United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued April 10, 2001 Decided June 8, 2001

No. 01-5029

Pharmaceutical Research and Manufacturers of America,
Appellant

v.

Tommy G. Thompson, in his official capacity as Secretary,
United States Department of Health and
Human Services, et al.,
Appellees

Appeal from the United States District Court
for the District of Columbia
(No. 00cv02990)

Allen R. Snyder argued the cause for appellant. With him
on the briefs were Darrel J. Grinstead and Jeffrey Pariser.

Ronald A. Shems argued the cause for appellee State of
Vermont Agency of Human Services. With him on the brief


were Susan R. Harritt and Rebecca Ellis, Assistant Attor-
neys General, State of Vermont.

Scott R. McIntosh, Attorney, U.S. Department of Justice,
argued the cause for the federal appellees. With him on the
brief were Wilma A. Lewis, U.S. Attorney at the time the
brief was filed, and Barbara C. Biddle, Attorney.

G. Steven Rowe, Attorney General, and Paul Stern, Deputy
Attorney General, State of Maine, were on the brief for
amicus curiae State of Maine in support of appellee.

Before: Sentelle, Rogers and Tatel, Circuit Judges.

Opinion for the Court filed by Circuit Judge Tatel.

Tatel, Circuit Judge: The Medicaid statute requires phar-
maceutical manufacturers to rebate a portion of the price of
their drugs as a condition for participating in Medicaid. In
this case, pharmaceutical manufacturers challenge the De-
partment of Health and Human Service's approval of a Ver-
mont demonstration project requiring the manufacturers to
rebate a portion of the price of drugs purchased directly by
certain individuals who are not otherwise covered by the
state's Medicaid program. Because Congress imposed the
rebate requirement in order to reduce the cost of the Medic-
aid program, and because no Medicaid funds are expended
under the Vermont demonstration project and thus no Medic-
aid savings produced by the required rebates, we conclude
that the Department lacked authority to approve the project.
We therefore reverse the district court's decision to the
contrary and remand for further proceedings.

I

Funded jointly by the federal government and the states,
Medicaid pays medical expenses for low-income people.
Medicaid services are provided pursuant to plans developed
by the states and approved by the Secretary of Health and
Human Services. 42 U.S.C. s 1396a(a)-(b). States pay doc-
tors, hospitals, pharmacies, and other providers of medical
goods and services according to established rates. The feder-
al government then pays each state a statutorily established


share of "the total amount expended ... as medical assis-
tance under the State plan." Id. s 1396b(a)(1). Medicaid
beneficiaries cannot be required to contribute more than a
"nominal" amount toward the cost of the benefits they re-
ceive. Id. s 1396o.

Pharmaceutical manufacturers participating in Medicaid re-
bate to the states a portion of the price of drugs purchased
for Medicaid purposes. Manufacturers do this because the
Medicaid statute, id. ss 1396-1396u, permits the federal gov-
ernment to reimburse states only for drugs purchased from
manufacturers who have agreed to pay statutorily specified
rebates. Id. s 1396r-8(a)(1). Rebates equal the number of
units of a drug provided by a state's Medicaid program times
the greater of (1) the difference between the average price of
the drug and the lowest price its manufacturer gives any
wholesaler, provider, health maintenance organization, non-
profit, or governmental entity, or (2) 15.1 percent of the
average manufacturer price. See id. s 1396r-8(c)(1). If the
average price of a manufacturer's drug has increased faster
than the consumer price index, the manufacturer must pay an
additional rebate for each unit of the drug equal to the
difference between the average price of the drug and the
price of the drug on July 1, 1990 (or the day the drug first
entered the market) adjusted to the consumer price index.
Id. s 1396r-8(c)(2). So calculated, rebates ensure that states
get at least the best prevailing wholesale price--and possibly
even a much better price--for drugs they purchase for Medic-
aid beneficiaries. In language central to this case, section
1396r-8 provides that rebate agreements shall require manu-
facturers to pay rebates on drugs for which "payment was
made under the State plan." Id. s 1396r-8(b)(1)(A).

