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January 12, 2016 Articles

It's the Hard-Knock Life: The Rough-and-Tumble over Orphan Drug Pricing

Constituencies that disagree with regulations issued by HHS are likely to have more opportunities to challenge their validity.

By Mark P. Goodman, Maura K. Monaghan, Kristin D. Kiehn, Jacob W. Stahl, and Kaitlin T. Farrell

The Department of Health and Human Services (HHS) has encountered hurdles in implementing the voluminous Patient Protection and Affordable Care Act (PPACA), including the challenge of accomplishing its health care policy objectives where those objectives are not clearly expressed in, or even appear to conflict with, the PPACA’s statutory text. HHS has been sued by impacted constituencies regarding its interpretation of the PPACA on a number of occasions and will likely face more lawsuits in the future.

At the same time, the issue of the affordability of drugs, particularly drugs for serious, life-threatening conditions, is receiving intense public attention. Turing Pharmaceuticals, and its chief executive officer Martin Shkreli, came under fire for raising the price of Daraprim, a drug used to treat parasitic infections in HIV patients, from $13.50 per pill to nearly $750 per pill, an increase of 5,000 percent. After initially defending the price hike as necessary to keep the company in business, Shkreli backed down, promising to lower the price and provide the medication for free to the uninsured. The Senate Special Committee on Aging has just issued requests for documents about drug pricing to four different pharmaceutical companies, and the House Investigations Committee is reportedly considering whether to launch its own probe.

These two trends collided when the Health Resources and Services Administration (HRSA), a division of HHS, clashed with the pharmaceutical industry over the implementation of a PPACA provision that entitles certain types of health care providers to purchase drugs at significant discounts.

At issue is an exemption to the discount program for orphan drugs, i.e., drugs designated by HHS and approved by the Food and Drug Administration to treat rare conditions. The statute is unclear as to whether a drug that has been approved for both orphan and non-orphan indications is eligible for the orphan drug exclusion only when the drug is being administered for an orphan indication or whether the exclusion always applies to the drug, even for its far more common usages.

HHS issued regulations taking the position that the drug exclusion applied only when the drug is administered for an orphan indication. The Pharmaceutical Research and Manufacturers of America (PhRMA)—a pharmaceutical industry advocacy group—immediately challenged HHS’s position in federal district court on the basis that HHS lacked statutory authority to issue the regulation. HHS responded by issuing an “interpretive rule” advising the public of HHS’s construction of the statute. As this issue has a potentially significant impact on pharmaceutical industry revenues and the budgets of governments and hospitals, litigation unsurprisingly continued.

On October 14, 2015, the United States District Court for the District of Columbia granted PhRMA’s motion for summary judgment, vacating the interpretive rule as contrary to the plain language of the statute. The effect of that ruling is that for newly added entities (including certain children’s hospitals, cancer hospitals, rural referral centers, and sole community hospitals), a program of price ceilings does not apply and those entities must pay higher prices for orphan drugs, even when those drugs are prescribed for common conditions.

The Orphan Drug Act of 1983 encourages the development of drugs that are designed to treat rare medical conditions (commonly referred to as “orphan” conditions) by granting qualifying drugs an extended period of market exclusivity, tax credits, and research grants for clinical testing. Congress found that “because so few individuals are affected by any one rare disease or condition, a pharmaceutical company which develops an orphan drug may reasonably expect the drug to generate relatively small sales in comparison to the cost of developing the drug and consequently to incur a financial loss.” 96 Stat. 2049 § 1(b)(4).

HHS issues orphan drug designations prior to the time that the FDA decides whether or not to approve a drug. 21 U.S.C. § 360bb(a); see 21 C.F.R. § 316.23(a). Some drugs that receive an orphan designation are also approved by the FDA for non-orphan conditions. For example, Prozac is designated an orphan drug because it treats autism and body dysmorphic disorder, but is also approved and commonly prescribed for depression. Id.Similarly, Rituxan is designated an orphan drug because it treats rare forms of lymphoma and leukemia, but it is also approved for non-orphan conditions such as rheumatoid arthritis and multiple sclerosis. See Orphan Drug Designation and Approvals List as of March 3, 2014, at 254.

