Federal Court of Appeals Rejects HHS Stance on Section 340B Contract Pharmacies

On January 30, 2023, the Court of Appeals for the Third Circuit issued a precedential decision rejecting a policy of the Department of Health and Human Services (HHS) in implementing the 340B Program. Under that policy, HHS took the stance that drug manufacturers must distribute discounted drugs to an unlimited number of so-called contract pharmacies, and that drug manufacturers that failed to do so were in violation of the 340B Program. The Third Circuit’s decision rejected that position, effectively permitting manufacturers to restrict the number of drug distribution channels to mitigate the risk of drug diversion – i.e., the dispensing of deeply discounted 340B drugs to patients who are not entitled to the discount.

The 340B Program is designed to allow certain qualifying hospitals and clinics that treat low income and uninsured patients, among other entities (referred to as “covered entities”), to buy certain prescription drugs at substantial discounts from manufacturers. Participation in the program is effectively mandatory for drug manufacturers seeking to reach a broad patient population because manufacturers must accept its conditions in order to obtain Medicaid coverage for their drugs. 42 U.S.C. § 256b.

The 340B Program statute seeks to prevent these highly discounted drugs from being diverted to individuals who are not eligible patients of the covered entity by requiring covered entities to dispense 340B-qualifying drugs only to their own patients. 42 U.S.C. § 256b(a)(5)(B). Because the drugs are sold at steep discounts, the 340B Program statute also prohibits duplicate discounts by exempting sales under the 340B program from various other discounting and rebate requirements. Covered entities’ compliance with the anti-diversion and duplicative-discount prohibitions is subject to audits by both HHS and drug manufacturers, and violations can be penalized.

But despite these requirements, concerns about diversion and duplicative discounts have grown as covered entities have increasingly contracted with outside pharmacies to administer their 340B programs. The use of these “contract pharmacies,” which generally serve patients of both covered entities and non-340B Program providers, and the inability of drug manufacturers to audit those contract pharmacies have magnified concerns about diversion of the discounted drug to ineligible patients.

The explosion in the use of contract pharmacies was facilitated by a change in HHS policy. In 1996, HHS issued guidance stating that covered entities could use one contract pharmacy each. 61 Fed. Reg. 43,549 (Aug. 23, 1996). In 2010, HHS issued new guidance stating that covered entities could use an unlimited number of contract pharmacies rather than only one. 75 Fed. Reg. 10,272 (Mar. 5, 2010). Amid rising concerns about the proliferation of contract pharmacies and the inability to audit the actions of those pharmacies, several drug manufacturers pushed back with policies limiting the use of contract pharmacies — for example, restricting covered entities to a single contract pharmacy, requiring approval from the manufacturer before multiple contract pharmacies could be used, or conditioning the use of multiple contract pharmacies on the submission of specified claims data for auditing purposes. HHS responded with an Advisory Opinion declaring that the 340B Program required manufacturers to deliver 340B-covered drugs to an unlimited number of contract pharmacies. It later issued “violation letters” to several drug manufacturers, which in turn filed suit. During the course of litigation, HHS rescinded its Advisory Opinion but continued to stand behind its legal position that placing conditions on the use of contract pharmacies violates the 340B Program. District courts in Delaware and New Jersey reached conflicting decisions on the policy, which resulted in appeals to the Third Circuit.

In the Third Circuit decision announced on January 30, 2023, the court unanimously held that HHS’ policy was not supported by the statute, which is silent with respect to how the discounted drugs were to be delivered to covered entities. As a result, the court concluded, the drug manufacturers’ policies were lawful and HHS’ efforts to enforce its contrary interpretation were not. In the course of its decision, the court noted that “one could argue” that a delivery condition completely barring the use of contract pharmacies might violate the statute to the extent that it would effectively prevent covered entities that lack their own in-house pharmacy from accepting and dispensing drugs. But the court explained that question was not presented by the drug manufacturers’ policies at issue, which merely limited covered entities’ ability to use more than one contract pharmacy.

The Third Circuit’s decision represents an important precedent for drug manufacturers seeking to limit drug diversion under the 340B Program by placing conditions on deliveries to contract pharmacies. Nevertheless, questions about such policies remain and may be the source of further disputes and litigation. First, the Third Circuit decision formally binds HHS only as to the three drug manufacturers in the case, and it remains to be seen whether the agency will acquiesce to the court’s holding or adhere to its own interpretation in other circuits. Second, state governments have also entered the fray, and litigation is pending as to whether state protections for contract pharmacies under the 340B Program are preempted by federal law. See PhRMA v. McClain, No. 21-cv-864 (E.D. Ark.). The Third Circuit’s decision may affect that preemption question, but it does not alone resolve it.

For more information regarding the contract pharmacy dispute and other current controversies in the 340B Program, please see our recent Health Law360 and Life Sciences Law360 article, “4 Key Issues Driving Drug Discount Abuse Must Be Addressed” (Jan. 9, 2023).