The state Employees’ Retirement System and the Hawaii Health Systems Corp., which operates the state’s public hospitals, formally agreed to drop a lawsuit this week over benefits for about 1,500 employees at three Maui County hospitals.

ERS, the retirement fund for 120,000 current and former state and county employees, filed the complaint in August to block a new law that would have authorized either severance payments or retirement bonuses for hospital workers affected by the privatization of Maui Memorial Medical Center, Kula Hospital and Lanai Community Hospital to Kaiser Permanente Hawaii, scheduled for July 1.

The parties claimed that the law threatened the tax-exempt status of the ERS’ retirement fund. Last August, an Oahu Circuit Court judge issued a temporary restraining order barring state officials from implementing the law. In September, the parties agreed to delay the court proceedings until an opinion could be issued by the Internal Revenue Service, which ruled the state couldn’t offer a choice of severance or retirement benefits.

The state Attorney General’s Office said in a news release that the parties agreed to withdraw the suit after the Legislature repealed the law and passed a new measure that provides only severance payments.