In 1992, Congress created the “340B Program” to protect certain government-supported hospitals and clinics that provide services to indigent patients from some types of drug price increases (“covered entities”). 42 U.S.C. § 256b. The enacting statute provided that Medicaid would provide reimbursement for certain outpatient drugs (“covered outpatient drugs”) only if the manufacturers agreed to sell them at a significant, statutorily defined discount to the covered entities.

In 2010, the PPACA broadened the 340B program by expanding the definition of covered entities to encompass additional eligible facilities, including critical access hospitals, rural referral centers, children’s hospitals excluded from the Medicare prospective payment system, and sole community hospitals (“newly covered entities”).

A week after the PPACA was passed, however, the Health Care and Education Reconciliation Act (HCERA) provided an important qualification on the newly covered entities: It stated that “the term ‘covered outpatient drug’ shall not include” an orphan drug. In other words, orphan drugs are exempt from the 340B discount. The statute leaves unanswered the meaning of “orphan drug” in this context: Does the exclusion apply to all drugs with an orphan indication, regardless of whether they are being administered for an orphan condition, or does the exclusion apply only where a drug is being administered for an orphan condition?

HHS received a barrage of inquiries requesting clarification on the orphan drug exclusion. On July 23, 2013, following a 60-day comment period, HHS codified a rule interpreting the orphan drug exclusion. See Final Rule, Exclusion of Orphan Drugs for Certain Covered Entities under 340B Program, 78 Fed. Reg. 44,016, 44,017 (July 23, 2013). The rule provided that newly covered entities would be required to pay full price for a drug that was being administered to treat an orphan condition but would receive the discounted price if the same drug was being administered to treat a non-orphan condition. The rule also imposed on newly covered entities the duty to maintain records evidencing their compliance with this pricing scheme and stated that failure to do so would be “considered a violation” of the 340B program law. 42 C.F.R. § 10.21(c), (f).

PhRMA’s Lawsuit 
In September 2013, PhRMA filed suit challenging HHS’s rule on the ground that HHS lacks the statutory authority to issue a regulation limiting the 340B exemption to drugs prescribed for orphan indications. Judge Rudolph Contreras of the United States District Court for the District of Columbia agreed. On May 23, 2014, he issued a ruling that sided with PhRMA and invalidated HHS’s rule on the basis that that HHS did not have statutory authorization to issue rulemaking with respect to the orphan drug exemption. See Pharm. Research & Mfrs. of Am. v. U.S. Dep’t of Health & Human Servs., No. 13-1501 (D.D.C. May 23, 2014).

HHS’s “Interpretive Rule”
Rather than continuing to litigate the validity of its administrative rule, HHS issued what it termed an “interpretive rule” on July 21, 2014. The interpretive rule—which sets forth HHS’s statutory interpretation but purportedly lacks the legal effect of a binding administrative rule—states HHS’s view that the exclusion under the 340B program for orphan drugs applies only to drugs administered for their orphan use. Health Res. & Servs. Admin., Interpretive Rule: Implementation of the Exclusion of Orphan Drugs for Certain Covered Entities Under the 340B Program.

Unlike the prior legislative rule, the interpretive rule does not set forth specific record-keeping guidelines for newly covered entities, instead stating only that “[i]f a covered entity lacks the ability to track drug use by indication, such entity would be unable to purchase drugs with orphan designations through the 340B Program.” Id. HHS has emphasized that its interpretation is consistent with the purpose of the 340B program, which is “to stretch scarce Federal resources as far as possible, reaching more eligible patients and providing more comprehensive services.” H.R. Rep. No. 102-384(II), at 12 (1992).

