Even before the 100-year-old church burned to the ground two years ago, it was clear that St. Mary Magdalen Church of Lost Creek, Pa., had seen better days.

But for the 260 members on the rolls at the time of the fire -- less than half its membership 25 years ago -- the church in the coal-mining town 80 miles north of Harrisburg was the center of their social life, as well as their spiritual home.

So there was no question in the minds of the parishioners that the church would be replaced, if not by as elaborate a building as the original, at least by some structure that would continue to provide, as had the old church, a meeting place.

"We, our parents, our grandparents -- we'd paid the insurance premiums and we always thought that if anything happened, the insurance money would be there for a new church," said Jean Joyce, a lay leader in the Roman Catholic parish.

But the bishop of Allentown, the Most Rev. Thomas J. Welsh, had other ideas. When the $474,472 check from the insurance company arrived, he deposited it in the diocesan account and allocated the money for other programs.

Asserting that a parish of fewer than 300 members was too small to justify building a new church, Welsh earmarked $100,000 to expand and refurbish a small chapel in the rectory. An additional $174,472 went into an interest-bearing account to subsidize parochial school tuition for the children in the parish.

The diocesan high school nearest the parish received $100,000 and $100,000 went into another diocesan interest-bearing account.

The outraged parishioners began refusing to attend mass in the refurbished chapel.

"It can't seat more than 50 people," said Joyce.

The parishioners began exploring other means of protest. Last fall they formed the St. Mary Magdalen Committee and, in November, they sued Welsh, a former bishop of Arlington, and the diocese, charging among other things, that he had no right to act unilaterally in cashing the insurance check.

"The insurance policy was issued to the church and the diocese, and the check was, too," said Stephen G. Welz, attorney for the parish. "It was illegal for the check to be deposited in the diocesan account. It was also illegal for the bank to accept the check with only one of two required endorsements."

The Industrial Valley Bank and Trust Co. of the Lehigh Valley, which accepted the check, also was named as a defendant.

In a response filed earlier this month, attorneys for Welsh and the Diocese of Allentown argued that the bishop had acted within both state and canon law.

In contending that the parishioners should have no say in the disposition of the money, diocesan attorneys said: "Under canon law, only the pastor under the authority of the bishop may act for and in the name of the parish, and no parishioner has such authority."

The response of the defendants' lawyers also said that, even before the Jan. 19, 1984, fire, Welsh had held conversations with the then pastor of St. Mary Magdalen, the Rev. Joseph Carroll, about the possibility of dissolving the parish because of its small size.

"That's news to us," said Joyce, one of the eight-member St. Mary Magdalen Committee, which brought the suit. She said that no one in the parish knew of such discussions, but added that Welsh is pressing to close small parishes in the diocese.

Earlier, Welsh had sought to head off the court suit by blaming the illness of the newly appointed parish priest on the turmoil.

When the Rev. Thomas Horan, who reportedly had a history of frail health, was hospitalized, Welsh sent parishioners a letter linking Horan's illness to the parish's problems.

"I appeal, therefore, to those who are involved in the decision to go to court against the diocese, please reconsider," he wrote. "If you continue to pursue it, it can only harm Father Horan even more, as well as do a great deal of harm to your parish and the diocese.

"I know that if legal action were dismissed, it would bring a great deal of comfort to Father Horan and, God willing, restore him to health and your parish."

And, Welsh added: "If Father Horan does not recover his health, I will not be able to send another priest to St. Mary Magdalen."