The Third Circuit recently ruled that certain agency actions requiring drug manufacturers to distribute discounted prescription drugs to contract pharmacies under the 340B Drug Pricing Program violate the Administrative Procedure Act. The court’s decision has important ramifications for oversight of the 340B program and will trigger new considerations for certain hospitals that rely on 340B payment to supplement federal grants and other financial sources.

Background on the 340B Program

The 340B program gets its name from section 340B of the Public Health Service Act. Under that program, drug manufacturers that participate in Medicare and Medicaid are required to sell certain outpatient drugs to safety-net health care providers at a discount. These health care providers — known as “covered entities” — are supposed to use the savings from the discounts to provide comprehensive services to underserved communities, including low-income individuals, racial and ethnic minorities, and rural communities. Covered entities include sole community hospitals, rural referral centers, children’s hospitals, cancer hospitals, Tribal/urban health centers, and critical access hospitals. But recent press reports suggest certain hospitals may be taking advantage of the 340B program to pursue greater profits rather than meet the needs of low-income patients. Through the Health Resources and Services Administration (HRSA), the U.S. Department of Health & Human Services (HHS) oversees the 340B program.

To ensure the integrity of the program, federal law prohibits covered entities from giving 340B drugs to ineligible patients (drug diversion) and providing 340B discounts and Medicaid rebates on the same drugs (duplicate discounts). HRSA monitors compliance with these requirements by auditing the covered entities’ expense reports. Manufacturers may also bring claims against covered entities for diversion and duplicate discounts.

The mechanics of how 340B drugs are dispensed and distributed through pharmacies — whether in-house or via contract with a third-party — have evolved over the years. The use of contract pharmacies has long been governed by HRSA guidance. In 1996, HRSA issued guidance that allowed a covered entity to use only one contract pharmacy. In 2010, HRSA updated its guidance, specifying that covered entities could use multiple, unlimited contract pharmacies. This policy dramatically expanded the use of contract pharmacies. According to a Government Accountability Office (GAO) report, there were nearly 23,000 contract pharmacies, mostly for-profit chain pharmacies in 2019. The expanded use of contract pharmacies has, to a degree, impeded HRSA’s oversight of the 340B program and made it difficult to guard against drug diversion and duplicate discounts.

In 2020, citing concerns about duplicate discounts and drug diversion by contract pharmacies, some major drug manufacturers began limiting discounted drug supply to contract pharmacies. AstraZeneca, for example, said it would supply the drugs to only one pharmacy for an entity that did not have an in-house pharmacy. Novartis said it would limit its supply to pharmacies within a 40-mile radius of the covered entity’s location.

HHS’s Response and Litigation

In response to the drug manufacturers’ decision to limit supply of 340B drugs, the HHS Office of General Counsel (OGC) issued an advisory opinion affirming its position that drug manufacturers are required to deliver discounted drugs to any contract pharmacies because those pharmacies are covered entities’ agents. HRSA subsequently sent letters to the drug manufacturers informing them that their policies violated the statutory requirements under the 340B program.

A flurry of lawsuits by the manufacturers challenging the advisory opinion and violation letters ensued. The suits were filed in federal courts in Delaware, New Jersey, Indiana, and the District of Columbia (D.C.). The Delaware and D.C. courts sided with the manufacturers, while the other courts concluded that requiring the distribution to all applicable contract pharmacies was permissible. The New Jersey and Delaware decisions were appealed to the Third Circuit, which ruled that drug manufacturers’ refusal to deliver drugs at a discounted price to contract pharmacies did not violate federal law. The Third Circuit is the first appellate decision on this issue. As of the publication of this piece, appeals in the other cases are pending before the D.C. and Seventh Circuits.

The Court’s Decision in Sanofi Aventis v. HHS

The Third Circuit had to decide whether the 340B statute requires manufacturers to deliver drugs “to an unlimited number of contract pharmacies.” The court concluded that it does not. First, the court noted that the statute’s text does not mention “contract pharmacies” or manufacturers’ delivery obligations. The statute simply states that drug manufacturers “shall offer each covered entity covered outpatient drugs.” The court read this narrowly as requiring manufacturers to only “present” the drugs so that the covered entities may accept them. Because the manufacturers’ refusal to deliver the drugs to contract pharmacies does not prevent covered entities from accepting the presented drugs, the court concluded that the delivery restrictions do not violate the 340B statute. The court also found that the manufacturers’ restrictive delivery policies were permissible because they are not explicitly prohibited by the 340B statute.

Second, the court noted that elsewhere in the 340B statute Congress allows the HHS Secretary to establish a prime vendor program through which covered entities may enter into drug distribution contracts. The court also looked at another program that regulates how the federal government pays for drugs. There, Congress explicitly mentioned contract pharmacies. Thus, it stands to reason, the court concluded, that Congress knew how to impose delivery-related requirements, including the use of contract pharmacies, but did not do so for the 340B program.

The court also reasoned that leaving drug delivery decisions up to the manufacturers aligned with other federal laws that require the manufacturers to safely distribute high-risk drugs. Because manufacturers assure safe distribution of these high-risk drugs by distributing them to only a few pharmacies, giving the manufacturers the discretion over the distribution of 340B drugs allows them to comply with those safety laws and 340B obligations.

For these reasons, the court concluded that the advisory opinion and violation letters on the use of contract pharmacies were unlawful.

The Stakes

High prices for prescription drugs continue to burden patients, employers, taxpayers, and federal programs. Notwithstanding major reforms enacted through the Inflation Reduction Act to provide HHS more authority to negotiate prices in Medicare and to lower costs, more action is needed to combat abuses by drug manufacturers. These abuses — highlighted by policymakers and other stakeholders in recent years — distort markets and create significant access concerns, especially for low-income and underserved communities.

Sanofi Aventis v. HHS — the first appellate decision weighing in on the dispute over drug manufacturers’ seeking to limit distribution through contract pharmacies — narrowly reads the 340B statute and limits HHS’ enforcement options. The use of unlimited contract pharmacies has generated legitimate concerns about duplicate discounts and drug diversion (which ultimately increase heath care spending). At the same time, leaving the distribution of 340B drugs to manufacturers’ sole discretion could hamper access to these drugs and comprehensive care, especially by underserved communities who have to navigate other structural barriers to access health care. With future litigation pending related to the 340B program, including some more novel constitutional claims pursued by drug manufacturers, upcoming decisions could significantly affect access to affordable drugs, health care spending, and agency authority.