Following HHS’s promulgation of the interpretive rule, PhRMA immediately moved to prevent HHS from evading the court’s earlier ruling. HHS responded by arguing that it “issue[ed] an interpretive rule to provide guidance to interested parties that it is adopting essentially the same interpretation going forward, though without the binding effect that a substantive rule would have.” Defendant’s Supplemental Memorandum at 1, Pharm. Res. & Mfrs. No. 13-1501 (D.D.C. filed July 24, 2014), ECF No. 53.

HHS “chose not to defend its prior issuance . . . as an interpretive rule,” having “reasonably concluded that defending that document on such grounds was inadvisable because it was so clearly framed in terms of legislative rulemaking.” Id. at 3–4. The court agreed, holding on August 27, 2014, that HHS was no longer defending the invalidated legislative rule in any form and that HHS’s interpretive rule constituted new agency action that was not challenged in the existing lawsuit. The court noted that “[t]he plaintiff is free to challenge that interpretive rule, but such a challenge is beyond the scope of the instant action,” and thus issued a final judgment in the case. Pharm. Res. & Mfrs., at *4 (D.D.C. Aug. 27, 2014).

The Latest Battle
The dispute between HHS and PhRMA, however, continued apace. On October 9, 2014, PhRMA filed a new lawsuit in the U.S. District Court for the District of Columbia, challenging HHS’s interpretive rule as a violation of the Administration Procedure Act, 5 U.S.C. § 706(2)(A).

In the suit, PhRMA alleged that this interpretive rule “contains the same substance as the first rule, adopts the same flawed interpretation of [the PPACA], and should similarly be invalidated as inconsistent with the statute.” PhRMA supported its claim by referencing HHS’s website, which states that “[a] manufacturer’s or covered entity’s failure to comply with the statutory requirements could subject a manufacturer or covered entity to an enforcement action . . . which could include refunds to covered entities in the case of overcharges, as well as termination of a manufacturer’s Pharmaceutical Pricing Agreement.” HHS, 340B Drug Pricing Program, FAQs.

Despite HHS’s “interpretive” categorization, PhRMA urged that the new rule is effectively a legislative rule (which, as Judge Contreras already held, HHS lacks the authority to promulgate). An agency’s classification of a rule as “legislative” or “interpretive” is not dispositive. As one judge on the U.S. District Court for the District of Columbia recently observed, “[f]irst impressions [of a rule] can deceive. A rule that superficially appears to interpret existing law may, on closer inspection, be discovered to have independent, substantive effect.” Scenic Am., Inc. v. U.S. Dep’t of Transp., No. CV 13-93 (JEB), 2014 WL 2803084, at *3 (D.D.C. June 20, 2014).

The D.C. Court of Appeals, moreover, has cautioned that “[w]hile an agency’s construction of the statute need not always be correct for its rules to be considered interpretative, . . . the fact that its subsequent interpretation runs 180 degrees counter to the plain meaning of the regulation gives [courts] at least some cause to believe that the agency may be seeking to constructively amend the regulation.” Nat’l Family Planning & Reprod. Health Ass’n, Inc. v. Sullivan, 979 F.2d 227, 235 (D.C. Cir. 1992).

In his most recent ruling issued on October 14, 2015, Judge Contreras granted summary judgment to PhRMA, concluding that the interpretive rule is a final agency action that is subject to immediate challenge and that the rule conflicts with the statute’s plain language. He emphasized the text of section 340B(e), which provides as follows:

(e) Exclusion of orphan drugs for certain covered entities

For covered entities described in subparagraph (M) (other than a children’s hospital described in subparagraph (M)), (N) or (O) of subsection (a)(4), the term “covered outpatient drug” shall not include a drug designated by the Secretary under section 360bb of Title 21 for a rare disease or condition.

42 U.S.C. § 256b(e).

Judge Contreras held that, by its plain terms, the orphan drug exclusion applies to any drug that is “designated . . . for a rare disease or condition,” holding that “[t]he section refers only to the designation of that drug, and makes no mention of whether the so-designated drug is in fact used by the covered entity to treat the rare disease or condition for which is was designated.” In other statutory references, by contrast, when Congress wanted to limit a provision’s application to occasions when the designated orphan drug was actually used to treat a rare disease or condition, additional clarifying language appears.

