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Business Law Today

August 2023

Third Circuit Deals HHS Another 340B Blow: Congressional Action Needed to Fill Regulatory Gaps

Casey Warren Baker, Susan Lanham, Alberto Coustasse, and Kenneth Maxik


  • The 340B program is a federal program in which the government requires drug manufacturers participating in Medicare or Medicaid to sell certain covered drugs to qualifying health-care organizations (“covered entities”) at discounted prices. 
  • Drugmakers pushed back against covered entities’ use of multiple contract pharmacies for delivery/dispensing of purchased drugs. The Department of Health and Human Services (“HHS”) issued Advisory Opinion No. 20-06, stating that restrictions on use of multiple contract pharmacies were impermissible. 
  • The Third Circuit, relying on the Uniform Commercial Code to rule in favor of the plaintiffs in Sanofi Aventis U.S. LLC v. U.S. Department of Health & Human Services, concluded that HHS’s authority over drug prices doesn’t give it other 340B regulatory powers.
  • If 340B is interpreted as imposing restrictions only on price, drugmakers will have significant leverage over covered entities in negotiating purchase agreements. To address policy concerns, Congress would need to pass legislation empowering HHS to coordinate use of contract pharmacies in the 340B system.
Third Circuit Deals HHS Another 340B Blow: Congressional Action Needed to Fill Regulatory Gaps Tan

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The purpose of this commentary is twofold: (1) to identify deficiencies in the 340B statute related to the use of multiple contract pharmacies and delivery to them—deficiencies that have resulted in the need for courts to resolve issues through judicial interpretation, and (2) to encourage policymaker action to address these deficiencies.

Overview of 340B Program

Under the 340B program, the federal government requires drug manufacturers participating in Medicare or Medicaid to sell certain covered drugs to qualifying health-care organizations at discounted prices. Health-care organizations that qualify to enter the program—referred to as covered entities—include hospitals and providers serving low-income or rural populations. The maximum price that drug manufacturers may charge a covered entity for covered drugs is the average manufacturer price for the preceding quarter minus a statutorily mandated rebate. The discounts provided to covered entities typically range from 20 to 50 percent off the market price of eligible drugs. As of 2020, there were approximately 50,000 registered 340B covered entity sites, with 2021 discounted drug purchases totaling $44 billion, or approximately 7.6 percent of the $576.9 billion of nationwide pharmaceutical purchases in 2021.

Conceptually, covered entities can stretch scarce resource dollars by profiting from the difference between their 340B drug resales—paid at full Medicare and insurance reimbursement rates—and the discounted drug acquisition costs. Covered entities can use the profits to finance affordable patient care for underserved communities.


However, there are risks that covered entities and drugmakers may operate in ways that contradict Congress’s intentions. For example, of the 189 audits of covered entities performed by regulators in 2022, sixty-six—more than one-third—included findings of misconduct. Likewise in 2022, regulators issued at least thirty-four citations to drug manufacturers requiring refunds to covered entities.

Part of this contradiction can be attributed to statutory silence—the 340B statute does not require covered entities to use their profits in a way that subsidizes needed-but-unprofitable care. But even where the statute expressly prohibits abusive activities, certain business practices by covered entities have amplified the risks of abuse.

Covered Entities’ Use of Multiple Contract Pharmacies

Of particular concern is the covered entity practice of using multiple contract pharmacies to handle the delivery and dispensing of purchased 340B drugs.

When the 340B program first began, few covered entities had their own in-house pharmacies to manage purchased drugs. Thus, in order to expand the reach of the 340B program, the Department of Health and Human Services (“HHS”) allowed covered entities to dispense 340B drugs through contract pharmacies—pharmacies not owned or operated by covered entities.

The extent to which covered entities can use contract pharmacies to dispense medications purchased under the 340B program for their patients raises some concerns. Drug manufacturers have alleged that covered entities use multiple contract pharmacies to engage in prohibited practices, such as diversion of discount drugs to ineligible patients or duplicative discounting.

Federal Support for Covered Entities’ Use of Multiple Contract Pharmacies

Despite these concerns, federal regulators have required drugmakers to accept covered entity demands for use of multiple contract pharmacies. Under the HHS “ship to, bill to” process, the covered entity owns the drugs after purchase and is billed directly for them, but the drugmaker must physically deliver the drugs to all contract pharmacies that the covered entity designates. Beginning in 2010, HHS permitted covered entities to use an unlimited number of contract pharmacies as long as applicable legal requirements were satisfied. Drugmakers objected to the practice out of fears that it enables covered entities to avoid compliance mechanisms.

Pushback from Drugmakers

The 340B statute says nothing about contractual delivery terms, where drugmakers must physically deliver drugs sold, or what party has the right to make the delivery determination. Rather, the statute only imposes price restrictions on drugmakers. Thus, in 2020, three drugmakers—Sanofi, Novo Nordisk, and AstraZeneca—began requiring 340B covered entities to accept the drugmakers’ conditions for place of delivery. Essentially, the three drugmakers offered to deliver purchased drugs to either an in-house pharmacy or a single contract pharmacy of the covered entity’s choosing, but not multiple contract pharmacies.

