food stamps and welfare benefits annually to 1.2 million households through a network of 16,000 retailers.

"Illinois and Texas are two of the really big states" in EBT processing, Mr. Carmody said.

Texas' move to electronic benefits "has reduced fraud dramatically, eliminated wasteful bureaucracy, increased retail sales, and increased dignity for recipients," said Mr. Palazzo. "We intend to bring that experience to Illinois."

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