For example, in a provision within the Medicaid program that provides for prospective, pass-through payments of certain drugs and medical devices, the payments for “current orphan drugs” are limited to “[a] drug or biological that is used for a rare disease or condition with respect to which the drug or biological has been designated as an orphan drug. . . .” In a statute providing for tax credits for clinical testing expenses incurred during an orphan drug’s development, similar language appears specifying that the tax credit applies “only to the extent such testing is related to the use of a drug for the rare disease or condition for which it was designated. . . .”

The absence of any reference to the use of the orphan drugs means that the exclusion of designated orphan drugs from the discount program applies regardless of the use for which the orphan-designated drug is prescribed.

Judge Contreras recognized that there might well be sound policy reasons for excluding orphan-designated drugs from the section 340B pricing program only when they are used to treat rare diseases or conditions, particularly in light of the PPACA’s clear effort to expand the 340B program. He also acknowledged, readily, that the plain meaning of the unqualified congressional language was “curious” and might be “difficult to reconcile” with the generally stated goal of the 340B program to lower drug prices for covered entities. But he described the court as “bound by the language that Congress has so far provided,” while noting that “Congress remains free to amend section 340B(e) if it determines that, in practice, the scheme it has set up is not a workable one or does not provide the hoped-for benefits to the extent envisioned.”

The fiscal impact of the decision is potentially profound. Because orphan drugs typically sell at prices substantially higher than non-orphan drugs, and there are many drugs that have both orphan and non-orphan indications, the outcome is economically meaningful to the government, hospitals, and the pharmaceutical industry. Unless an appeal reverses Judge Contreras, the present status is a victory for the pharmaceutical industry and higher returns on drug companies’ research and development investments in orphan drugs, unless and until Congress acts to revise the statutory language (a prospect that appears unlikely at best).

The Broader War over PPACA Interpretation 
Would an appeal result in a reversal, if not by the District of Columbia Circuit, then by the United States Supreme Court? The disagreement between HHS and PhRMA over orphan drug pricing is just one piece of a much larger conflict regarding PPACA interpretation. The Supreme Court, in the last term, of course, resolved another widely reported example of this conflict when it ruled that the Internal Revenue Service (IRS) may grant tax credits to individuals who purchase health insurance on both state-run insurance exchanges and federally facilitated exchanges created and operated by HHS. While the language of the PPACA provides tax credits to individuals who purchase health insurance through marketplaces that are “established by the State under section 1311” of the act, HHS argued that the subsidies are also available to those who purchase insurance through a federal exchange.

In Halbig v. Burwell, the U.S. Court of Appeals for the D.C. Circuit held that, contrary to HHS’s interpretation of the PPACA, the government cannot give financial assistance to anyone buying coverage on the insurance marketplace run by the federal government. The U.S. Court of Appeals for the Fourth Circuit in King v. Burwell, however, sided with HHS in holding that the IRS can provide health insurance subsidies to people using the federal as well as state-run exchanges. In an approach that seems much less limited to the plain statutory language than the one adopted by Judge Contreras, the Supreme Court held that the tax credits apply to individuals who purchase insurance through the federal exchanges. King v. Burwell appears to argue in favor of more deference to the general legislative purpose of the PPACA and the agency interpretation than Judge Contreras’s decision manifests.

One thing is clear: As HHS continues to issue regulations implementing the PPACA over the next several years, constituencies that disagree with regulations issued by HHS are likely to have more opportunities to challenge their validity.


Keywords: litigation, health law, Patient Protection and Affordable Care Act, PPACA, Orphan Drug Act, pharmaceuticals


Mark P. GoodmanMaura K. MonaghanKristin D. KiehnJacob W. Stahl, and Kaitlin T. Farrell are attorneys in the New York, New York, office of Debevoise & Plimpton, LLP.

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