The Social Security Act, of which the Medicaid statute is a
part, authorizes HHS to approve experimental "pilot" or
"demonstration" projects that the Secretary determines are
"likely to assist in promoting the objectives of [Medicaid]."
Id. s 1315(a). Although the Act authorizes the Secretary to
waive certain Medicaid requirements for such demonstration
projects, it does not authorize him to waive any requirements
of section 1396r-8's rebate provision or the requirement that


Medicaid beneficiaries contribute no more than a "nominal"
amount to the cost of medical benefits they receive. See id.
s 1315(a)(1).

For several years, Vermont has administered demonstra-
tion projects that extend pharmaceutical benefits to classes of
individuals not otherwise covered by Medicaid. By letter
dated March 17, 2000, Vermont sought HHS approval to
"extend the Medicaid ... rebate structure" to nearly 70,000
new demonstration project beneficiaries, thus requiring phar-
maceutical manufacturers to pay rebates on drugs purchased
by this group. Known as the Pharmacy Discount Program,
or "PDP," the expanded services would be funded as follows:
Pharmacies would charge new beneficiaries the Medicaid
price of a given drug minus the estimated average rebate
Vermont receives for all drugs (approximately eighteen per-
cent in 2000). Vermont would pay the pharmacies the eigh-
teen percent and then bill manufacturers for that amount.
As a result, PDP benefits would be paid not with funds
appropriated by Congress and the states for Medicaid ser-
vices, but by beneficiaries (eighty-two percent) and drug
manufacturers (eighteen percent). By letter dated November
3, 2000, HHS approved the PDP.

Appellant, the Pharmaceutical Research and Manufacturers
of America, whose members have entered into Medicaid
rebate agreements and so would be required to pay rebates
under the PDP, filed suit in the United States District Court
for the District of Columbia claiming that the program violat-
ed two provisions of the Medicaid statute. First, the manu-
facturers argued that because the federal government and
Vermont pay nothing under the PDP, the program violates
the provision under which pharmaceutical manufacturers owe
rebates only for drugs "for which payment was made under
the State plan." Id. s 1396r-8(b)(1)(A). Second, pointing out
that program beneficiaries would pay for approximately
eighty-two percent of the price of their prescriptions, the
manufacturers argued that the PDP violates the requirement
that states charge Medicaid beneficiaries no more than a
"nominal" amount. Id. s 1396o. Seeking a preliminary in-
junction, the manufacturers argued that if they refused to


make payments under the PDP, HHS could terminate their
eligibility to participate in the entire Medicaid program, but if
they made such payments, Vermont's sovereign immunity
would preclude them from recovering their money should
they ultimately prevail in the litigation.

The HHS Secretary, along with the Secretary of Vermont's
Agency of Human Services, who intervened as a defendant,
responded that "payment" means payment, and that even
though Vermont is reimbursed by manufacturers, it has still
made a payment under the ordinary understanding of that
word. As to the manufacturers' nominal copayment claim,
the HHS Secretary argued that the manufacturers lacked
standing to represent the interests of PDP beneficiaries. The
Secretary did not deny that manufacturers refusing to make
PDP rebate payments risked losing Medicaid eligibility na-
tionwide, nor did the Vermont Secretary deny that sovereign
immunity would bar recovery of any rebates paid.

On January 17, 2001, sixteen days after Vermont began
implementing the PDP, the district court, concluding that the
manufacturers were unlikely to succeed on the merits, denied
their request for a preliminary injunction. Pharm. Research
& Mfrs. of Am. v. United States, No. 2000-2990 (D.D.C. Jan.
17, 2001) (order denying preliminary injunction); see also
Pharm. Research & Mfrs. of Am. v. United States, 135
F. Supp. 2d 1 (D.D.C. 2001). Renewing the arguments they
made in the district court, the manufacturers appeal.