HHS: Advisory Opinion No. 20-06

HHS responded by issuing Advisory Opinion No. 20-06, which stated that once drugs have been “purchased by” covered entities, the delivery point is irrelevant to the agreement. Likewise, because contract pharmacies have long been used in connection with the 340B program, HHS found that drugmaker-imposed restrictions on their use was impermissible. Thus, according to HHS, covered entities should be free to require physical delivery to contract pharmacies—and drugmakers must comply.

HHS: Lack of Broad Rulemaking and Interpretive Authority

Unfortunately for federal regulators, HHS lacks broad rulemaking or interpretative authority to achieve its policy goals. In general, a federal agency’s administrative powers are limited to those powers delegated to it statutorily by Congress. Furthermore, while courts will generally defer to reasonable agency interpretations of ambiguous statutes, such deference is granted only when the agency acts under statutorily delegated rulemaking authority. If an agency adopts a statutory interpretation beyond its statutory authority, the interpretation lacks the force of law.

Regarding the 340B program, HHS has only narrow rulemaking authority pertaining to three specific administrative functions. First, Congress authorized HHS to establish an administrative dispute resolution process for drugmakers and covered entities contesting the conduct of their counterparties. Second, the statute allows HHS to establish by regulation a schedule of civil monetary penalties for violations. Neither of these provisions grants HHS the authority to create contractual rights or impose contractual duties upon drugmakers or covered entities in their dealings with each other.

Finally, the statute directs HHS to issue regulations to define the standards and methodology for calculating the maximum price that drugmakers can charge covered entities—referred to as the ceiling price in the statute. This provision deals with the complex process of determining the average manufacturer price and the statutorily mandated rebate to which covered entities are entitled for each drug covered by the statute. Thus, HHS does have some authority to create substantive contractual rights between covered entities and drugmakers—the agency establishes the maximum price for any sale. But the authority to calculate the ceiling price is not necessarily a grant of authority to regulate other aspects of the contractual relationship between the drugmaker and the covered entity.

Third Circuit Ruling

Clearly, regulators are limited in their ability to achieve policy goals via regulatory guidance. Thus, after HHS issued Advisory Opinion No. 20-06 and then violation letters to Sanofi, Novo Nordisk, and AstraZeneca (on the basis that the companies were in violation of the contract pharmacy delivery requirement as specified by the advisory opinion), the drugmakers challenged the regulatory actions in court. In January 2023, the U.S. Court of Appeals for the Third Circuit ruled in favor of the plaintiffs in Sanofi Aventis U.S. LLC v. U.S. Department of Health & Human Services. The case consolidated conflicting federal district court rulings over whether Advisory Opinion No. 20-06 and the resulting violation letters were valid.

According to HHS, the ability to regulate the delivery point was inherent to its statutory authority to regulate the “purchase” of eligible drugs. HHS relied on the Uniform Commercial Code (U.C.C.) for its logic. Under the U.C.C., by default, ownership of goods passes from seller to buyer when the seller’s delivery responsibilities are complete. According to HHS, because a “purchase” by a covered entity necessarily requires a transfer of ownership, HHS may dictate that the covered entity gets to designate how it takes title by designating the place of delivery.

Furthermore, in Advisory Opinion No. 20-06 and before the Third Circuit, HHS conceded its limited regulatory rulemaking authority—but that was of little consequence, according to the agency. Because it had long required that drugmakers sell to contract pharmacies, HHS claimed Advisory Opinion No. 20-06 did not create any new substantive rights or duties. HHS argued that this long-standing practice, combined with the statutory authority inherent in its role of regulating 340B sales relationships between drugmakers and covered entities, justified its regulatory actions.

The Third Circuit disagreed, finding that HHS’s requirements on drugmakers exceeded what the statute permits:

The “purchased by” provision imposes only a price term for drug sales to covered entities, leaving all other terms blank. HHS has suggested that covered entities get to fill in those blanks so long as they foot the bill. However, when Congress’s words run out, covered entities may not pick up the pen.

Essentially, because the statute’s language states nothing about how the parties are to handle physical shipment and delivery of purchased drugs, there is no indication that Congress intended to give covered entities the authority to dictate those terms in their purchase agreements with drugmakers.

Implicit in the Third Circuit’s opinion were concepts from the U.C.C. distinguishing different rights under a contract for the sale of goods. An understanding of these distinct rights is key to understanding the flaws in HHS’s logic, as HHS was essentially dictating what rights must arise in a sales contract between covered entities and drugmakers without the statutory authority to do so.

