Failor's Pharmacy v. Department of Social and Health Services

• Decision Date: 15 December 1994
• Docket Number: No. 61105-0,SAV-ON,61105-0
• Citation: 886 P.2d 147,125 Wn.2d 488
• Court: Washington Supreme Court
• Parties: , Medicare & Medicaid Guide P 43,001 FAILOR'S PHARMACY, a sole proprietorship, Respondent, v. The DEPARTMENT OF SOCIAL AND HEALTH SERVICES of the State of Washington, Petitioner. J & M SERVICE CO., INC., a Washington corporation, Respondent, v. The DEPARTMENT OF SOCIAL AND HEALTH SERVICES of the State of Washington, Petitioner.DRUGS, INC., a Washington corporation, Respondent, v. The DEPARTMENT OF SOCIAL AND HEALTH SERVICES of the State of Washington, Petitioner.

Page 488

125 Wn.2d 488

886 P.2d 147, Medicare & Medicaid Guide P 43,001

FAILOR'S PHARMACY, a sole proprietorship, Respondent, v. The DEPARTMENT OF SOCIAL AND HEALTH SERVICES of the State of

Washington, Petitioner.

J & M SERVICE CO., INC., a Washington corporation, Respondent, v. The DEPARTMENT OF SOCIAL AND HEALTH SERVICES of the State of

Washington, Petitioner.

SAV-ON DRUGS, INC., a Washington corporation, Respondent, v. The DEPARTMENT OF SOCIAL AND HEALTH SERVICES of the State of

Washington, Petitioner.

No. 61105-0.

Supreme Court of Washington En Banc.

Dec. 15, 1994.

Christine O. Gregoire, Atty. Gen., Mary Jo Diaz, Asst., Olympia, for petitioner.

Inslee, Best, Doezie & Ryder, P.S., Thomas H. Grimm, Bellevue, Law Offices of Everett Holum, Everett Holum, Tacoma, for respondents.

DOLLIVER, Justice.

Defendant Department of Social and Health Services (DSHS) seeks a reversal of a Superior Court decision granting partial summary judgment to Plaintiffs Failor's Pharmacy, J & M Service Company, Inc., and Sav-On Drugs, Inc., and denying Defendant's cross motion for dismissal. Defendant challenges the Superior Court's holding that DSHS changes to Medicaid reimbursement payment schedules for prescription drugs must be adopted by rulemaking pursuant to the former Administrative Procedure Act and that the payment schedules in this case are consequently invalid. We affirm.

Defendant is the state agency charged with administration of the State's Medicaid program. RCW 74.09. The federal Medicaid program allows states to receive federal assistance for the provision of medical care to eligible needy persons. Wilder v. Virginia Hosp. Ass'n, 496 U.S. 498, 502, 110 S.Ct. 2510, 2513, 110 L.Ed.2d 455 (1990). A participating state has flexibility to administer its program within the confines of the federal Medicaid Act and federal regulation. Wilder, 496 U.S. at 502, 110 S.Ct. at 2513. In Washington, state law allows DSHS to purchase Medicaid services by contract or at rates established by the Department. RCW 74.09.120. Within this delegation DSHS has managed participation in the Medicaid program by requiring providers to apply for a provider number, sign a Core Provider Agreement (Agreement), and abide by all applicable state and federal licensure requirements. WAC 388-87-007. The Agreements permit a provider to withdraw by written notice from the program at anytime without penalty. Plaintiffs became Medicaid providers of prescription services under Agreements signed by Failor's Pharmacy in 1970, by Sav-On in 1972, and by J & M, Inc., in 1982.

The terms of reimbursement for prescription services are incorporated into the Agreements by reference Reimbursement for covered services will be made according to the Schedule of Maximum Allowances, the drug formulary and other applicable payment levels or schedules. This must be accepted as sole and complete remuneration for services covered under the program.

Clerk's Papers, at 23; WAC 388-91-035. Title XIX (of the Social Security Act, 42 U.S.C. § 1396 et seq.) program regulations require all state Medicaid agencies to reimburse providers for prescriptions on the basis of two factors: (1) actual or estimated cost for pharmacies to acquire drug ingredients, and (2) a dispensing fee. 42 C.F.R. § 447.331. Following the federal mandates, state regulation establishes DSHS methodology for determining pharmacy reimbursement:

The department will not pay more than the lower of ingredient cost plus a dispensing fee or the provider's usual and customary charge to the public. Ingredient cost will be set at the estimated acquisition cost, which is the department's best estimate of the price providers generally are paying for a drug. The dispensing fee will be set by taking into account the results of surveys and the costs of pharmacy operation. Reimbursement may also be made through exclusive service contracts for the provision of prescription drugs for nursing home patients.

WAC 388-91-040(4).