II

According to the Vermont Secretary of Human Services,
"[p]rescription drug prices can place an enormous burden on
working Vermonters." Intervenor's Br. at 58. "The unin-
sured and under-insured," she explains, "are often unable to
obtain drugs because of the high cost.... Without the
assistance of the PDP, these individuals might forego obtain-
ing these medicines, reduce the amount or frequency of their
prescriptions for financial reasons, or elect to obtain medi-
cines by sacrificing other necessities." Id. (internal quotation
omitted). Our task, however, is neither to evaluate the PDP's


policy justification nor to determine whether the program
best serves the pharmaceutical needs of the poor. Cf. Robert
Pear, States Creating Plans to Reduce Costs for Drugs, N.Y.
Times, Apr. 23, 2001, at A1 (describing various state programs
to help low-income elderly people buy prescription drugs).
We face a straightforward legal issue: Did the Department
exceed its statutory authority by authorizing Vermont to
require pharmaceutical manufacturers to make rebates under
the PDP?

The manufacturers argue that the Department lacked au-
thority to approve the PDP because, as they interpret the
statute, the payments Vermont makes to pharmacies are not
"payment[s] ... made under the State plan." As they see it,
Vermont merely acts as a conduit for money received from
drug manufacturers, which could not possibly be what Con-
gress meant by "payment":

[T]he only plausible reading of the "payment" require-
ment is that the State must make an actual outlay of
funds.... Had Congress wanted Medicaid rebates to be
triggered by loans, pass-throughs, or individual beneficia-
ries' outlays, it would have said as much. The Act
cannot reasonably be interpreted such that the only
"payment ... under a state plan" necessary to justify a
manufacturer rebate is the manufacturer rebate itself.

Appellant's Opening Br. at 22. The HHS Secretary responds
that Vermont does make payments: it pays approximately
eighteen percent of the price of drugs purchased by PDP
beneficiaries. Citing a dictionary, the Secretary argues that
"[t]o say that Vermont is not making a 'payment' to pharma-
cies when it pays them for the drugs they dispense to PDP
participants is to abandon any ordinary understanding of the
meaning of 'payment.' " Appellees' Br. at 24. The fact that
Vermont gets reimbursed, the Secretary asserts, does not
mean that Vermont's outlays of funds are not payments: "if
an automobile owner pays a garage to repair the owner's car,
the owner has made a payment to the garage; if the owner
later receives a check from his insurance company that covers


the cost of the repairs, it hardly follows that he no longer has
made any payment." Id. at 25.

To resolve this debate, we proceed in accordance with
Chevron U.S.A. Inc. v. Natural Resources Defense Council,
Inc., asking first "whether Congress has directly spoken to
the precise question at issue." 467 U.S. 837, 842 (1984). If it
has, "that is the end of the matter; for the court, as well as
the agency, must give effect to the unambiguously expressed
intent of Congress." Id. at 842-43. If we find the statute
either silent or ambiguous with respect to the precise ques-
tion at issue, we proceed to the second step of Chevron
analysis, asking "whether the agency's answer is based on a
permissible construction of the statute." Id. at 843. At this
stage of Chevron review, we afford substantial deference to
the agency's interpretation of statutory language. Id. at 844.
Of course, not all agency interpretations of statutes warrant
Chevron deference. See Christensen v. Harris County, 120
S.Ct. 1655, 1662 (2000) ("Interpretations such as those in
opinion letters--like interpretations contained in policy state-
ments, agency manuals, and enforcement guidelines, all of
which lack the force of law--do not warrant Chevron-style
deference.") (internal citations omitted). In this case, howev-
er, we need not decide whether the Department's approval of
the PDP would be entitled to Chevron deference, for using
traditional tools of statutory interpretation--text, structure,
purpose, and legislative history, see Bell Atl. Tel. Cos. v. FCC,
131 F.3d 1044, 1047 (D.C. Cir. 1997)--we conclude that Con-
gress has "directly spoken to the precise question at issue";
that is, whether "payment" includes expenditures that are
fully reimbursed by manufacturer rebates.