Under the U.C.C., a contract may exist even if the parties do not agree on all terms, with “gap filler” provisions operative only when the parties do not have express agreement on the specific term. Among the U.C.C. gap filler terms are default provisions on price and place of delivery. Under those provisions, the parties’ express agreement trumps the U.C.C. default terms.

The Third Circuit opinion acknowledged that the 340B program allowed HHS to restrict the parties’ abilities to set their prices—drugmakers must sell at no more than the ceiling price set by HHS. But because the 340B statute is silent regarding place of delivery, there is no corresponding restriction on negotiating delivery terms.

The HHS advisory opinion misconstrued the U.C.C. provisions on this point. By default, under the U.C.C., ownership of goods transfers when the seller’s delivery obligations are complete. But contractual parties are free to negotiate an alternative moment of title transfer. Furthermore, if the parties do not agree on a place of delivery, delivery of goods is deemed to occur at the seller’s place of business.

Thus, under the default U.C.C. provisions, ownership of goods transfers at the seller’s place of business, and delivery to the buyer’s chosen location is not required by the U.C.C. for transfer of title or completion of sale. Contrary to HHS’s interpretation, the U.C.C. expressly contemplates that the buyer and seller can negotiate these terms.

HHS took the position that because it is responsible for enforcing the parties’ rights and duties with regard to the sale as a whole, it can regulate these sale terms. But, as the Third Circuit held, the 340B statute does not empower HHS to impose these contractual terms on the parties. The statute only expressly permits HHS to regulate price. HHS’s limited 340B rulemaking and interpretive authority prevents it from conflating other sale rights to reconcile ambiguity in the statute and otherwise achieve policy goals.

Other Court Action

As of February 2023, similar cases were pending in the U.S. Court of Appeals for the Seventh Circuit and the U.S. Court of Appeals for the D.C. Circuit, and court watchers do not expect a circuit split.

Likewise, other courts have ruled in favor of drugmakers that received violation letters from HHS for imposing contract pharmacy restrictions. For example, in November of 2021, in a lawsuit by Novartis and United Therapeutics, the district court found that the plaintiffs’ conditions imposed on qualifying 340B entities did not violate Section 340B as alleged in HHS’s violation letters. The court also found that the drugmakers provided “credible evidence” that using multiple contract pharmacies “increased the potential for fraud in the 340B program.” The court recognized, however, that HHS has “legitimate concerns about the degree to which the manufacturers’ new conditions have made it difficult for covered entities to obtain certain drugs at discounted prices.”

Significant Challenges for Covered Entities

If, as the Third Circuit held, the 340B statute imposes restrictions only on price, drugmakers can force acceptance of all other contract terms—and will have gained significant leverage in negotiating purchase agreements with covered entities.

A 2022 survey of 482 covered entities with contract pharmacy relationships details an anticipated $448,000 per entity annual loss for critical-access hospitals and a $2.2 million per entity annual loss for more extensive facilities after fourteen drugmakers announced restrictions, with more than 75 percent of covered entities needing to cut programs and services if the restrictions remain permanent.

Congressional Action Needed

Drugmakers, pharmacy benefit managers, and covered entities have competing interests related to the profit on the drug sales. In between, federal regulators seek to control their own Medicare reimbursement costs while promoting the congressionally intended benefits to health-care providers. Unfortunately, ambiguity in the 340B statute raises questions about the appropriate interpretation of the statute and the scope of HHS’s authority to ensure compliance with program goals.

While the 340B program has the attention of some lawmakers, proposed legislation does not address the specific issues with contract pharmacies or the general issues of regulatory empowerment. For example, on April 6, 2023, Representatives Abigail Davis Spanberger and Dusty Johnson introduced the “PROTECT 340B Act of 2023” in the U.S. House of Representatives. The bill primarily addresses reimbursement discrimination against covered entities by health insurers and pharmacy benefit managers. While the bill acknowledges the use of contract pharmacies, it does not give HHS the explicit statutory authority to direct when and how contract pharmacies may be used in the delivery of drugs.

The multitude of policy questions surrounding the 340B program will not be answered through litigation alone. These questions go beyond the use of contract pharmacies by covered entities and restrictions by drugmakers. Like a loose thread on a sweater, the more one pulls on 340B, the more the legislation unravels. For example, it is unclear whether the program fulfills its goal of expanding care to needy communities. And from a policy standpoint, observers question the appropriate use of the revenue generated by covered entities from 340B discounted drugs and who should qualify as a “patient” of a covered entity. Other commentators have highlighted the numerous administrative difficulties associated with the 340B program.

Courts are only willing to implement HHS’s reforms with explicit statutory authority. As courts strike down HHS efforts to pursue policy goals, congressional inaction may signal implicit acquiescence of a paralyzed administrative agency. To preserve the long-standing and often critical role of contract pharmacies in the 340B system, Congress must pass legislation expressly empowering HHS to coordinate their use.

The views expressed in this publication represent those of the author(s) and do not necessarily represent the official views of HCA Healthcare or any of its affiliated entities.