Under federal law prior to 1987, states might establish the dispensing fee by considering periodic cost surveys including operational, professional services, overhead, and profit data and might vary fees according to various factors, including pharmacy size and location. Former 42 C.F.R. § 447.333(a), (b) (1983). DSHS conducted surveys of all pharmacies in the Medicaid program in 1976 and 1978. In 1979, DSHS then introduced a new two-tiered reimbursement schedule for dispensing fees. Lower volume pharmacies selling fewer prescriptions than 35,000 per year would be reimbursed at a higher rate than high volume pharmacies selling 35,000 or more per year. The dispensing fee assigned each group was periodically increased through 1984.

DSHS contracted another cost survey conducted by the Washington State Pharmaceutical Association (WSPA) in 1980. In 1984, DSHS moved to the current 3-tiered system for dispensing fees that breaks providers into three groups: 35,000 prescriptions or more per year, 15,000 to 35,000, or fewer than 15,000. Pharmacies are surveyed annually to update volume levels, and a pharmacy may seek reevaluation of its volume level by submitting its prescription data over 6 months.

The second reimbursement factor, ingredient costs, also follows a schedule system of reimbursement. Until 1982, ingredient cost reimbursement was fixed by the lower of: (1) maximum allowable cost (MAC), a price list for generic drugs; or (2) actual acquisition cost (AAC), the full average wholesale price (AWP) based on published reports from wholesalers on their actual prices. See former WAC 388-91-040 (Supp.1979). Based on field audits of pharmacies and the 1980 survey, DSHS changed in 1982 to the current estimated acquisition cost (EAC) system, WAC 388-91-040, and began to reimburse ingredient costs at the lower of the MAC or a percentage of the AWP. Originally set at 90 percent of the AWP for most drugs, DSHS lowered the EAC schedule to the current rate of 89 percent in 1984.

DSHS notified providers of the changes in reimbursement schedules by policy memoranda 10 days before implementation. It neither published public notice nor provided an opportunity for public comment. DSHS has stated that the 1980 survey and subsequent reimbursement schedules did not consider profit and did not reimburse all costs. Plaintiffs continued to perform and receive payment under the changed reimbursement schedules and the Agreements; J & M went out of business in 1987, but Failor's and Sav-On continue to perform and receive payments to date.

On August 21, 1987, Plaintiffs brought an action against Defendant in Thurston County Superior Court. The complaint requests injunctive relief to invalidate the 1978 and 1984 reimbursement schedule changes for failure to comply with rulemaking procedures of the former Administrative Procedure Act (APA), RCW 34.04.010(2)(c) (1987), and seeks damages for past losses under those reimbursement systems. The trial court granted Plaintiffs' Motion for Partial Summary Judgment and invalidated the reimbursement schedules. The court's order held: (1) The setting of reimbursement schedules constituted rules within the meaning of the APA; (2) no contractual or statutory provision exempted the schedules from APA rulemaking procedures; and (3) Defendant's failure to comply with the APA rendered the schedules invalid. The trial court further denied Defendant's Cross Motion for Summary Dismissal of the Complaint. The issue of damages was reserved for trial. The Supreme Court then granted discretionary review upon Defendant's petition.

I

The first issue before this court is whether the trial court's summary judgment order invalidating the reimbursement schedules for failure to comply with APA rulemaking procedures was proper. When reviewing an order for summary judgment, the appellate court engages in the same inquiry as the trial court. Syrovy v. Alpine Resources, Inc., 122 Wash.2d 544, 548-49 n. 3, 859 P.2d 51 (1993). This court will affirm summary judgment if no genuine issue of any material fact exists and the moving party is entitled to judgment as a matter of law. CR 56(c). All facts and reasonable inferences are considered in the light most favorable to the nonmoving party, Taggart v. State, 118 Wash.2d 195, 199, 822 P.2d 243 (1992), and all questions of law are reviewed de novo, Syrovy, 122 Wash.2d at 548-49 n. 3, 859 P.2d 51. This court will sustain the trial court's judgment upon any theory established in the pleadings and supported by proof. Wendle v. Farrow, 102 Wash.2d 380, 382, 686 P.2d 480 (1984).

For rulemaking procedures to apply, an agency action or inaction must fall into the APA definition of a rule. Former RCW 34.04.010(2). The court will consider this challenge to reimbursement rates established in 1978 and 1984 under the APA in place prior to 1988. We note, however, the Legislature carried over the prior definition into the current Act and that cases interpreting the latter may illuminate the former. See RCW 34.05.010(15).

The definition of a rule under the Washington statute, unlike that in the federal or other state APA's, is inclusive and specifies two elements required to qualify an agency action as a rule. State v. Straka, 116 Wash.2d 859, 868, 810 P.2d 888 (1991). First, the action must be "any agency order, directive, or regulation of general applicability". Former RCW 34.04.010(2). In addition, the action must also fall into one of five enumerated categories:

(a) the violation of which subjects a person to a penalty or administrative sanction; (b) which establishes, alters, or revokes any procedure, practice, or requirement relating to agency hearings; (c) which establishes, alters, or revokes any qualification or requirement relating to the enjoyment of benefits or privileges conferred by law; (d) which establishes, alters, or revokes any qualifications or standards for the issuance, suspension, or revocation of licenses to pursue any commercial activity,...