We agree with the Secretary that our inquiry begins with
the words of the statute. But a word's "ordinary understand-
ing" is not always controlling. Words draw meaning from
context. Consider Article III, Section 1 of the Constitution:
"Judges ... shall hold their Offices during good Behaviour."
Although the dictionary includes "conformity with ... the
norms of good manners or social decorum" among its defini-
tions of "behavior," Webster's Third New International
Dictionary 199 (1993), no one would suggest that judges be


removed for failing to observe Emily Post's standards of
etiquette--the use of "behaviour" in the context of judges'
qualifications for office rules out such an interpretation. In-
deed, just last week the Supreme Court emphasized that
statutory terms can have a narrower meaning in context than
the same words have in common usage. See Buckhannon
Bd. & Care Home, Inc. v. W. Va. Dep't of Health & Human
Res., No. 99-1848, 2001 WL 567728 (U.S. May 29, 2001)
(interpreting the word "prevailing" in the statutory term
"prevailing party" to have a narrower meaning than it has in
Webster's); cf. K Mart Corp. v. Cartier, Inc., 486 U.S. 281,
319 (1988) (Scalia, J., concurring in part and dissenting in
part) ("While looking up the separate word 'foreign' in a
dictionary might produce the reading the majority suggests,
that approach would also interpret the phrase 'I have a
foreign object in my eye' as referring, perhaps, to something
from Italy.").

So too here. Although as the Secretary's car repair exam-
ple illustrates, the word "payment" is broad enough to include
reimbursed expenditures, consideration of the word's con-
text--the statute's purpose and legislative history--reveals a
far narrower meaning. Properly understood, "payment" here
means only payments with state or federal funds appropriat-
ed for Medicaid expenditures; absent such payments, phar-
maceutical rebates would not contribute to reducing the cost
of the taxpayer-funded Medicaid program, and the legislative
history makes quite clear that Congress's purpose in requir-
ing rebates was to do just that. Senator Pryor, sponsor of
the rebate provision, explained in his statement introducing
the bill that rebates are designed to stop pharmaceutical
manufacturers from "bankrupting the coffers of the State
Medicaid drug programs." 136 Cong. Rec. 24,145 (1990). The
provision "requires drug manufacturers to offer substantial
discounted prices to the Medicaid Program ... [b]ecause
there is no logical reason why, in an era of severe budget
constraints and social needs, the Medicaid Program should be
denied access to [the] same generous discounts" hospitals and
HMOs receive. Id. Rebates, the Senator estimated, would


"achieve in excess of $2.5 billion in savings" over five years.
Id.

The House Report on the bill likewise demonstrates that
Congress required rebates in order to reduce Medicaid ex-
penditures: "[T]he bill is framed to achieve significant Medic-
aid savings...." H.R. Rep. No. 101-881, at 98 (1990). Re-
sponding to projections that federal Medicaid payments for
prescription drugs would reach $2.8 billion in 1991, the House
Report declared that "Medicaid, the means-tested entitlement
program that purchases basic health care for the poor, should
have the benefit of the same discounts on single source drugs
that other large public and private purchasers enjoy." Id. at
96.

This legislative history demonstrates that Congress im-
posed the rebate requirement for two overlapping reasons: to
reduce the cost of Medicaid and to prevent pharmaceutical
manufacturers from charging the government and taxpayers
above-market prices for Medicaid drugs. Understood within
this context, "payment" excludes situations where no govern-
ment funds are spent; otherwise, manufacturers could be
required to pay rebates that neither "achieve significant
Medicaid savings" nor prevent pharmaceutical companies
from "bankrupting the coffers of the State Medicaid drug
programs." Because Vermont's PDP payments are fully
reimbursed by manufacturer rebates, and because the rebates
produce no savings for the Medicaid program, the state's
payments to pharmacies are not "payments" within the mean-
ing of the statute.

