Opinion analysis: Third-party beneficiaries cannot sue drug manufacturers for over-charging

In a brief, unanimous decision authored by Justice Ruth Bader Ginsburg, the Court reversed a Ninth Circuit decision that had held that state public health care facilities (known as “340B entities”) have a right, as third-party beneficiaries of federal Pharmaceutical Pricing Agreements, to enforce those contracts for alleged over-pricing of drugs. In order to participate in state Medicaid programs, pharmaceutical companies enter into price-ceiling contracts with the Secretary of Health and Human Services (HHS). In enacting a complex statutory scheme, the Court held, Congress vested enforcement compliance authority for drug pricing with the Secretary of HHS, and not with the public health facilities.

The Court simply held that suits by these public health care facilities would be incompatible with the statutory scheme that permits pharmaceutical companies to participate in the state Medicaid Rebate and 340 Programs. The Court first noted that the statutory scheme provided no express private right of action to enforce the pricing contracts in the third-party beneficiaries of those contracts. In absence of an express right to sue to enforce compliance, the Ninth Circuit erred in concluding that such entities had a right to pursue relief as third-party beneficiaries of the agreements. The Court held that the statutory scheme vested no auxiliary enforcement role in these 340B entities.

The Court held that the PPA agreements simply incorporate statutory obligations with regard to drug pricing, and register the drug manufacturers’ agreements to comply with those terms. Any third-party suit to enforce a PPA agreement, then, would in essence be a suit to enforce the statutory scheme.

The Court’ brief decision is largely a statutory construction exercise and forged no new novel jurisprudential grounds. As such, the decision most likely will have circumscribed precedential value beyond the limited facts of the case.

The Court also rejected the Ninth Circuit’s rationale in support of the third-party entities’ right to sue based on the theory that this would assist the federal government by spreading the enforcement burden around among many beneficiaries. The Court instead concluded that “spreading the enforcement burden” was not what Congress contemplated when it made HHS the administrator of the Medicaid and 340B programs. In addition, third-party suits would undermine efforts of HHS and the Health Resources and Services Administration (HRSA) to administer the programs uniformly and harmoniously throughout the United States.

Finally, the Court responded to the Ninth Circuit’s suggestion that HRSA enforcement efforts with regard to drug over-pricing had been lax, as reported by the Inspector General of the HHS, and consequently these lax enforcement efforts justified third-party beneficiary suits. The Court, however, indicated that Congress did not respond to the reports of lax enforcement by authorizing third-party beneficiary suits. Instead, Congress amended the law to strengthen and formalize HRSA’s enforcement authority, to make a new adjudicative framework as the proper remedy for covered entities to complain of over-charging violations, and to provide for judicial review under the Administrative Procedure Act for the HRSA’s resolution of over-pricing claims.

The appeal by the Astra pharmaceutical defendants was grounded in a complicated federal statutory scheme and centered on whether Santa Clara County, California, on behalf of a large number of California public health facilities, could bring a suit against pharmaceutical companies for over-pricing the cost of their drugs to these facilities, in violation of law.

The basis for this litigation was two inter-related, complex federal statutes: the Public Health Service Act and the Medicaid Rebate Act. Provisions of these statutes impose drug-pricing regulations on drug manufacturers whose drugs are covered by Medicaid. Provisions of the Public Health Service Act impose ceilings on the prices that drug manufacturers may charge for prescription medicines that are sold to specified health care facilities and entities, which are referred to as 340B entities. 340B entities include public hospitals and community health centers, many of which provide safety-net services to the poor. Approximately 14,500 entities across the United States participate in this program as 340B entities.

The Medicaid Act and Public Health Services Act, as a condition of participating in state Medicaid programs, requires drug manufacturers to enter into contracts with the Secretary of Health and Human Services, by which the drug manufacturers agree to adhere to the Acts’ pricing restrictions which set ceilings on the permissive price of drugs. Ceiling prices for a particular drug are determined based on the manufacturer’s “average manufacturing price” and “best price” prescribed and defined by the Medicaid Act. The drug companies have reporting duties regarding these parameters for setting a ceiling price for a drug.

The contracts that pharmaceutical companies enter into with the Secretary are known as Pharmaceutical Pricings Agreements (PPAs). Under the PPAs, the drug manufacturers agree to provide discounted prices to the 340B health care providers and entities. Approximately 550 drug manufacturers have entered into agreements with the Secretary, covering more than 35,000 drugs.

The Medicaid Act contains several provisions authorizing the Secretary of HHS to enforce the drug-pricing requirements. The Secretary may survey wholesalers and manufacturers to verify manufacturer prices. The Secretary may suspend agreements and impose penalties of a thousand dollars per day for companies who fail to report their “average manufacturing price” or “best price” on a timely basis. Manufacturers are subject to civil monetary penalties of up to $100,000 for providing false information. The Secretary may terminate an agreement for violation of the agreement, or other good cause.

If the Secretary believes that a manufacturer is not complying with the requirements, the Pharmaceutical Pricing Agreement authorizes the Secretary to initiate an informal dispute resolution process. The PPA specifies that the agreement shall be construed in accordance with federal common law, but it contains no provision that allows a 340B entity, or any third-party beneficiary of the agreement, to enforce the terms of the pricing agreement.

Originally Santa Clara County, on behalf of numerous 340B health care facilities in California, brought a class action lawsuit in California state court, alleging that various pharmaceutical companies were over-charging for drugs sold to the facilities. From 2003 to 2005, Santa Clara County’s 340B entities spent approximately $90 million on drugs sold under the agreement with drug manufacturers.

The drug companies removed the litigation to the federal court for the Northern District of California. After removal, the County amended its complaint to add a third-party beneficiary breach of contract claim, on behalf of the 340B health facilities, alleging that the pharmaceutical companies were over-charging the health care facilities under the 340B program, in violation of the pharmaceutical pricing agreements.

In an unreported decision, the federal district court dismissed all the state law claims, including the third-party beneficiary breach of contract claim. The court held that the 340B entities were intended third-party beneficiaries under the PPA agreement. However, the court held that neither the statute nor the pricing agreement reflected an intent to provide private parties the right to sue to enforce the pricing requirements.

On appeal, the Ninth Circuit reversed and held that federal common law provided a third-party beneficiary, such as a 340B health care facility, with a breach of contract action to enforce the Act’s drug pricing provisions, as incorporated into the agreements. The court held that allowing such suits was consistent with Congressional intent in enacting the program, even though the statute itself did not create a federal private right of action. The Ninth Circuit disagreed with the district court’s conclusion that something more was needed to allow 340B entities to sue to enforce the pricing agreement.

In subsequent proceedings, the Ninth Circuit invited the Secretary of HHS to file an amicus brief. In response, the United States government expressed the view that “it never imagined that a 340B entity could bring a third-party beneficiary lawsuit” and that such a lawsuit would confer “rights never intended” by the pricing agreements. The Secretary also indicated that permitting a private right of action would be disruptive to the statutory pricing and enforcement schemes.

The Supreme Court relied heavily on the Government’s amicus brief setting forth the same position to the Court.

Justice Kagan did not participate in the decision of the case.

Linda S. Mullenix is the Morris & Rita Atlas Chair in Advocacy at the University of Texas School of Law