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Drug companies are required by federal law to extend discounts that they give to health plans, hospitals and other private purchasers to Medicaid and other government health care programs. This is based on the idea that government programs should get as good a deal as any private purchaser.

There’s a complicated system to set the maximum price that can be charged to state Medicaid programs, community health centers and other health facilities serving uninsured and underserved patients. This system relies on so-called “best price” information that drug companies are required to provide to the Center for Medicare and Medicaid Services (CMS). CMS is the federal agency that runs both Medicare and Medicaid.

But this system only works as it should when drug companies accurately and honestly report to CMS the prices they’ve given to different purchasers. If a drug companies conceals a discount it offered to a private entity, then states and the federal government end up paying more than they are legally supposed to. There have been numerous lawsuits brought against drug companies for failing to report accurate “best prices,” resulting in hundreds of millions of dollars in settlements. (Taxpayers Against Fraud’s website describes many of these)

But until recently, only states or the federal government itself could go after drug companies for “best price fraud.” Community health centers, certain hospitals, and other providers couldn’t enforce their rights to similar ‘best price’ discounts under a federal law known as “340B,” until recently.

In August 2005, Santa Clara County (California) filed a lawsuit against a group of pharmaceutical companies on behalf of 340B-covered entities. Santa Clara County operates seven hospitals or health clinics which are “covered entities” under 340B, meaning they are entitled to the discounts that are based on “best price” calculations. This lawsuit was in response to reports issued in March 2003 and June of 2004 by the Office of Inspector General (OIG) of the Department of Health and Human Services. These reports documented that 340B entities were being significantly overcharged for a wide range of drugs. A 2006 OIG report, for instance, estimated that 340B entities overpaid $3.9 million in a single month (June 2005).

Santa Clara County’s case was dismissed, in part because the federal Court hearing the case held that 340B entities didn’t have the right to sue to enforce the contracts that drug companies enter into with CMS, called Pharmaceutical Pricing Agreements (“PPA”).

Normally, only the parties that make a contract have the right to enforce its terms in court. But the exception to this rule is called “third party beneficiary.” Parties can create a contract for the benefit of a third person or entity who’s not one of the parties signing the contract. A good example is life insurance – let’s say Jack buys a life insurance policy (which is a contract) from Acme Insurance, and lists Jill as the person who will receive the proceeds in the event of his death. If Acme refused to pay her upon Jack’s death, Jill could sue Acme as the third party beneficiary of the contract.

Similarly, Santa Clara County had argued that their county hospitals and health centers, as 340B entities, were the third party beneficiaries of the PPAs. The District Court disagreed, and dismissed the case. But on August 27, 2008, the Ninth Circuit Court of Appeals ruled that the County and other 340B entities are the ‘intended beneficiaries’ of both the contract and the federal law that sets the prices, so Santa Clara County could sue to enforce the PPA contract. This of course is not the end of the saga – the lawsuit now returns to the District Court, where it will pick up where it left off.

There’s a particular irony about this lawsuit. Members of Prescription Access Litigation have brought a number of class action lawsuits alleging fraud in the Average Wholesale Price (AWP) system (see here and here). Most private insurers and pharmacies purchase drugs from drug companies and wholesalers based on AWPs, which are self-reported by drug companies but not subject to any government oversight.

By contrast, the data that drug prices paid by Medicaid and 340B entities are based on are reported to CMS and are subject to audit and enforcement. Yet, as the OIG’s reports have amply demonstrated, no one’s minding the store — the federal government is not adequately monitoring whether or not drug companies are reporting accurate price information. While there have been hundreds of millions of dollars in settlements with drug companies for reporting false “best prices,” these cases are most likely the tip of the iceberg.

The price information reported to CMS is confidential, presumably on the notion that it’s a “trade secret” or that revealing information on discounts would help companies’ competitors. Since there’s no transparency, it’s essential that the agencies charged by Congress with policing the system actually do so. Otherwise, the only avenue to recover overpayments requires 340B entities, like Santa Clara County, to sue years after the fact. And even if Santa Clara County’s suit is successful, or settles, the drug companies accused in the complaint have held on to many millions of dollars in improper overcharges for years, depriving health systems that care for some of neediest members of society of much needed funds.