An additional feature of the Medicaid statute reinforces our
view that when Congress said "payment," it meant payment
with funds appropriated for Medicaid purposes. Section
1396r-8(a)(4) provides that if a state had a rebate agreement
with a manufacturer before the federal rebate requirement
took effect, that agreement would "be considered to be ... in
compliance" with the Medicaid statute if "such agreement
provide[d] for a minimum aggregate rebate of 10 percent of
the State's total expenditures under the State plan for cover-
age of the manufacturer's drugs." 42 U.S.C. s 1396r-8(a)(4).


This provision makes sense only if a state's expenditures for
drugs are determined by the price of the drugs, not by the
amount of expected rebates. If, as in the PDP, the amount of
a state's expenditures were determined by the size of the
rebates the state expected, section 1396r-8(a)(4)'s minimum
would be entirely circular--it would require the rebate to be
at least ten percent of the state's expenditures, and those
expenditures would be equal to the rebate, suggesting that
the rebate would have to be at least ten percent of itself.
This provision, in other words, does not contemplate that
expenditures would be set at the amount of the rebates a
state receives; rather, it assumes a net expenditure of funds
appropriated for Medicaid purposes in an amount determined
independently of the amount of the rebates.

The HHS Secretary argues that even if the PDP involves
no "payment[s]" within the meaning of the statute, Congress
gave the Department, as part of the power to approve
demonstration projects, authority to regard "costs of such
project[s] which would not otherwise be included as expendi-
tures ... as expenditures under the State plan." Id.
s 1315(a)(2)(A) (emphasis added). Yet in its March 17 letter
seeking approval of the PDP, Vermont assured the Depart-
ment that "there will be no ... cost to the program."
Because manufacturer rebates reimburse Vermont for all
PDP payments, the only cost the state arguably incurs is
"forgone interest" from "the significant delay between the
time that Vermont pays pharmacies and the time that it
receives corresponding rebates." Appellees' Br. at 25;
Pharm. Research & Mfrs. of Am., 135 F. Supp. 2d at 14
("[T]he state could have earned interest on the funds if they
were collected from taxpayers but not advanced to the phar-
macies on behalf of the manufacturers."). Even assuming the
Department may regard the cost of foregone interest as an
expenditure or payment, however, here it is not a payment
for pharmaceuticals. Under the PDP, Vermont makes pay-
ments to pharmacies and incurs the interest cost in order to
trigger the rebate requirement. Put another way, Vermont's
foregone interest cost is the cost of extending the manufac-
turers' rebate obligations to drug purchases made by individ-


uals not otherwise covered by the state's Medicaid program.
Yet the statute requires rebates only for "drugs ... for which
payment was made under the State plan." 42 U.S.C.
s 1396r-8(b)(1)(A) (emphasis added). The Department has
no statutory authority to treat the cost of providing rebate
benefits to non-Medicaid Vermonters as payment for outpa-
tient drugs.

Perhaps Congress could require manufacturers to pay re-
bates when no funds appropriated for Medicaid purposes
were actually expended. Perhaps Congress could authorize
HHS to accomplish directly what it has done indirectly
through the PDP--require pharmaceutical manufacturers to
provide substantial discounts to individuals not otherwise
covered by state Medicaid programs. But because it has
done neither, and because Vermont makes no "payments"
within the meaning of section 1396r-8, the Department lacked
authority to approve the PDP.

In reaching this conclusion, we recognize that nothing in
the statute's language or legislative history suggests that
Congress considered the possibility of requiring rebates
where no Medicaid funds are expended. But because we
think it so obvious that Congress's purpose in requiring
manufacturer rebates was to reduce the cost of the Medicaid
program, we think that Congress's silence cannot provide a
basis for allowing the Department to extend the rebate
requirement to situations where, as here, rebates produce no
Medicaid savings. Determining how to fund pharmaceutical
benefits for the poor and whether their cost should be shared
by pharmaceutical manufacturers is a responsibility that,
absent express congressional direction to the contrary, must
be left to Congress.

III

Having no need to consider the manufacturers' alternative
argument that the PDP also runs afoul of the statute's
"nominal" copayment requirement, we reverse the decision of


the district court and remand for further proceedings consis-
tent with this opinion.

So ordered.